Nigeria Lagging As Egypt Enacts Bold Reforms - Emerging Market Views

Nigeria Lagging As Egypt Enacts Bold Reforms

Egypt’s inflation cools dramatically from record peak, falls 20 basis points behind Nigeria’s

FDI jumps on subsidy cuts, FX liberalization

Annual inflation in Egypt has fallen behind Nigeria’s for the first time since a raft of painful reforms from a currency float to fuel subsidy cuts that started in 2016.

While North Africa’s largest economy has undertaken tough policy choices, Nigeria has struggled to take definitive action.  The annual inflation rate in urban parts of Egypt in May rose at its slowest pace in more than two years to 11.4 percent, a considerable way off the 30 percent mark it crossed in 2017 and 20 basis points below Nigeria’s 11.6 percent annual inflation for the same period. In the wake of a currency float, introduction of Value Added Tax (VAT), two reductions to energy subsidies and a hike in benchmark interest rate, inflation in Egypt ballooned to fever-pitch levels in 2017. In hindsight, Egypt’s tough choices at the time now seem to be paying off, while Nigeria continues to struggle.

Not only is inflation trending downwards in Egypt, other gains from its painful but promising reforms are gradually sprouting, especially in foreign investment inflows. Egypt emerged as  Africa’s most preferred investment destination in 2017 after recording inflows worth $7.4 billion, according to the United Nations Conference on Trade and Development (UNCTAD).

UNCTAD said Egypt’s investment attraction was as a result of “wide-ranging economic reforms such as financial liberalization, which fostered more reinvestment of domestic earnings.” Egypt’s FDI was more than seven times the inflows Nigeria mustered in 2017- $981.75 million, according to the National Bureau of Statistics (NBS).

The risk of stoking runaway inflation was the very threat the Nigerian monetary authorities were trying to avoid when the central bank ignored calls to ditch its expensive dollar, fuel and electricity subsidies, that had become a massive drain on public finances, spooked off foreign investors and put the economy in bad shape.

The lesson to be learned here for Nigeria is the need to take a long-term approach to implementing reforms rather than always applying short fixes. Policy analysts however admit that the political cost of non-populist reforms like an upward review in electricity tariffs and petrol prices makes it difficult for the government to act on these matters.

“There was little opposition in Egypt when the currency was devalued, because they practice a dictatorial style of government,” said Bismarck Rewane, a leading Nigerian economist and CEO of Lagos-based consulting firm, Financial Derivatives Company.

“So it’s not entirely the same as Nigeria, but that is no excuse for government to drag on necessary and long-term beneficial reforms,” Rewane said.

Meanwhile, the spread between Egypt’s official and parallel market rates have collapsed to 17.8 EGP per dollar, since the float last year. In Nigeria, the spread between the official and black market-one of several other markets- has remained at N57 per dollar (N306 vs 363). “This administration missed the best chance to ring in the right reforms whether it’s the currency or petrol prices,” said Zeal Akaraiwe, CEO of financial advisory firm, Graeme Black.

“Most of the reforms should have kick-started in the first year of administration,” Akaraiwe said by phone.

While the government is not entirely idling away given that it has implemented tax reforms like the Voluntary Assets and Declaration Scheme and some ease of business reforms which earned it a jump in the World Bank ease of business index to 145 from 169, the feeling is much more remains undone.

“Both Egypt and Nigeria have fuel subsidies. Both countries also need to increase their investment to GDP ratio, which is 15% of GDP or less in Egypt and Nigeria,” Charles Robertson, chief economist at Moscow-based investment bank, Renaissance Capital, said in an emailed response.

“It needs to be 25% of GDP.  Egypt is cutting its fuel subsidy so that it can spend more on investment. This will help Egypt in the long-term. Nigeria will struggle to increase government investment when so much money is spent on the fuel subsidy,” Robertson added.

While the Nigerian Central Bank’s approach to sanitizing its once illiquid foreign exchange market by creating several windows have been relatively successful, the government hasn’t had much success with subsidies and that has dampened foreign direct investment inflows.

“The controversial petrol subsidy remains the biggest elephant in the room.”

Crude oil prices have averaged $65 per barrel this year and while that seems a boon for Africa’s largest oil-producer’s finances, it is actually a headache for petrol prices.

The current petrol price template introduced in Nigeria on May 11 2016, after acute fuel shortages crimped economic output and fanned inflation, saw prices jump 62 percent to N145 per litre from N86.50 per litre. However, the current oil price and exchange rate have rendered the price obsolete, given that oil sold for $45 per barrel at the time of agreement on the price peg and the exchange rate was N280 per US dollar.

The naira has exchanged for N305 per dollar at the Central Bank of Nigeria (CBN) window since 2017.

Currently, petrol marketers have stopped importing products, as they will have to do so at a loss at the regulated N145 per litre price (47 US cents per litre), given that landing costs have shot up to N200 (65 US cents), according to data obtained from the local Petroleum Products Pricing Regulatory Agency (PPPRA).

State-owned oil company, Nigerian National Petroleum Corporation (NNPC), has had to fill the void left by the petrol importers, as well as take on the loss of selling the product below cost price.

The NNPC sells petrol to marketers at NGN134/litre, below the current landing cost of NGN200/litre, implying a NGN66/litre subsidy. The NNPC or the government is effectively spending NGN2.37 billion ($USD 7.8 million) daily by subsidizing c. 36 million litres of petrol per day.

The worry for analysts has always been that the subsidy is unsustainable in the long run.

Nigeria’s petrol prices are now among the lowest in the world at $0.47 cents/litre, which in isolation looks like a large discount.

However, factoring in relative GDP per capita alters the picture considerably: for example, Saudi Arabia’s GDP per capita is 10 times higher than Nigeria’s, and while Mexico produces the same amount of crude as Nigeria, its GDP per capita is four times higher, which means it can afford a petrol price that is double that of Nigeria.

Complete deregulation of petrol prices has been often touted as the best way out.

However, with the 2019 elections around the corner, government officials are unlikely to move the needle on painful economic reforms as any damage to their political capital could prove too expensive as they head into the polls next year.

Photo Credit: Bloomberg News