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THE FUEL SUBSIDY DILEMMA: THE SENSIBLE WAY OUT
By: Sir Henry Olujimi Boyo (Les Leba) first published in May 2015
INTRO:
Last week, this column republished “Why Higher Oil Prices Cripple the Economy.”It is written in a question-and-answer format and responds to misconceptions about the effect of oil prices on the economy. If you missed this republication, it can be accessed via the below link.
(See www.betternaijanow.com for this series and more articles by the Late Sir Henry Boyo)
The article republished today discusses Naira devaluation, the debt burden, and the mismanagement of the economy on the part of government. It expresses concerns of the Naira exchanging for over N300= $1 by the end of 2015. In our current year (2022), the Naira value has fallen by more than double this rate, showcasing that the situation has indeed worsened as the writer, the Late Sir Henry Boyo, feared. The writer blames the monetary strategy of the CBN and proceeds to discuss how this affects fuel prices, subsidies and the day-to-day workings of the economy. It provides a clear argument and effective strategy to avoid this cursed cycle of further devaluation of the Naira which only ensures poverty.
As you read through the below article taking note of previous events and rates, keep in mind its initial publication (2015).
The severe social discomfort and economic dislocation caused by fuel scarcity nationwide may stampede the incoming Administration of President-elect Muhammadu Buhari to settle the outstanding invoices of Petrol Marketers, and also accept over N200bn penalty interest charge for delayed payments and exchange rate differentials consequent upon the almost 20% recent Naira devaluation.
Some critics may suggest that the government representatives who accepted liability for such oppressive penalty charges, would not readily make such an undertaking if they represented their own private corporations or family assets, particularly in the face of a bleeding revenue base and rapidly increasing debt burden.
Nonetheless, Buhari may be forced to tow the same path of reckless financial management, if petrol marketers remain adamant and insist that government should first settle alleged outstanding debts before they commit to any fresh fuel importation; unfortunately, the longer it takes to reach an agreement on actual liability, interest payments may continue to increase and further bloat government’s indebtedness.
Clearly, however, the retired General certainly does not need an early confrontation with the public or indeed Labour who will as usual insist that subsidy should only be removed after sufficient local refineries can meet domestic consumption! In the event however, that refineries (depending on size) have between 18-36 months gestation, this may suggest that subsidy may not be wished away very soon!
Furthermore, Labour and Civil Societies also recognise that it would be foolhardy to accept deregulation, if the Naira rate continues its steady plunge against the dollar as fuel prices will simultaneously continue to spiral! Conversely, Buhari’s Team may plead that it is not sensible to dedicate over 20% of federal budgets to subsidy and almost 50% of total Crude Export Revenue to consumption of imported fuel annually.
We cannot predict the length of the ensuing stalemate, but as usual, in the interest of the nation, government and Labour are likely to once more agree to split the subsidy burden. Clearly, government’s share of subsidy will nonetheless rise if the Naira continues its downward slide or if “fortuitously” or “unfortunately”, crude oil prices rebound once again. For example, if the Naira is left to float as currently proposed by the Banker’s Committee, Naira could well exchange for over N300=$1 before the end of 2015, particularly if the instigation of systemic excess Naira remains an abiding feature of CBN’s monetary strategy.
Invariably, with such Naira depreciation, fuel prices will spiral about 50% above the price on which subsidy was initially calculated. Consequently, unless pump prices are adjusted upwards, government’s share of the subsidy burden will once again balloon and bring us back to square one, where subsidy exceeds 20% of annual federal budgets.
Furthermore, in the absence of fiscal discipline, subsidy refunds to marketers will invariably be delayed and will accumulate as usual, until the issue of delayed payments and exchange rate differentials surface once more to trigger fuel scarcity with the attendant painful, social and economic dislocations. Similarly, higher crude prices will also translate to higher fuel prices and increasing subsidy values.
In his attempt to end this horrendous cyclical narrative, Buhari will be well advised to recognise that subsidy can be eliminated if crude price remains below $50/barrel, so that ex-refinery cost remains low; ironically, if this happens, our oil revenue base will unfortunately remain depleted and further threaten the Naira exchange rate as is currently the case. Ultimately, increasing speculative dollar demand will instigate further Naira depreciation which would inadvertently pump-up fuel price and also swell the existing value of subsidy.
Clearly, if weaker Naira rates instigate higher fuel prices and fuel subsidy values, it stands to reason that an increasingly stronger Naira should also reduce fuel price and ultimately eliminate subsidy while new refineries will be established with the complete deregulation of the sector.
