Declining Oil Price and Looming Economic Recession: The Nigerian Experience

Introduction

The oil price, in 2014, crashed to about $30 per barrel from a high of $114 per barrel. Some other factors contributing to the last economic recession in Nigeria are the absence of synchronization and coordination of the activities between the monetary and fiscal authorities, increased pressure on foreign reserves as a consequence of high import bills, falling foreign exchange earnings from the official market foreign exchange shortages and volatility in exchange rates.  Nigeria is a nation that is highly dependent on oil. The Economic Recovery and Growth Plan (ERGP) established one of its objectives as the diversification of the economy. However, the last recession and the current declining oil price has clearly shown that the plan did not achieve its goal. This policy will illustrate the causes of the decline in oil price, the issues that Nigeria faces as a result, and how it is set for another recession if drastic actions are not taken. In 2016, the Nigerian economy entered into a recession and thus encountered a paradox owing to growing inflation amid increasing unemployment and negative GDP growth. An economy is said to have entered a recession after it experiences two consecutive negative GDP growth. The paradoxical experience of the last recession illustrates that the inflation at that time was not demand-driven but instead supply-driven and was as a result of an exogenous negative shock from the global oil price.

Causes of the fall in oil price

• COVID-19

In the early months of 2020, a recent virus called COVID-19 broke out in China, which eventually led to a pandemic. This greatly affected the Chinese economy as it hindered its productive activities. According to the General Administration of Customs, it was posited that China is the second-largest consumer of oil as well as the largest importer of oil globally. China is responsible for a large portion of the global demand for crude oil. Thus a fall in their demand for crude oil as a result of a halt in their economic activities, in turn, meant that the global crude oil demand was going to be negatively affected, which thus led to a drastic fall in the price of oil.

According to a report by the National Bureau of Statistics, as of the third quarter of 2019, China accounted for 31.34% of Nigeria’s total imports, which therefore illustrates that the Chinese economy greatly affects the Nigerian economy.  Due to this fall in global demand for crude oil as a result of a fall in demand in China, the oil price will continue to decline, and this will mean that the federal government’s fiscal activities would be in danger as a result of a fall in revenue below its set target in the budget. If Nigeria does not act quickly regarding this drop in oil prices, then its economy is headed for another recession.

• Saudi-Arabia and Russia trade war

Saudi-Arabia and Russia are two of the world’s largest oil producers (Standish & Johnson, 2020). In March 2020, an oil price war began between the two countries. Before then, both countries agreed to combine their market influence and power to put a floor under oil prices by limiting output and production (Bremmer, 2020). The oil price war broke out when Saudi Arabia decided to go against the already established agreement and cut their oil production further in order to stabilize prices as a response to the slowing demand for oil. This led to a decline in the global oil prices and greatly affected and continues to affect countries whose economies are highly dependent on oil, such as Nigeria.

Economic consequences of fall in oil price

However, the recent crash in oil prices has shown that the country is still highly dependent on oil. Going further, the fall in oil prices has had various impacts on the Nigerian economy. Firstly, the fall has made nonsensical the budget prepared by the Nigerian government. This is so because the budget was prepared with oil price fixed at $57 per barrel (pb), and the oil price fell to about $30pb. This means that both the revenue and expenditure figures have to be adjusted adequately in order to avoid severe consequences in the economy. The fall in global oil demand and price meant that countries whose economies are highly reliant or dependent on oil would be hit severely. Examples are countries in OPEC, such as Nigeria, amongst many others. For instance, Nigeria has a mono-economy, which means that it’s run mainly on the revenue generated from oil. As such, a sudden crash in oil prices is going to affect the economy in various ways, which will be looked at in the sections to come. One of the recent development plans, the Economic and Recovery Development Plan (ERGP), had in its set objectives to diversify the economy.

