Pump price deregulation triggers inflation worries

Nothing good comes easy; there is no such thing as free lunch; if you cannot bear the heat in the kitchen, then ship out; no matter how bad it may be, the teeth and the tongue must endure leaving together.

These are all popular sayings, especially in corporate circles, and apt summary of the various analysis that have greeted the new pump price cum deregulation policy announced by the government last week by the federal government.

The emotions that appear to be rife is that since some people in government stopped the implementation in the past, it must also be stopped this time around as a revenge.

Myriads of reactions and questions trailed the policy and some analysts have responded to these.
The chief executive officer of Financial Derivatives, Bismarck Rewane, in his bi-monthly report, believes that after a year of persistent fuel scarcity, the government has announced a new pump price range for PMS of N135-N145/litre, a move that was greeted with relief by analysts, given the lower oil prices and depleting government revenue.

But he is, however, afraid that it might push up inflation, a word that sends jitters down the spine of investors and consumers.

He agrees also that this 57 per cent increase in petrol prices, and the pending inflationary pressure, threatens to deepen the woes of the public.

The good news, according to him, however, is that in the long term, the petrol market is expected to find its equilibrium as free competition increases production efficiency and pushes down costs and prices.

“Additionally, the messianic budget of N6.08 trillion will act as the key panacea that will stimulate the country out of the current economic slump. Ultimately, all is well that ends well. The combination of timely policies is the much needed boost for economic recovery and growth,” he concluded.
For analysts at Afrinvest, though the economy is not where it should be, it is close.

They, however, express fears that the cap in price introduces doubt into a deregulation process, and that it might also spike inflation.

The analysts recalled that last week, after months of speculation and lobbying by the business community and multilateral agencies, the federal government finally made a move to liberalise the petrol market by eliminating import quotas and licences and introduced a price band for the product with a price cap of N145/litre and a floor of N135/litre.

This represents a marked upward adjustment from a fixed peg of N86.50/litre introduced in January and also implies that subsidy would no longer be paid on any price differential between the total retail costs (including distribution margins) estimated by the PPPRA at N138.26/litre and the new regulated price band.

The deregulation of Nigeria’s downstream oil & gas sector has for long been in the offing but efforts to partially or fully implement it has historically proven to be deeply unpopular and been fought by the civil society groups and labour unions. Despite the widely acclaimed inefficiency and ineffectiveness of the subsidy regime, with frequent product scarcities and controversies surrounding diversion of products and validity of subsidy claims, removing/reducing subsidy has proven to be the Achilles’ heels of successive administrations which approval ratings and popularity took a beating each time efforts were made.

The Afrinvest analysts said that they had noted in an earlier report in December 2015 – A Change in Market Sentiments: 5 Signs to Watch – that the huge fiscal costs of N680 billion in 2015 (or 17.4 per cent of budgeted recurrent spending) of the subsidy burden, in light of a weakened government revenue base and external reserves, makes it imperative to deregulate the market and free up cash flow to invest in higher priority capital projects necessary to boost productivity in the real sector. Subsidy regime has complicated the administration of monetary policy due to pressure on the reserves.

In a 2011 policy communique, the Monetary Policy Committee (MPC) noted that “the committee expressed concerns about the genuineness of demand for petroleum imports. This year alone, oil importers have bought over $7 billion from Wholesale Dutch Auction System (wDAS), thereby, depleting the nation’s external reserves. This demand, in the committee’s view, might have been fuelled by rent-seeking and subsidies.”

At the time, this represents 17.1 per cent of foreign exchange utilisation. Thus, in the analysts’ view the removal of restrictions and quota system is positive for the following: firstly, the removal of subsidy, although belated, is prudent for fiscal management as it reduces recurrent expenditure and closes a potential source of leakages.

According to the minister of state for petroleum, N13.7/litre was being paid as subsidy claims before the recent price adjustments, which translates to N16.4 billion paid monthly.

Thus, retaining the previous price would imply that extra-budgetary expenditure would be made since the recently passed budget does not make provision for subsidy.

Secondly, the current consumption rate of 45 million litres per day has been deemed inaccurate with the NNPC claiming that products are being diverted to neighbouring countries where the product is being sold at higher prices.

Adjusting local prices to reduce the arbitrage incentive could potentially reduce petrol demand and foreign exchange obligations.

Yet, there are limitations to the policy shifts. Introduction of a price cap implies that the PPPRA still regulates pricing, thus speculative practices cannot be avoided close to seasonal adjustment dates of the pricing template.

Also, since domestic prices reflect impacts of exchange rate and crude oil price movements, fixed landing cost and distribution margin set in the current pricing template may be inadequate to ensure stable margin for industry players, thus constituting a business risk for marketers.

The minister of petroleum did mention that the pricing guideline is at an initial stage of the deregulation process and ultimately allow market dynamics to set in.

“We believe that the ultimate conclusion of the reform and pricing dynamics (exchange rate and crude oil prices) ought to be left for market forces to determine. More importantly, policy inflexibility of foreign exchange market still constitute a burden to importers and tacit approval granted to marketers to source foreign exchange at secondary markets could pressure exchange rate further at the parallel market. We think that the recent effort should be complimented with an exchange rate liberalisation policy. Hence, we anticipate a major move on foreign exchange by the CBN this month.

“We expect the price review to mount further pressure on May inflation numbers. We see inflation rate in April at 13.6 per cent year-on-Year (Y-o-Y) and expect further increases in May driven by transport division and electricity, gas and other fuels, COICOP Divisions, which both contribute 23.2 per cent to the CPI weighting. Real consumption spending growth may also be dragged by the hike but we believe that gains in productivity from petrol availability will partially be offset in the short term while budget implementation will unlock more benefits in the medium term,” Afrinvest analysts said.
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