Nigeria’s federal government is expected to raise the Value Added Tax (VAT) to 15 per cent from the current 7.5 per cent by 2027 to enable it fund its fiscal deficit and debt service obligations, including social and job creation projects. International business research firm, Economist Intelligence Unit (EIU), stated in its Country Report.
EIU said the deficit could widen to five per cent of Gross Domestic Product (GDP) in 2024, slightly above the estimate for 2023. It said this was expected to average 4.5 per cent of GDP annually between 2025 and 2028 – more than the legal limit of three per cent of GDP and representing an unusually lax period of fiscal policy for the country.
On the foreign exchange (FX) regime, EIU predicted the naira to weaken to N2, 381 to the dollar, stating that the spread with the parallel market will be five per cent to 15 per cent.
The report added that persistently high inflation, deficit monetisation, negative short-term real interest rates, low foreign reserves, and a backlog of foreign-exchange orders would continue to sap confidence in the naira, despite a 45 per cent devaluation in February.
It said traders will continue to be concerned that controls on the currency could be tightened at any point, adding, however, that another step devaluation is unlikely.
The report forecasted foreign borrowing to be used to rebuild foreign reserves and said the local currency would stabilise towards the end of 2024.
It pointed out that given that the naira was increasingly appearing undervalued in real terms, the rate could end up stronger if the Central Bank of Nigeria (CBN) tightened monetary policy more aggressively than expected.
EIU further predicted a fresh 100 basis points hike in Monetary Policy Rate (MPR) to 23.75 per cent from the current 22.75 per cent in 2024, should deficit monetisation continue and imported inflationary pressures remain strong.
“However, our core view is that the CBN will fail to deliver a positive real short-term interest rate, as doing so would cause unemployment at a high political cost.”
The report stated, “Accounting for further near-term losses, we expect an end-2024 rate of N1, 770: $1, compared with about N1, 600: US$1 at end-February. However, this forecast is finely balanced.
“Any number of knocks to confidence could cause a sharper weakening. Alternatively, given the naira is increasingly appearing undervalued in real terms, the rate could end up stronger, if the CBN tightens monetary policy more aggressively than we expect.”
EIU stated in the report that following a sizable real-terms correction, naira’s outlook for 2025 was relatively stable, and might close at N1, 817 to the dollar in the review year.
Nonetheless, the EIU report said, “We maintain our view that a lax monetary-fiscal policy mix will undermine the longer-term value of the naira. In line with a slide in world oil prices from a cyclical peak, we forecast that the currency will end 2028 at N2, 381: $1 and that the spread with the parallel market will be 5-15 per cent.”
The report further predicted the country’s foreign exchange reserves to gradually rise over the forecast period, aided by a more market-driven exchange rate system and greater access to foreign borrowing. It added, however, that this would still provide only about seven months of import cover in 2028.
In addition, the report stated that an expected rise in formal borrowing would cause the public debt/GDP ratio to rise sharply in 2024-28. It predicted that a statutory 40 per cent ceiling would be breached by end of 2026, pushing public debt to GDP to 50.4 per cent by 2028, from less than 20 per cent in 2022.
The report said, “We expect relatively large budget deficits as a consequence of Mr. Tinubu’s ‘fiscally active’ job creation and infrastructure spending agenda, as well as an implicit subsidy on petrol.
“The 2024 budget includes a large increase in non-debt recurrent spending as high inflation necessitates higher public-sector salaries and cash transfers to poor households.”
The report forecasted inflation to average 30.3 per cent in 2024, from 24.7 per cent in 2023, reflecting the fact that petrol price increases in June 2023 will drop out of the year-on-year calculation from mid-2024, and prevent the rate from being even higher.
It stated, “Assuming the naira stabilises, average inflation should fall to 20.7 per cent in 2025 and 11.7 per cent in 2028.
“Inflation will, thus, remain well above the 6-9 per cent target range throughout the forecast period, owing to expected VAT rate increases, insecurity in agricultural regions (raising food prices), Nigeria’s infrastructure deficit, periodic monetisation of fiscal deficits, currency weakness, and a general inflation bias within economic policymaking.”
The report said following the recent hike in MPR by 400 basis points, to 22.75 per cent in February, and the cash reserve requirement by 1,200 basis points, “Another 100 basis points is likely to be added to the policy rate in 2024, assuming deficit monetisation continues and imported inflationary pressures remain strong.”
It added, “The CBN has mentioned a switch to inflation targeting, but as this would rub up against government economic policy and given the CBN’s record of unorthodox policy, such a framework would have little credibility in anchoring inflation expectations.
“The MPC attaches a large weight to economic growth, and policy will be subject to political interference. Assuming inflation falls from 2025, we expect the CBN to begin unwinding its tight stance, with rate cuts beginning early in that year, despite inflation remaining above the ceiling of the CBN’s 6-9 per cent target range.
