The End of Fuel Subsidy?
Perhaps it is, but time will tell.
Nigeria’s current president declared the termination of the fuel subsidy scheme, which was previously supported and cuddled by the immediate past government of Muhammadu Buhari. The outgoing government initially announced the end of the fuel subsidy scheme due to zero budget provisions for it in the second half of the fiscal year. But unsurprisingly reversed itself days later without much clarity — by implying that the subsidy is currently not funded but cannot be “removed” yet. This neatly demonstrates the incoherence of policymaking in Nigeria since 2015.
However, the new leader, having campaigned on the platform of discontinuing the fuel subsidy, was left with no other choice but to go through with the elimination.
As a result, the announcement on the day of the presidential inauguration sparked market changes that were seen quickly. Lines of cars waiting for fuel reappeared and prices rose across Nigeria’s thirty-six states due to price adjustments by the national oil company. The labour unions in the country had planned to go on strike but backed off after a meeting with the president. Nothing concrete has been released about the policy from the government, apart from some statements praising the president’s decision and asking for public trust. On Democracy Day, the president addressed the people, assuring them that their patience will pay off.
In an attitude of cautious optimism, I am offering my initial thoughts on the potential removal of fuel subsidies, with no judgment of either approval or disapproval.
The problem with fuel subsidies
Fuel subsidies are popular, not just in Nigeria. Governments, both democratic and autocratic, offer them sometimes as easy ways to deliver public goods or as distributional policies to win votes and retain popular support. And despite the prevalent and persistent criticism of subsidies, they are usually discontinued when the country is in fiscal distress. Nigeria is no different here. In 2012, when fuel subsidy removal was announced, widespread protests (helped by a well organised political opposition) broke out across the country and the government ultimately backed off. Today, the subsidy bill is bigger but what makes the prospect of a complete removal possible is the threat of the country plunging into a debt crisis.
I believe there are two convincing arguments for why fuel subsidies should be abolished — which show that the expenses to the public and the nation’s finances surpass the advantages they provide. Firstly, government spending on fuel subsidies diverts resources away from other areas, like healthcare and education, which have more economic and social benefits. But beyond the allocative inefficiency of public funds, fuel subsidies distort market prices in a way that discourages investment in the sector and impedes the development of the petroleum products value chain. This lack of investment causes economic stagnation in an industry that could have created a lot of technological transfer, human capital development, and jobs. The welfare loss to fuel subsidies is not mitigated by being a net crude oil exporter. But it can be masked by high domestic oil earnings through exports and a small population. Nigeria has not been lucky in both regards.
Fuel subsidies are also notoriously prone to corruption. For example, the subsidy scheme in Nigeria lacks transparency. There is no credible estimate of the exact volume of petrol (Premium Motor Spirit) consumption in the country on a daily basis. It provides a strong incentive for smuggling cheap petrol across the country’s borders to neighbouring markets to sell for a decent margin at the expense of Nigeria’s treasury — and such a trade will involve a network of politicians, bureaucrats, security operatives, and private firms. This rampant corruption transfers public money into private pockets and can grow large enough to threaten the fiscal position of the government. Nigeria is already in a position where it is no longer earning anything substantial from crude oil sales due to a sharp reduction in oil production added to a ballooning budget deficit.
Eliminating Fuel subsidies
If the case against fuel subsidy is a strong one, then the next step is how to remove it. As I said earlier, the president seems to have chosen the ‘’shock therapy’’ approach in his inaugural address and subsequent public statements— but other than that, we have not seen much of a plan from the government. This has created some uncertainty but all stakeholders seem to be proceeding with the assumption that the fuel subsidy is gone for good. Two of the top audit and advisory firms in the country have issued reports with very good recommendations on what the government should do.
KPMG has a rich list that includes using the foregone spending on fuel subsidy to reduce the fiscal deficit, investing in mass transit, investing in green technology, and voucher-based subsidy system for people who are most exposed to the price hike in petrol.
Their report concludes that;
While success at the PMS fuel subsidy removal will require political will and commitment by the Federal Government, this must be complemented by a robust coordination with the States. Coordination by the fiscal authorities and CBN in managing the monetary aspects of deregulation and subsidy removal are key. Without foreign exchange reforms, and an elimination of the gap between the official and parallel exchange rate, the reforms will not work.
To minimize the negative impacts of subsidy removal, there is a need for a set of coordinated actions that considers the inflationary impact, potential social unrest, and the need for compensating measures to cushion the poor. The USD 800 million World Bank proposed “Compact with the People” is therefore a step in the right direction. Communication is also key in ensuring that stakeholders are properly informed and engaged in the decision-making process
PwC on their part put forth three possible approaches for the government to either terminate or revamp the fuel subsidy program in their report.
They came to the conclusion that:
The present practice of fuel subsidy is unsustainable and may lead to a debt crisis in the medium to long term. It is imperative that the government restrategises its approach and focus on targeting the poorest of the poor, and those who have been identified as being in need of it. Targeted subsidy will reduce corruption, increase government savings and investment in infrastructure, and reduce poverty and hardship.
A wholesale removal of subsidy (option 1) may not be politically feasible and the possible disruption that may follow such a decision may hurt the economy more than the projected benefit from subsidy removal especially in the short term. We recommend either a full subsidy removal with targeted palliative (option 2) or a targeted subsidy scheme funded through a subsidy levy (option 3). Either option 2 or 3 is likely to elicit less opposition from the LabourUnion and other key stakeholders that are historically opposed to subsidy removal.
Figuring out how to remove petrol subsidies is important. But I think there is a deeper question that needs to be answered — and that is ‘’why are we doing this?’’. So far, most policy analysts are providing answers to the ‘’why do we need to do this now’’ question. And the consensus answer to that is that “because we can no longer afford it”.
But if we are serious about the growth and prosperity of Nigeria, then every policy needs to have clear developmental goals and alignment. Do we simply want to discontinue petrol subsidy so that the new government can have the fiscal room to raise new debts in pursuit of its own white elephants? Or is subsidy removal the first step in a multi-year reform plan that ends in a globally competitive energy industry that powers Nigeria’s industrialisation? I believe this is what we need to figure out first, and it should inform how we approach the elimination of petrol subsidies.
Rethinking Public Goods
Unless you are subscribed to the strange economics of Modern Monetary Theory (MMT), decisions on public spending are always about trade-offs. One of the arguments against the subsidy scheme is that it takes money away from other more beneficial ways public money can be spent. But spending money on the ‘’right’’ things is not straightforward.
Subsidies are a form of public good. Governments that rely heavily on them are either unable or unwilling to provide other public goods that have wide and visible positive effects. In a similar vein, administering subsidies universally is much easier — because it avoids the political and logistical difficulty of figuring out who is deserving and who isn’t.
Hence, defunding subsidies for fiscal reasons does not mean governments now have the incentive and capability to spend on the necessary but more complex public goods that will enhance growth and reduce poverty. That is worth keeping in mind.
