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22June2018

Delay in passage of the Bill: An impediment to Investment inflows

The high uncertainty that pervades the oil industry about the outcome of the PIB with apparent divergent interest amongst various stakeholders is currently preventing investment inflow into the industry. One of the consequences of the delayed passage of the PIB is the combination of a lull in new investment in the sector and divestment from domestic oil assets (especially on-shore assets) by existing and potential investors as they await the outcome of the reform process. The Nigerian National Petroleum Corporation (NNPC) reported that Nigeria loses over US$287m from Production Sharing Contracts (PSC) monthly due to the non-passage of the PIB. On the aggregate, the sector may be losing an estimated US$18 billion in annual investment due to this constraint as International Oil Companies (IOCs) continue to divest from on-shore assets in favour of off-shore assets pending the outcome of the PIB among other factors. 

It is also believed that the delay in the passage of the Petroleum Industry Bill  has caused the IOCs operating in Nigeria to hold back on their proposed investment in the oil industry estimated at N17.2 trillion ($109 billion). Furthermore, planned investment estimated at $33 billion over the next five years by operators might be in jeopardy as the fiscal terms of the PIB are believed to be unfavourable. In other words, except the PIB is passed into law to reverse this trend, declining oil and gas investment would further worsen the nation’s FDI inflows, which declined from $8.9 billion in 2011 to $7.0 billion in 2012( due to national insecurity and a weak global economy).  

 

Local participation would increase when the PIB is passed into law 

Developing local capacity will ensure that indigenous companies benefit from the multi-billion dollar investments expected to flow into the country after the passage of the Petroleum Industry Bill. The PIB makes adequate provision for the sufficient localization of the servicing and manufacturing ends of the industry’s operations.

Nigerian companies are expected to benefit extensively from the reforms in the industry as they are to be given first priority in the award of oil blocks, oil field licences, oil lifting licences and in all project awards. Indigenous service sectors and companies in petroleum engineering and engineering support services, engineering designs, fabrication, manufacturing and installation, seismic data processing, drilling and exploration services, maintenance services, finance and insurance, health, safety and environment etc. would also be direct beneficiaries of the reforms in the oil industry via the Local Content Act. These provisions should ensure steady growth in Nigerians’ participation in the industry, increase local capacity and industry knowledge and expertise, and boost job creation. It has been estimated that over 3 million jobs could be delivered in the first 5 years of the implementation of the law.

Therefore, as concerted efforts are being made to entrench Nigerian content on the journey to a post-PIB oil industry for the benefit of the local economy, there is a need to launch a vehement campaign on human capacity building to forestall the challenges and opportunities that its implementation would throw up.

 

Diversification is the solution in the long run

While the long-run hedge against the impending oil market glut is the substantial diversification of the economy away from oil to non-oil sectors, particularly government finances and external trade positions, this is only achievable in the medium to long term. In the short term however, enacting a competitive, inward looking Petroleum Sector Act that factors in the evolving global oil scenario is the ideal solution.

While we note that the passage and implementation of the PIB will not eliminate the problem, it would expand investment in the sector while increasing indigenous companies’ participation. This is expected to result in the domestication of a significant portion of revenue, including taxes to government, on the oil and gas value chain. In this regard, we advocate for the conscious creation of a domestic market for crude oil as an extant action to the PIB to facilitate local trading in the commodity on different scales. It is also important to fully deregulate the refining subsector and allow multi-level participation provided the final end products meet the standards required by the government agency/regulator. This way, the existing illegal refineries in the country can be licenced to operate legally.

It is now very important that an investor-friendly Petroleum Industry Bill is passed into law in good time as its delay is holding back investment and is impacting negatively on the Nigerian Economy. Meanwhile, in the face of the comatose start of nations’ refineries in spite of previous efforts made by the Government to revive and maintain them, the PIB must provide an enabling environment to encourage investors to build and maintain new refineries in Nigeria. It is also imperative for Government to diversify the economy from being solely oil dependent, to other streams of income generation such as Agriculture and solid minerals, otherwise the ripple effect of our over-reliance on crude exports to the US, will be devastating to the economy.

