As the Federal Government struggle to cut down on its expensive petrol subsidy, Sub-Saharan African (SSA) countries are increasingly dumping the unpopular policy, to save funds for more productive expenditure, particularly infrastructure, according to a recent report by Renaissance Capital, (RenCap) a leading investment bank focused on the emerging markets of Russia, Ukraine, Kazakhstan and sub-Saharan Africa.
The report highlighted why countries like Ghana, Tanzania and Uganda tackled the expensive policy head on, and noted that it was prone to corruption. It further observed the regions infrastructure frustrations had made jettisoning subsidy a prerogative, despite the implication for inflation. It added that the position was more compelling for price libralisation, viewed largely as a major influence on foreign investment onflow.
“In recent weeks, we have observed the cutting of subsidies in a few Sub-Saharan African (SSA) countries,” Rencap said. “SSA governments appear to be moving to rid themselves of expensive subsidies which divert funds from other productive expenditure (particularly infrastructure), and put downward pressure on budget deficits, implying higher borrowing costs.”
The Federal Government recently negotiated a phased subsidy removal that resulted in a smaller petrol price increment to N97 per liter.
But petrol subsidy removal overshadowed similar actions in Ghana, Uganda and Tanzania . Ghana withdrew subsidies on petroleum products effective 29 December 2011, which resulted in fuel prices increasing by about 20 percent on 1 January 2012. In East Africa , the subsidy removals were on electricity.
Uganda ended subsidies paid to power generators from 12 January 2012, implying a 42 percent increase in electricity tariffs. Tanzania ’s energy regulator has approved a 40 percent increase in electricity tariffs.
“We believe this cutting of subsidies signals a price liberalisation trend, the implications of which we explore below,” says RenCap.
Rencap believes fuel subsidies are an expedient tool used by some big oil exporters, to appease citizens frustrated with delayed development or democracy.
It says subsidies are evidently expensive, particularly for governments that have limited sources of finance and competing developmental needs, including infrastructure. Cutting subsidies will enable these governments to redeploy funds more effectively.
“We think the debt crisis in the EU, which has put donor countries’ government budgets under significant pressure, has also compelled SSA governments to seek other ways of creating fiscal space. This includes doing away with non-essential expenditure.”
The report suggests that subsidy removals imply higher inflation. In addition to higher utility and transportation costs, the cost of production is also likely to increase on the back of power and fuel price hikes.
“In Nigeria , the complete removal of the petrol price subsidy would push up inflation to the mid-teens in 2012, from about 11% in 2011, in our view.”
Recap reckons that a phased subsidy removal implies a more moderate increase in inflation. They expect the impact on Nigeria ’s inflation to be pronounced, not only because of the magnitude of the price hike but also because petrol is used to power generators that produce electricity.
“Electricity costs are accordingly likely to increase significantly, adding to upward pressure on inflation. We expect Ghana ’s inflation to be less significantly impacted by the increase in the price of petroleum products – we now expect inflation to average 10.7 percent in 2012, vs. our initial projection of 9.2 percent. A moderate increase in inflation is positive for the cedi.”
Across the continent in East Africa, Uganda ’s 40%-plus electricity tariff hike is likely to have a significant impact on households’ and industry’s production costs. This will, in our view, partially counter the inflation-dampening effect of good rains and the base effect in 2012.
“We still expect Uganda ’s inflation to drop below 20% in 2012, from 27% YoY at YE11, but at a slower rate. We think rising inflationary pressures in 2012, on the back of reduced subsidies, will compel some central banks to tighten monetary policy. We expect higher interest rates in Nigeria , particularly if the central bank wants to preserve positive real rates,” Recap noted.
“Conversely, in Ghana , we do not think the increase in inflation warrants tighter monetary policy. We think monetary policy is set to remain firm in both Uganda and Tanzania, however we expect some moderation in Uganda’s policy rate (currently 23%), given its high base from 2012.
“In our view, Nigeria will be even more committed to a stable currency to counter inflationary pressures, however we expect the naira to become more overvalued. Moreover, Nigeria has the FX reserves to keep the currency relatively stable. In East Africa , where the authorities are less committed to a prescribed exchange rate, inflationary pressures imply weak Ugandan and Tanzanian shillings.”
Market prices needed to attract investment. Cutting subsidies on fuel and utilities reflects a growing realisation that market prices are required for the power and petroleum sectors to attract much-needed investment.
“Only then will investors be assured of covering their costs and getting a positive return on their investments. Otherwise, large infrastructure plans, like that for the 39,000 MW Grand Inga Dam in the Democratic Republic of Congo, will remain pipe dreams.”
It is generally believed Nigeria ’s petrol subsidies have made it unattractive for investors to invest in the downstream oil industry and build refineries. The Federal Government hopes the removal of the petrol subsidies will attract investment in refineries, and is looking at an ambitious timeframe of 18-24 months to get the refineries back on stream.
Currently, Nigeria ’s refineries work at 30 percent capacity. The removal and cutting of subsidies on electricity tariffs in Uganda and Tanzania , respectively, is intended to attract investment into East Africa ’s power sector, which suffers from significant inefficiencies.
Uganda’s government plans to use part of the savings from scrapping the electricity subsidy to build the 600 MW Karuma hydropower project.
“We would expect private investors to be more encouraged to invest in Uganda ’s (SSA) power (infrastructure) projects if the government takes a larger equity stake.”