For example, if Naira exchanges for N100=$1, this would be a 50% appreciation from the current N200=$1, in this event, the unsubsidized current actual fuel price of about N150/litre will immediately fall below N80/litre, and make N7/litre available as sales tax if the current regulated price of N87/litre remains unchanged. Notably, the relative sales tax potential will increase beyond N7/litre if the Naira strengthens below N100=$1.
The million-dollar question however, is how the Naira can appreciate when oil revenue is dwindling; after all, as some experts claim, it is the size of our reserves that defines the exchange rate of the Naira! Curiously, in the Nigerian context however, in order for CBN to build up its dollar reserves, it must consciously continue to induce the suffocation of the domestic money market with surplus Naira, despite the adverse attendant economic consequences.
Expectedly, with such a Naira antagonistic strategy, the Naira exchange rate will be pummeled when it is constantly pitted against the paltry dollar rations, auctioned weekly by CBN from its caché of public sector dollars which were earlier captured and substituted with Naira allocations at an exchange rate that is unilaterally determined by the Apex Bank. This bizarre payment strategy apart from instigating excess Naira, also induces the unforced error of the official provision of presumably ‘scarce’ public sector dollars for the unsubstantiated forex requirements of the black market.
Instructively, however, if the foreign exchange component of federal allocations is paid with dollar certificates rather than the outright monthly substitution of Naira values which precipitate the constant spectre of surplus Naira and its oppressive train of inflation, huge cost of funds, a weaker Naira as well as higher fuel prices, which make the removal of subsidy impossible.
Incidentally, the above recommended reform in fiscal allocations, will gradually mop up the unrelenting flood of surplus Naira which swallow the dollar rations sold weekly by CBN; clearly, if this fiscal payment practice is sustained, the Naira may still ultimately exchange below N100=$1despite reduced crude oil revenue within Buhari’s first year in office.
Thus, Buhari will avoid a protracted social and economic dislocation, if he quickly engages Organised Labour and Civil Societies on a consensus to sustain partial deregulation with government, “reluctantly” conceding 50% of the difference between the current N87/litre and the unsubsidized current actual market price of about N150/litre; with this arrangement, the agreed pump price would be set at N120/litre excluding government’s subsidy of about N33/litre.
Clearly, the implication is that when the Naira ultimately exchanges for N100=$1 because of better managed Naira liquidity, the government could also recoup over N10/litre as sales tax on 40 million litres of fuel consumed daily. Such returns from petrol sales tax will continue to rise as the Naira exchange rate improves with the reform in government’s payments strategy.
Save the Naira, Save Nigerians!!
By: Sir Henry Olujimi Boyo (Les Leba) first published in May 2015
INTRO:
Last week, this column republished “Why Higher Oil Prices Cripple the Economy.”It is written in a question-and-answer format and responds to misconceptions about the effect of oil prices on the economy. If you missed this republication, it can be accessed via the below link.
(See www.betternaijanow.com for this series and more articles by the Late Sir Henry Boyo)
The article republished today discusses Naira devaluation, the debt burden, and the mismanagement of the economy on the part of government. It expresses concerns of the Naira exchanging for over N300= $1 by the end of 2015. In our current year (2022), the Naira value has fallen by more than double this rate, showcasing that the situation has indeed worsened as the writer, the Late Sir Henry Boyo, feared. The writer blames the monetary strategy of the CBN and proceeds to discuss how this affects fuel prices, subsidies and the day-to-day workings of the economy. It provides a clear argument and effective strategy to avoid this cursed cycle of further devaluation of the Naira which only ensures poverty.
As you read through the below article taking note of previous events and rates, keep in mind its initial publication (2015).
The severe social discomfort and economic dislocation caused by fuel scarcity nationwide may stampede the incoming Administration of President-elect Muhammadu Buhari to settle the outstanding invoices of Petrol Marketers, and also accept over N200bn penalty interest charge for delayed payments and exchange rate differentials consequent upon the almost 20% recent Naira devaluation.
Some critics may suggest that the government representatives who accepted liability for such oppressive penalty charges, would not readily make such an undertaking if they represented their own private corporations or family assets, particularly in the face of a bleeding revenue base and rapidly increasing debt burden.
Nonetheless, Buhari may be forced to tow the same path of reckless financial management, if petrol marketers remain adamant and insist that government should first settle alleged outstanding debts before they commit to any fresh fuel importation; unfortunately, the longer it takes to reach an agreement on actual liability, interest payments may continue to increase and further bloat government’s indebtedness.
Clearly, however, the retired General certainly does not need an early confrontation with the public or indeed Labour who will as usual insist that subsidy should only be removed after sufficient local refineries can meet domestic consumption! In the event however, that refineries (depending on size) have between 18-36 months gestation, this may suggest that subsidy may not be wished away very soon!