• Fall in External Reserves and Exchange Rate

The fall in the oil price to less than $30pb meant that the external or foreign reserves that accrue to the government from international trade of its oil would greatly decline as demand for oil produced is at a low. This fall in external reserves will further affect many other aspects of the economy, such as the exchange rate. In addition, since Nigeria heavily relies on exports to China, a fall in China’s demand means that the demand for the Naira will fall leading to a depreciation of the currency due to a fall in exports. The Nigerian economy operates about seven (7) different exchange rates, and the Central Bank of Nigeria (CBN) uses the external reserves to service its exchange rate.  A fall in the level of external reserves means that there will be fewer funds available to finance its exchange rate. As such, this led to the depreciation of the Naira. The value of the Naira to other currencies such as Dollar, Pounds, and Euros began to fall. The exchange rate of the Naira to the Dollar went from $1/N365 at the beginning of March 2020 to a high of $1/N402 in the middle of the same month. This sudden depreciation of the Naira made the monetary authority of the country, CBN, to take the drastic measure of devaluing its currency to $1/N380 and unifying all the multiple exchange rates in the economy.

• Inflation and Standard of Living

The last recession in the country saw inflation rise to an all-time high of 18.72% year on year in January 2017 (National Bureau of Statistics, 2020). The recession at that time was a result of a fall in global oil prices, which is similar to the current circumstance at hand. Therefore, this fall in oil prices is likely to lead to an increase in the level of inflation in the economy. This is a result of a fall in the external reserves, which is used to service the exchange rate, wherein a fall in the value of the Naira will lead to an increase in the cost of production which will thus reduce the number of goods produced and increase prices thus leading to inflation.

The increase in the cost of production will thus lead to the laying off of staff, which increases the unemployment rate and ultimately reduces the GDP of the country. In January 2020, the Central Bank of Nigeria released its Consumer Expectations Survey (CES) for Q4, 2019. The report showed that the purchasing power of consumers is likely to drop this year as a result of a rising inflation rate (Central Bank of Nigeria, 2020). This means that fewer goods are purchased at higher prices than before. In the long run, this will lead to a fall in the standard of living of the populace.

Recommendations and the way forward

Data from the National Bureau of Statistics shows that the unemployment rate was 23.10% in Q3, 2018. It has especially been on the increase since the last recession and is the highest rate ever recorded in the country’s history. Therefore, as stated earlier, if the oil price continues to drop and negatively affect the economy, it will lead to an increase in inflation, which will lead to the laying off of workers and eventually, a recession. Thus, the government has to put in place adequate measures to avoid such a catastrophic scenario.

• Review of the Budget

A hazy budget, such as the present 2020 Nigerian budget will greatly inhibit the growth of the economy. This is a result of the fact that the budget was formulated based on $57 per barrel of oil, and due to COVID-19 and the Saudi Arabia and Russia oil trade war, the oil price has fallen below $30 per barrel. The government can also finance its budget deficits by borrowing from its financial markets. The review of the budget is definitely a key factor in avoiding a recession. The budget should be adjusted adequately to reflect the change in oil prices. In adjusting the budget, priority should be given to sectors that are more in need in these trying times of the COVID-19. Such essential sectors include the health and the agricultural sectors.

• Diversification of the economy and targeting other foreign earnings

The Nigerian economy is highly dependent on oil prices and production and the recent oil shock shows that the country needs to, more than ever, diversify its economy. The government should look into spending and investing more in other sectors, asides the oil and gas sectors. The government can invest and grow other sectors such as the agricultural sector, so it does not have to have to solely rely on oil for foreign exchange earnings and revenue generation. According to Nations Encyclopedia (2020), about 70% of the country’s population still engages in agriculture at a micro-level. In addition, the agricultural sector contributed about 41% of the country’s GDP in 1999. However, Statista (2020) reports that the sector was responsible for only 21.2% of the country’s GDP in 2018. This shows that the contribution of the sector to GDP has fallen by about 48% from 1999 to 2018.  Therefore, with government expenditure in sectors such as this, more people can be employed, which will lead to an increase in the output of the economy.

