Doug Winslow, senior director of Sovereigns at Fitch, a rating firm said that Nigeria’s new government is yet to unveil measures to grow the tax base, but that the signs are to focus on tax administration rather than changes to headline rates.
“Our key to fiscal consolidation over a longer period would be how successful government efforts are to grow the tax base. Nigeria’s extremely high interest revenue is a key rating weakness, and it reflects one of the worst tax-to-GDP ratios at nearly seven percent of any sovereign Fitch rates. The new government has yet to unveil measures in this area. But the signs are to focus on tax administration rather than changes to headline rates,” he said.
Nigeria’s tax-to-GDP ratio of 10.9percent is one of the lowest in the world, and this is a major constraint on the government’s ability to finance its spending.
Winslow pointed out that the rating upgrade prior to the new government’s tenure was predicated on expectations of moderate reform, including the gradual removal of fuel subsidies and greater exchange rate flexibility.
He said these reforms have been implemented with impressive speed. The withdrawal of oil subsidies, the unification of exchange rate windows, and the depreciation of the official exchange rate all contributed to this positive momentum.
“There will be a firm Nigeria’s B- rating and the stable outlook, our last review in early May which was before the new government took office and key to that was their expectation for moderate reform, including the phased elimination of fuel subsidies and greater exchange rate flexibility, and the early progress in these areas were significantly faster than anticipated, providing additional support for the rating,” he said.
Winslow said recent developments have somewhat tempered this progress. The divergence between the parallel exchange rate and the official rate, coupled with a freeze on domestic petrol prices, raises concerns. Additionally, disappointing oil production figures and questionable net international reserves further complicate the economic landscape.
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Despite these challenges, Winslow commends President Tinubu’s government for its commitment to reform. He views the finance minister and the president as market-friendly and technocratic figures, though the implementation of reforms remains uneven due to practical challenges and potential political pressure.
Nigeria’s inflation which rose to 25.80percent in the month of August 2023 due to currency adjustments and rising petrol prices, poses further obstacles. The government’s limited electoral mandate and the recent cabinet formation process add to its susceptibility to political pressures.
“Sizable socio-practical challenges are likely to make reform progress uneven and create sizable implementation risks. These appear to have been more telling in recent weeks against the more difficult economic backdrop and threats of further strike action. Inflation has risen to 24 percent partly due to the currency pass-through and the near tripling of domestic petrol prices, a weak net international reserve possession may be hampering the pace of the exchange rate by polarisation through the more constrained FX supply and the potential for it to weigh on investor sentiment.”
The lack of transparency in the Central Bank’s financial statements regarding foreign exchange reserves also hampers investor confidence. While some reserves are encumbered by swaps with domestic banks, the extent of liabilities tied to international counterparts remains unclear.
Winslow highlights the uncertainty surrounding off-balance-sheet commitments related to foreign exchange forwards and currency swaps. This opaqueness, combined with a backlog of unsettled forwards, underscores the challenges of transitioning to a fully liberalised exchange rate.
The interview emphasizes the need to address these concerns, as they pose substantial risks to Nigeria’s external finances. The government must prioritize sustaining investor confidence, exchange rate liberalisation, and policy tightening to attract capital inflows.
On the economic front, the government faces the challenge of reviving oil production, which has suffered from underinvestment and production outages in recent years. Although progress is expected, reaching pre-2020 production levels remain a formidable task.
The removal of fuel subsidies is a positive step, as it significantly reduced fiscal burdens. However, the recent announcement to freeze petrol prices introduces uncertainty regarding potential subsidy reinstatement.
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