“We expect the policy rate to fall to 12.5 per cent in 2026 and remain there throughout the remainder of the forecast period.”
The EIU report predicted real GDP growth to slide from 2.9 per cent in 2023 to 2.5 per cent in 2024. It explained, “Given population growth of about 2.4 per cent, this will mean continued stagnation in GDP per head. Sluggish growth reflects a surge in already high inflation, expected monetary tightening and balance-sheet constraints facing multinationals that earn in local currency, given the naira’s collapse.
“Rising insecurity in Nigeria’s agricultural heartlands also makes it improbable that a strong harvest in 2023 will be repeated in 2024.
“Net exports will be the primary growth driver in 2024, supported by the constraining impact on imports of the recent large currency devaluation and by higher crude output as the government gets a better handle on oil theft in the Niger Delta and as the Dangote refinery ramps up capacity.
“As inflation falls and monetary policy becomes expansionary from 2025, domestic demand will return to (low) growth.
Consequently, real GDP growth will quicken to 3.5 per cent in 2025—the second highest rate in a decade, owing partly to rebound effects—and average 3.3 per cent a year in 2026-28. Factors such as power outages, rampant insecurity, a lack of land titling and a giant infrastructure gap will hold back the economy.”
On policy trends, the report pointed out that market reforms under President Bola Tinubu were intended to attract investment but did not constitute a coherent plan.
It said, “His two flagship policies, the elimination of petrol subsidies and the liberalisation of the exchange rate, have an inner contradiction. As Nigeria imports virtually all its fuel, devaluations of the naira, the latest being a 45 per cent drop in February, should be reflected in the pump price.
“However, owing to the threat of industrial action there has been little movement since June, despite the naira having weakened from N461:$1 in May 2023 to N1, 600:$1 in late February 2024.
“This indicates the return of a (large) subsidy. Denying this publicly, the government has a strong incentive to turn to the Central Bank of Nigeria (CBN) for financing to cover the fiscal cost.”
EIU continued, “Deficit monetisation and high inflation will undermine the currency. A possibility is that monetary policy will be tightened to a point at which foreign investors view the naira more favourably.
“Although the CBN raised its policy rate in February, Mr. Tinubu has expressed an aversion to high interest rates as his overarching economic goal is to double GDP by 2031. As inflation has been allowed to rise to a level at which a positive real short-term interest rate would create a significant rise in unemployment—adding another policy-induced element to economic hardship—we assume that politics will prevent this from happening.”
The report said, “The CBN’s independence has been heavily eroded in recent years; because fiscal firepower is so limited, the government will continue to rely on monetary policy to achieve job-creation and development objectives.”
It said, “Our view is that it will take foreign borrowing to rebuild the CBN’s buffers, fully clear a backlog of unmet foreign exchange orders and restore confidence.
“This is probably only achievable towards the end of 2024. In mid-January Nigeria took out a $3.3 billion loan from the African Export-Import Bank, secured on oil revenue in a so-called crude oil prepayment facility.
“This follows a $1 billion loan from the African Development Bank in November, and another US$1.5bn is being sought from the World Bank.
Falling risk premiums on government international bonds make tapping the international capital market another viable (albeit costly) option once US interest rates start to fall from the second half of 2024.
“For most of this year, the naira will be highly volatile, leading to regulatory erraticism that can affect businesses, especially those holding foreign currency. The CBN lacks the liquidity to support the naira itself; out of $33 billion in foreign reserves, a large share (estimated at nearly $20 billion), is committed to various derivative deals.
“The CBN recently imposed restrictions on oil companies repatriating export earnings abroad, and there is a risk of wider convertibility limits being imposed until the currency stabilises.”
Furthermore, the report described the new 650,000-barrel/day Dangote mega-refinery as another possible circuit breaker for the country. It said the facility was gearing up for its first fuel exports, to be followed by cargoes to the domestic market.
It said, “In theory, the facility can meet all domestic needs but petrol subsidies make it unclear whether doing so will be profitable (let alone profit maximising).
“In any case, Nigeria will continue to depend on fuel imports for most of the year as the refinery ramps up output. The wider business environment will remain highly challenging, undermined by corruption, cronyism, rampant insecurity and a giant infrastructure gap.
“Multinationals are increasingly deciding to quit Nigeria or reduce their presence; we estimate there was a net withdrawal of foreign direct investment in 2023, to be repeated in 2024 as naira losses exert pressure on balance sheets carrying large foreign liabilities.”
The report also stated regarding the huge exit of investors, “The exodus includes oil majors who are selling onshore assets, which are high-cost and vulnerable to insecurity, leading to indigenisation of the sector over time.
“Although in principle this is positive for foreign exchange accumulation, local companies will be unable to match the investing power of outgoing multinationals. We forecast that crude oil production will rise from 1.23m barrels/day (b/d) in 2023 to 1.48m b/d in 2028, although this remains about 250,000 b/d below the 2019 level.”
James Emejo
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