Nigeria, IMF and the Least Bad Policies

Nigeria, IMF and the Least Bad Policies

photo: Nicolas Raymond

As Nigeria’s economic challenges are rising, the IMF has been increasingly vocal. What is really needed are policies that are in the interest of most Nigerians.

According to the International Monetary Fund (IMF), Nigeria’s external challenges are substantial and deteriorating. Due to the reliance on oil revenues, the general government deficit doubled to 3.3 percent of the GDP in 2015. Meanwhile, exports plunged 40 percent, which caused the current account deficit to climb to 2.4 percent of GDP.

In turn, foreign portfolio flows shrank, which caused reserves to fall to $28 billion at the year-end, officially.

For its part, the IMF is urging an integrated policy package centering on fiscal discipline, reduction of external imbalances, increased efficiency of the banking sector, and strong execution of structural reforms. These policies could enable priority infrastructure investments.

In principle, it sounds good but what does it mean practice? Well, in the past two months, the IMF has become more vocal about its priority areas.

The IMF focus on flexible foreign exchange

In January, IMF Managing Director Christine Lagarde visited Nigeria to discuss the fall in oil price, the need for fiscal discipline, and offering advice on improving tax and debt management. Seizing the opportunity, she also called for greater flexibility in the foreign exchange policy. Furthermore, she recommended the broadening of the country’s revenue based by increasing the value added tax (VAT).

Yet, raising the VAT will not resolve Nigeria’s challenges. The VAT is like a sales tax in that ultimately only the end-consumer is taxed. Recently, it has backfired even in advanced economies, such as Japan where Prime Minister Shinzo Abe hoped it would strengthen the economy while supporting the growth. In reality, it undermined progress, penalized growth and weakened the debt-ridden economy.

The VAT is also a regressive tax in that the poor usually end up paying more than the wealthy, as a percentage of their income. Now, in Nigeria, agriculture still employs some 70 percent of the labor force. Official unemployment rate has climbed to 10 percent, while underemployment rate exceeds 17 percent. More than 60 percent live below the poverty line of US$1 per day. Under such conditions, the VAT would only increase challenges. Finally, the VAT is difficult and costly to administer, so revenues from the VAT are often lower than expected.

However, the IMF could have recommended a steep increase in VAT on imported luxury goods and services that provide to a select few. Instead, in February, Lagarde spoke again about Nigeria in Washington saying the IMF was willing to give loans if needed. However, the country needed a “sensible” foreign exchange policy to fend of external economic shocks, she added.

In February, a visiting IMF team in Nigeria underscored the same themes.

Export competitiveness – or import vulnerability

President Muhammadu Buhari and the CBN Governor Godwin Emefiele oppose devaluation and appear to resist such moves as long as possible. In contrast, the proponents of devaluation argue that devaluation would strengthen Nigeria’s export competitiveness. But is that what the country needs?

Even before his attempts at structural reforms, Japan’s Premier Abe began to push a substantial de facto devaluation of the yen. In a large economy relying on export-led growth, that makes Japanese cars and consumer electronics more competitive in international markets.

However, Nigeria is not a global car producer. Buhari’s foremost concerns do not involve jobs and revenues at Toyota and Honda. From Japan and Nordic states to Asian tigers and China, countries that rely on export-led growth have occasionally benefited from devaluation or depreciation to support export competitiveness. However, their competitive advantages rely on industrial strengths – not energy resources.

In their opposition to devaluation, Buhari and Emefiele are less motivated by Nigeria’s oil export potential than with its import vulnerability. Since Nigeria imports much of its food and even refined fuel needs, any devaluation would cause challenging price rises to consumers and small businesses. In particular, it would heavily penalize Nigeria’s nascent middle class, workers and rural laborers.

True, the Buhari administration has been broadly criticized for its stance by advanced economies, including the IMF and Western media. Recently, The Economist accused Buhari for not letting the market set the value of the currency. Nevertheless, advanced economies have a dark track-record of urging emerging economies to embrace the kind of shock therapy that is hardly ever deployed in their own domestic markets.

The least bad policies

Here’s the bad news: the reversal of capital flows from emerging economies has only begun. While monetary tightening will occur slower in the advanced economies than expected, it will still cause huge outflows from emerging economies.

Second, no relief can be seen in the short term. In 2016, the current consensus sees the Brent price around $40 per barrel; by 2018, around $50. Third, as global, regional and domestic economic prospects will continue to erode, downside risks will remain elevated for years to come.

If that’s the near-term – possibly medium-term – status quo, the government should drastically accelerate the implementation of structural reforms, infrastructure investments, expansion of small-and-medium size companies and efforts to boost the information technology and communication (ICT) sector – the potential base of the nation’s innovation in the future.

According to State Minister for Petroleum Resources Emmanuel Kachikwu, the government is planning to break the state-owned oil company into 30 separate units. That is vital to rid it of corruption and to boost competitiveness and employment. Along with appropriate fiscal discipline and resolute anti-corruption stance, such measures will also attract foreign direct and portfolio investment over time.

Regionally, Nigeria should seize its role as Africa’s prime BRIC nation and push for greater cooperation and coordination in the face of common challenges. Most energy-exporting emerging economies are suffering from disruptive reversals of hot money flows. A united front would strengthen these nations’ bargaining power in the global economy.

What about naira?

To avoid costly shocks, Nigeria’s central bank (CBN) moved to ration foreign exchange by April 2015. While oil prices peaked in mid-2014, it had fallen some 40 percent by then. Meanwhile, the official naira-dollar exchange rate had depreciated by 21 percent to 197 naira per dollar.

The problem is that oil prices continued to fall almost 50 percent more between April 2015 and January 2016. Yet the official rate remains at N197, even though the parallel rate is now at N320-N330 (after a peak of N380 around mid-February).

Indeed, the challenge facing the CBN is not really the absolute question “to devalue or not to devalue,” but the widened relative margin of the exchange rate between the official and the parallel market.

In the near future, the CBN can continue the selective supply of dollars, adjust the “price” of the naira or float the currency. The first option was predicated on the near-term reversal of oil prices, which is no longer in the cards. The third option would allow markets to determine the exchange rate, which could drastically penalize Nigerian households, boost inflation and weaken the economy.

That leaves the second option, the phased adjustment of naira. For now, the government’s decisive stance against devaluation has reduced speculation at the market. In practice, Buhari and Efemiele are likely to stick to the current peg, as long as possible – but may then be compelled to adjust the “price” to reduce the gap between the official and parallel market exchange rates.

The original version was released by BusinessDay (Nigeria) on March 7, 2016