• Friday, December 01, 2023
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Nigeria’s subsidy removal – What went wrong?

As of this moment, fuel prices have surged towards the N1000 mark, and the dollar to naira exchange rate has surpassed N1000. Palliative measures appear ineffectively sporadic, while the NNPC has once again assumed its role as the primary fuel importer, with assurances of no imminent fuel price hike. This shift raises questions about the previously advocated market-based pricing approach. Some argue that the removal of subsidies is leading to daily savings in the trillions. However, it’s essential to recognize that the concept of subsidy, while not as it was traditionally understood, still persists. This time, it operates in a different context even though fuel prices are substantially higher. This describes the journey thus far.

In view of the above and the government’s frequent policy reversals, there is a need to have a close look at the management of subsidy removal by the current administration. What factors have contributed to the inconsistencies in subsidy removal? What really went wrong?

In the realm of economic policy, both subsidies and their removal represent strategic maneuvers, and their efficacy is inherently tied to efficient management. These policies yield positive economic outcomes when properly implemented and affordable. Subsidies become problematic when their cost places an excessive burden on government revenue, leading us to question their viability. Likewise, when the promised benefits of subsidy removal fail to materialize for the general population, there is often a desire to revert to the subsidy system. In essence, the effectiveness or inadequacy of both these policy instruments is primarily a result of management decisions.

A wrong notion that followed the removal of subsidy was that it benefited only the rich and the elite. Curiously, this notion was often perpetuated by some political figures who presented themselves as modern-day Robin Hoods. However, the reality that emerged after the subsidy’s removal shed new light on the situation. It became evident that subsidy removal had far-reaching consequences that extended well beyond merely affecting the wealthy. Transportation costs surged, the prices of essential food items and commodities skyrocketed, inflation reared its head, and poverty deepened. It was clear that subsidy removal was not a simple wealth redistribution mechanism; instead, it disproportionately burdened the less affluent. While the affluent managed to weather these economic shifts, ordinary citizens found themselves sinking deeper into financial hardship. Characterizing subsidy removal as a noble attempt to ‘eat the rich’ obscured the core issues tied to the abrupt announcement by the President. This is fundamentally an economic matter that transcends political rhetoric and calls for a more comprehensive evaluation.

In the context of the government’s approach to subsidy removal, there is a concern regarding the prevailing tendency among public servants to address economic challenges primarily through short-term palliative measures. While cash transfers and palliatives serve as valuable stopgap solutions, they often provide only temporary relief and typically lack the substantial impact needed to uplift the average person facing financial hardship. In July when the Nigerian Labor Congress intended to embark on strike action because of the hardship from high fuel prices, the president addressed them promising to disburse various kinds of money to mitigate the hardship, all without a clear strategy for equitable distribution. The NLC took this as a form of compensation despite being aware that palliatives mostly end up in the hands of corrupt persons. When the government predominantly resorts to addressing pressing economic problems through short-lived remedies, it signals a potential absence of the robust commitment needed to resolve the issue comprehensively.

Another fallacy that began to spread was that the Nigerian economy does not support economic theories. People found it easy to discredit the laws of demand and supply, often treating Nigeria as an exception. They see a bad economic decision and blame the adverse effects rather than hold the decision makers accountable. The subsidy removal initiative initially encompassed multiple components, including a unified exchange rate, the deregulation of the petroleum sector, and the end of NNPC’s fuel importation monopoly. Regrettably, as of today, none of these supplementary measures remain in effect. The exchange rate has surged, impeding importers’ access to foreign exchange, and NNPC has reverted to its role as the exclusive fuel importer.

Subsidy removal fails in the absence of prudent and accountable management during the transition towards a market-determined pricing system. While the President’s address may have been perceived as sincere and heroic if fuel pricing were solely a domestic concern, the complex truth is that fuel prices are intrinsically linked to international oil prices. Failing to consider the wider implications of geopolitical factors and global price fluctuations, subsidy removal can impose a significant burden on our citizens, as we are currently witnessing.

Subsidy removal fails where inefficiency, leakages, wastes and widespread corruption persist. The original intent behind subsidy payments has often been eroded by systemic corruption and mismanagement. Transitioning from the subsidy era to subsidy removal is hindered when institutional corruption remains pervasive. Additionally, issues like oil theft and cross-border fuel smuggling continue to plague the industry. As a result, Nigeria struggles to meet its OPEC quota of 1.8mb/d and consistently produces below 1.4 mb/d. This production shortfall means that the increase in global oil prices doesn’t necessarily translate into higher foreign exchange earnings, and the Nigerian naira remains vulnerable to depreciation.

Subsidy removal fails where the Excess Crude Account (ECA) is tapped out. The ECA represents one of the critical accounts where the Nigerian government accumulates surplus revenues resulting from discrepancies between the budgeted benchmark crude oil price and the actual international market prices for a given year. Conceptually, the ECA was conceived as a financial buffer to shield the country from the volatile fluctuations of global oil prices, particularly in today’s turbulent geopolitical landscape.

However, the current state of the ECA, which stands at a mere 473,754.57 U.S. dollars, is indicative of its near depletion. This situation leaves the nation vulnerable to the ripple effects of distant geopolitical events and erratic oil prices. At its core, a robust ECA would help stabilize the national currency, rendering it less volatile, and would alleviate the need for the NNPCL to intervene on a weekly basis in response to price fluctuations. With a well-funded ECA, the foreign exchange market would operate more smoothly, mitigating the challenges faced by fuel marketers in sourcing foreign exchange as market dynamics would tend to self-correct following volatile periods.

Read also: Fuel denial cripples Nigeria’s border towns despite subsidy removal (2)

Subsidy removal fails when refineries fail. Refineries are supposed to be available for oil marketers to buy directly and sell to the Nigerian market. However, the current dependence on imported fuel places substantial strain on our foreign exchange (FX) demands, thereby exerting considerable pressure on exchange rates and foreign reserves. It’s evident that foreign exchange rates play a pivotal role in determining the landing costs of fuel. Marketers, quite understandably, cannot buy PMS at a high foreign exchange rate and then sell it at a lower pump price. As the naira weakens, the landing costs of fuel in local currency surge, leading to an increase in the costs associated with subsidy removal, which in turn triggers a corresponding rise in pump prices. Effective subsidy removal strategies are most feasible when our currency is stable, and foreign exchange can be accessed without undue complications. Even when our refineries are functioning optimally, it is important to note that crude oil is still priced in dollars because upstream producers primarily transact in this currency. Implementing subsidy removal before addressing foreign exchange control is like attempting to put the cart before the horse. The sequencing of these actions is essential for an effective strategy.

Way forward

Subsidy has to go. However, the current strategy has led to increased fuel prices and uncontrolled hardship, with the state oil company bearing the brunt of the cost to prevent even steeper price hikes. This essentially means that despite the intention to remove subsidies, the current approach has not achieved the desired results and has created fiscal complexities.

Complete removal of subsidies would indeed result in higher fuel prices than today. However, the implementation of subsidy removal by the current administration was marred by certain missteps. A phased approach, combined with efforts to reduce government expenditures (including political appointments), curb oil theft, and establish effective relief measures for the commercial sector and vulnerable populations, could have yielded a more favourable outcome. Additionally, the introduction of tax incentives such as VAT and personal income tax exemptions, rather than focusing solely on keeping fuel prices low, could have ensured a more sustainable transition. While international factors affect fuel prices, a comprehensive strategy would help prevent us from regressing to the starting point (or a worse situation).