FUEL SUBSIDY TRANSACTIONS MAY HURT CREDIT RATINGS, RESERVES, ECONOMY

The opacity of transactions involving fuel subsidy is likely going to undermine the little successes so far recorded in the nation's economy. At a time, when the economies of many countries are showing signs of distress and actually looking for a bail out, Nigeria seems to be spending about 50 percent of its entire budget bailing out other economies through the payment of subsidy.

This is because, when you import finished goods, you are indirectly helping those economies to be more productive and keep their employment levels high. In Nigeria, people are losing jobs, whereas the country is paying the wages of people in other countries.

As 'blackmails' from some dubious petroleum product marketers intensifies, the federal government recently showed signs of buckling  and hinted that it may resort to using the funds under the Excess Crude Account (ECA) in paying for petroleum products subsidy, which real amount is yet to be ascertained.

'Why this subsidy thing may likely undermine the economy is that, very little is known about what the actual amount of the subsidy is', said one analyst.

The finance minister and co-ordinating minister for the economy Ngozi Okonjo-Iweala, said that additional $4 billion or N620 billion  be plunged into ensuring subsidy is paid. In other words, the payment will ensure that some people outside the country keep their jobs by producing petroleum products for Nigeria.

The N620 billion is outside the N888 billion earlier earmarked in this year's (2012) budget for subsidy payment. If, eventually, the government goes ahead to spend the monies initially meant for the three tiers of government on subsidy payment, then a whopping N1.51 trillion would have gone into paying for subsidy.

The matter did not just stop there. The complexity of the subsidy issue is deeper. This is because, the marketers are said to be owing international banks another $3.4 billion, about N530 billion.

This is where analysts fear that such debt overhang could debase Nigeria's credit rating, if the debts are not paid as at when due.

But another implication for the economy is that, if that amount owed international banks is part of the subsidy, then what government will pay this year would be N2.04 trillion.

As if that amount is not enough, the Nigerian National Petroleum Corporation (NNPC) is also said to be covering additional cost of imports with opaque crude swaps. Here the amount in value terms is not yet ascertained. All these point to the fact that, Nigeria may actually be spending more than 50 percent of its budget on subsidy.

Based on these facts, Razia Khan, Regional Head of Research, Africa Global Research, Standard Chartered Bank, London said the risks posed to the Nigerian economy by the continuation of the fuel subsidy are significant, and made a lot worse by the opacity of the sector.

'Fundamentally, the problem is Nigeria's continued heavy dependence on oil revenue.  In the event of a severe global shock hurting oil prices, Nigeria does not have much of a buffer to safeguard any spending, let alone spending on the fuel subsidy. It is crucial, given this risk, that buffers are rebuilt – and this should take some priority over any other discretionary spending.

'The problem is that the indebtedness of the oil sector creates ultimate claims on the Nigerian government, potentially hurting the country's credit standing. This is something that could easily spiral, if not properly addressed', she warned.

On whether the Nigerian economy will survive this, Khan said she is almost certain it will do. She however said; to minimise risks, timely action is required.

According to her, the money already spent on the subsidy needs to be properly investigated, and questions need to be asked about whether Nigeria can continue to prioritise subsidy spending, with the current flawed system, ahead of all other spending.

'It's a tax on the poor, and the country's development prospects and future creditworthiness, in order to add something to the pockets of a select few', she said.

Samir Gadio, Analyst with Standard Bank, London agreed with Khan, saying depleting the ECA further is certainly not the appropriate step at a time when the oil price is under heavy pressure.

'This would exacerbate the recent negative shift in confidence in the naira and put more upward pressure on dollar/naira', he said.

Gadio is of the view that the fiscal cost associated with the subsidy was becoming unbearable and has amplified already severe fiscal distortions.

According to him, not only does the subsidy perpetuate a vicious cycle of refined fuel dependency, but it diverts sizeable resources that could be used to bridge Nigeria's substantial infrastructure gap.

'So what is the actual benefit from the fuel subsidy?', he wondered.

Bismarck Rewane, chief executive officer of Financial Derivatives Company (FDC) Limited recalled that the recent Monetary Policy Report (MPR) clearly evidences the fact that the Central Bank of Nigeria (CBN) is seriously concerned about the risk of a potential depreciation in the naira, as a result of the recent developments in the international commodity and financial markets.

He said this concern was understandable as the Nigerian economy is heavily dependent on oil, the possibility of a softening in crude oil prices with potential fiscal revenue losses could lead to renewed pressure on the exchange rate.

If the weakening in the naira persists, which we expect, then the nation's forex reserves could deplete even faster than the CBN anticipates. The market would likely see such depletion as a sign of weakness which could lead to a further increase in currency speculation.

Last week, Rewane warned that with the events in the world markets, Nigeria may not be able to maintain robust external reserves.

According to him, the federal government's budget is bench-marked to oil price at $72pb, while Bonny Light crude is trading at $98pb. This is a variance of $26pb.

'Using our regression model, at the current rate of decline, we expect foreign exchange (forex) inflows to fall from $4.31bn in January to $3.34 billion in July. If oil prices were to drop to $80 per barrel ( which is 50 percent likelihood based on current trends), there is a 95 percent likelihood that forex inflows will decline to approximately $3.03 billionn. In this situation Nigeria's external reserves would be expected to follow suit and drop to a value as low as $22 billion, covering less than three months of imports. Resultantly, the CBN may be forced to allow the naira to depreciate sharply to N165/$, to compensate for the substantial loss in oil revenue.