Furthermore, Labour and Civil Societies also recognise that it would be foolhardy to accept deregulation, if the Naira rate continues its steady plunge against the dollar as fuel prices will simultaneously continue to spiral! Conversely, Buhari’s Team may plead that it is not sensible to dedicate over 20% of federal budgets to subsidy and almost 50% of total Crude Export Revenue to consumption of imported fuel annually.
We cannot predict the length of the ensuing stalemate, but as usual, in the interest of the nation, government and Labour are likely to once more agree to split the subsidy burden. Clearly, government’s share of subsidy will nonetheless rise if the Naira continues its downward slide or if “fortuitously” or “unfortunately”, crude oil prices rebound once again. For example, if the Naira is left to float as currently proposed by the Banker’s Committee, Naira could well exchange for over N300=$1 before the end of 2015, particularly if the instigation of systemic excess Naira remains an abiding feature of CBN’s monetary strategy.
Invariably, with such Naira depreciation, fuel prices will spiral about 50% above the price on which subsidy was initially calculated. Consequently, unless pump prices are adjusted upwards, government’s share of the subsidy burden will once again balloon and bring us back to square one, where subsidy exceeds 20% of annual federal budgets.
Furthermore, in the absence of fiscal discipline, subsidy refunds to marketers will invariably be delayed and will accumulate as usual, until the issue of delayed payments and exchange rate differentials surface once more to trigger fuel scarcity with the attendant painful, social and economic dislocations. Similarly, higher crude prices will also translate to higher fuel prices and increasing subsidy values.
In his attempt to end this horrendous cyclical narrative, Buhari will be well advised to recognise that subsidy can be eliminated if crude price remains below $50/barrel, so that ex-refinery cost remains low; ironically, if this happens, our oil revenue base will unfortunately remain depleted and further threaten the Naira exchange rate as is currently the case. Ultimately, increasing speculative dollar demand will instigate further Naira depreciation which would inadvertently pump-up fuel price and also swell the existing value of subsidy.
Clearly, if weaker Naira rates instigate higher fuel prices and fuel subsidy values, it stands to reason that an increasingly stronger Naira should also reduce fuel price and ultimately eliminate subsidy while new refineries will be established with the complete deregulation of the sector.
For example, if Naira exchanges for N100=$1, this would be a 50% appreciation from the current N200=$1, in this event, the unsubsidized current actual fuel price of about N150/litre will immediately fall below N80/litre, and make N7/litre available as sales tax if the current regulated price of N87/litre remains unchanged. Notably, the relative sales tax potential will increase beyond N7/litre if the Naira strengthens below N100=$1.
The million-dollar question however, is how the Naira can appreciate when oil revenue is dwindling; after all, as some experts claim, it is the size of our reserves that defines the exchange rate of the Naira! Curiously, in the Nigerian context however, in order for CBN to build up its dollar reserves, it must consciously continue to induce the suffocation of the domestic money market with surplus Naira, despite the adverse attendant economic consequences.
Expectedly, with such a Naira antagonistic strategy, the Naira exchange rate will be pummeled when it is constantly pitted against the paltry dollar rations, auctioned weekly by CBN from its caché of public sector dollars which were earlier captured and substituted with Naira allocations at an exchange rate that is unilaterally determined by the Apex Bank. This bizarre payment strategy apart from instigating excess Naira, also induces the unforced error of the official provision of presumably ‘scarce’ public sector dollars for the unsubstantiated forex requirements of the black market.
Instructively, however, if the foreign exchange component of federal allocations is paid with dollar certificates rather than the outright monthly substitution of Naira values which precipitate the constant spectre of surplus Naira and its oppressive train of inflation, huge cost of funds, a weaker Naira as well as higher fuel prices, which make the removal of subsidy impossible.
Incidentally, the above recommended reform in fiscal allocations, will gradually mop up the unrelenting flood of surplus Naira which swallow the dollar rations sold weekly by CBN; clearly, if this fiscal payment practice is sustained, the Naira may still ultimately exchange below N100=$1despite reduced crude oil revenue within Buhari’s first year in office.
Thus, Buhari will avoid a protracted social and economic dislocation, if he quickly engages Organised Labour and Civil Societies on a consensus to sustain partial deregulation with government, “reluctantly” conceding 50% of the difference between the current N87/litre and the unsubsidized current actual market price of about N150/litre; with this arrangement, the agreed pump price would be set at N120/litre excluding government’s subsidy of about N33/litre.
Clearly, the implication is that when the Naira ultimately exchanges for N100=$1 because of better managed Naira liquidity, the government could also recoup over N10/litre as sales tax on 40 million litres of fuel consumed daily. Such returns from petrol sales tax will continue to rise as the Naira exchange rate improves with the reform in government’s payments strategy.
Save the Naira, Save Nigerians!!