• Synchronization of Monetary and Fiscal Policies

Fiscal policy refers to the measures taken by the government to control the economy while monetary policy refers to the measures taken by the monetary authority of a country, which in this case is the Central Bank of Nigeria, to control the economy. In order to avoid the looming recession, expansionary policies should be established. For this to be effective, both the government and the Central Bank of Nigeria should synchronize and harmonize their activities. This is to ensure that both are working towards achieving the same goal. A recommendation will be for the government to increase spending in the economy and tie this spending and investment to the production of infrastructure, which will lead to more production and stimulate growth. If the government does this, the CBN should also adopt a similar policy by, for instance, reducing interest rates in order to stimulate foreign investment and increase the money supply, which will be tied to production and also increase economic output and growth. Therefore, the synchronization of monetary and fiscal policies will lead to economic growth and eventually circumvent another recession.

• Legal Framework and Corruption

Getting funds, donations, grants, and loans are one thing, using these funds for the purposes they are meant for is another. The government may be granted foreign aid such as loans and adequate personnel to foster growth and development in sectors other than the oil and gas sectors in the economy. However, due to corruption and ineffective leadership, the funds needed to “kick-start” the economy might be embezzled and thus not invested into the economy but instead used for the personal gain of those at the top in power. “Corruption is a big cankerworm that has really eaten deep into the fabric of our nation” (Kemi, 2019). Therefore, an adequate and legal legislative framework and structure should be set up in order to ensure these funds are effectively utilized, and the effects are trickled down to the people. If the funds are adequately utilized, it will lead to economic growth and development, and a recession will be evaded.

• Small Scale Enterprises

To boost the economy and avoid a looming recession, the government can place more emphasis on small and medium scale enterprises. The services sector contributed 52.01% to the country’s GDP in 2018 (Statista, 2020). This shows that the sector is promising and can even do more if the right incentives and an enabling environment is put in place. The government can reduce the tax rate of 24% (Trading Economics, 2018) to less than 20%. This is to increase the disposable income of the populace. An increase in disposable income will lead to higher purchasing power, which will lead to higher aggregate demand and consumption insofar as supply increases to match the demand. In addition, tax holidays can be given to various small scale businesses in order to help them begin again. The enterprises can be given tax holidays in order to increase their profit and encourage them to produce more, which ultimately leads to an increase in output. A tax holiday success story can be seen when President Olusegun Obasanjo was in power. He made the telecommunications sector thrive by giving the first companies that arrived a tax holiday of three years to settle in and build up. If there is a reduction in corporate taxes and production increases, it will make the economy more attractive and thus boost investor confidence (Konstantinou and Tagkalakis, 2011). Therefore, placing emphasis on other sectors such as the services sector and providing tax holidays and incentives will lead to an increase in production, which will lead to economic growth and, in the long run, foster foreign earnings.

Concluding Remarks

With the exposure of the Nigerian economy to incessant oil shocks, it is advisable for the country to diversify its economy by placing more emphasis, attention, and investment into other sectors other than the oil and gas sector in order to reduce the over-reliance on oil for revenue. In addition, the 2020 Nigerian budget should be reviewed, and changes should be made to the expected revenue and expenditure to reflect the changes in oil prices and allocate more resources to key sectors such as health and agriculture in order to stimulate a higher growth rate and avoid another economic recession.

References

Bremmer, I. (2020). Retrieved from Time Website. Available at: https://time.com/5806218/russia-saudi-arabia-oil/

Central Bank of Nigeria. (2020). Retrieved from Central Bank of Nigeria:https://nairametrics.com/2020/01/10/nigerians-purchasing-power-to-drop-in-2020-cbn-survey/

Kemi, A. O. (2019). Nigeria’s Economy Challenges: Causes and Way forward. IOSR Journal of Economics and Finance (IOSR-JEF), 78-82.

National Bureau of Statistics. (2020). Retrieved from National Bureau of Statistics: https://nigerianstat.gov.ng/elibrary

Standish, R., & Johnson, K. (2020). Retrieved from Foreign Policy: https://foreignpolicy.com/2020/03/14/oil-price-war russia-saudi-arabia-no-end-production/

Statista. (2020). Retrieved from Statista: https://www.statista.com/statistics/382311/nigeria-gdp-distribution-across-economic-sectors/

Trading Economics (2018). Retrieved from Trading Economics: https://tradingeconomics.com/nigeria/personal-income-tax-rate