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Nigeria Lifting Fuel Subsidies: Needed but Implementation to be Challenging

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Nigeria has dominated broadcasts around Christmastime as Boko Haram  attacks killed dozens in many parts of Northern and central Nigeria. The  government has upped security spending, declared a state of emergency  in a swathe of the country and insisted that it will get the situation  under control.  This is likely to be difficult as the government  measures have prompted an outcry from the Islamist group and further  escalation could undermine economic growth.

Nigeria is now making headlines for another reason, as the government is pushing ahead with a bold pledge to cut fuel subsidies,  which absorbed about 25% of the government budget in 2010 or US$8  billion.  The government petroleum products regulatory agency has  announced that it will no longer provide the subsidy to producers, who  will still have to sell products at an approved price, set biweekly, but  one that will be closer to global market price. As yet, there are still  questions about how the prices will be set and it is possible that  producers will be expected to make up some of the difference between  global and local prices, eating into profits if they cannot pass on the  price to consumers. Moreover there is still the potential for political  blockages -Nigeria’s parliament rejected the proposal last month –  though the senate is expected to approve. Even if the move is approved,  implementation could be difficult, some groups have threatened to strike  and the increase in energy prices could prompt a revival of  inflationary pressures, which have only just eased due to aggressive  monetary tightening, which paused the freefall of the naira.

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The  move has been considered for a long time, particularly since Nigeria  still lacks sufficient refining and distribution capacity to meet oil  product demand at home, meaning that it exports raw crude and imports  refined product, bearing extensive transportation costs and letting  others gain the additional returns and value-added from refining. RGE  has long seen this as a vulnerability to Nigeria’s oil sector and  economy. Subsidizing a good that must be imported, hits the government  budget directly. Other highly subsidizing oil exporters like Saudi  Arabia, instead forego potential export revenue as more of oil  production is absorbed at home. Neither is necessarily sustainable over a  longer horizon, but the tradeoff of importing costly products in the  face of low per capita oil revenues is particularly problematic.

One  question is whether Nigeria will suffer the sort of backlash  experienced in many Arab countries that tried to roll-back subsidies, or  whether like Iran, it will be able to ride the storm (at least  temporarily) of higher inflation and political pressure.  The jury is  still far out on the long-term in Iran despite some oddly positive  research from the IMF on the phase-out, but that is a topic for another  post.

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Fuel subsidies always pose problems, distorting both demand  and supply as companies are reluctant to produce a good sold at below  local or global market prices as they will lose money and lower prices  encourage greater demand as the price signals fail to influence demand.  Given the political rents to be garnered from Nigeria’s oil sector, the  extensive subsidies and other reform of the downstream oil sector have  been very difficult.

This bold move though, does suggest that  Goodluck Jonathan’s somewhat technocratic policy makers are committed to  bringing spending on to a more sustainable path  and using some of  Nigeria’s scarce resources on the needed infrastructure. This implies  that perhaps there might be some surplus left to go into the new and  vaunted sovereign wealth fund.

Given the precarious situation  politically at home, and uncertainties abroad, there is of course a risk  that Nigeria’s political class might block passage of the legislation  or prompt a return of subsidies. Either way, 2012 is set to be another  challenging year for Goodluck Jonathan’s government in light of a series  of political and economic risks. Other African countries also looking  to scale back the subsidy regimes and free up fiscal space for  investment, may follow a similar path. Ghana unwound some of its  subsidies in recent weeks. A busy political calendar could prompt some  reversals.

Source: EconoMonitor.com

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