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Nigeria’s education and health sectors can benefit from the Bolsa Família Model

Nigeria is a classic case of the paradox of growth without development. The record of sustained higher than peers GDP growth rates over the last ten years alongside a high incidence of poverty and unemployment, and dire health indicators and education statistics, is incongruous. Public allocated resources, in terms of budgetary and extra budgetary allocations to these critical sectors have been adjudged reasonable in most quarters even though they may be below international benchmarks.

Despite the high poverty in the land, the few government programmes that benefit the poor such as fertiliser and fuel subsidies are being threatened by fraud and corrupt practices and the debate as to whether there should be a welfare system for the public has come to the fore.

Poor health statistics compared to the average in Africa and other emerging economies

At 138 out of 1,000 births, the under-five mortality rate in Nigeria is higher than the African average of 127, similarly, 27% of children under five are underweight compared to the 20% African average. At 840 deaths per 100,000 births, the maternal mortality rate for Nigeria is substantially higher than the African average of 620 and Brazil’s 58. The proportion of births attended to by skilled personnel is 39% compared to an average of 57% for Africa. Due to the inadequacy of public health infrastructure and low affordability among the populace, many seek cheaper alternative methods.

Recent survey suggests that the Universal Basic Education programme is not achieving its objective

While the overall primary school enrolment and completion rates are impressive at 83% and 74% respectively, the statistics have been supported by data that is skewed to regions that are educationally advantaged. The most recent statistics suggest that over 4 million school age children are out of school in Nigeria and/or are engaged in one form of child labour or the other to support themselves and/or their families. This is despite the compulsory Universal Basic Education (UBE) programme which mandates compulsory first 9 years of schooling for all school age Nigerians. UBE receives statutory transfer status in the government’s annual budgetary allocation. 

Nigerian Poverty Incidence- hunger amidst plenty

Nigeria’s incidence of poverty is put at 57.61% on the average across four poverty measures. According to the National Bureau of Statistics (NBS) data, 40.63% of Nigerians are food poor, consuming an inadequate amount of calories per day; 60.48% are absolutely poor; 69% are relatively poor, spending less than two third of the total household expenditure; and 61% live on less than a dollar a day. This is compounded by an unemployment rate of 23.9% (2011) which also explains the high level of inequality in the country as indicated by the Gini coefficient of 0.447 in 2011. Gini coefficient is a measure of inequality in a country on a scale of 0 - 1 with 1 representing perfect inequality in terms of access to economic resources.

Addressing the poverty issue in Nigeria may require adopting the Brazilian Bolsa Familia model or a variant of it

There have been several attempts at providing social safety programmes in Nigeria in the form of pro-poor, women and/or employment programmes. Some notable ones that draw direct funding from the public budget include the National Directorate of Employment (NDE), Small and Medium Enterprises Development Agency of Nigeria (SMEDAN), National Poverty Eradication Programme (NAPEP), and in recent times YouWin and other women and child health related components of the Subsidy Reinvestment programme (SURE-P). A major concern however is the extent to which these programmes have produced the desired effects of employment generation, poverty eradication, and improved health for women and children in relation to the resources allocated to them each year.

Addressing this conundrum, in a country without a clear social security system that supports the poor and unemployed, requires an intelligent approach, especially in an environment where corruption is rife. In this regard, there have been suggestions that the ingenious approach developed and adopted by Brazil or a variant to suit the domestic situation could be adopted in Nigeria. The programme named Bolsa Família Programme (BFP) or family grant has been adjudged one of the most efficient social security systems globally by the World Bank. It is currently being recommended to other countries and has been adopted by the United States in New York's Opportunity NYC programme.

The Bolsa Familia Programme grants limited monthly income based on meeting specific conditions

The Bolsa Família Programme (BFP) was created in October 2003, through the merger of four pre-existing cash transfer programmes, in an effort to improve the efficiency and coherence of the social safety net and to scale up assistance to provide universal coverage of Brazil’s poor. The programme provides transfers ranging from 15 to 95 Brazilian Reals (R$) (US$7-45) per month to poor families. BFP is a conditional cash transfer programme that seeks to help reduce current poverty and inequality by providing a minimum level of income for extremely poor families, and break the inter-generational transmission of poverty. Eligibility for the transfers is based on beneficiaries’ compliance with three specific human capital requirements.

First, for a family to qualify for cash payments every month, children must stay in school until age 17, and attendance must be at least 85% up to age 14 and 75% thereafter. Secondly, children must get the full set of vaccinations in their first five years. And finally, mothers must attend pre and post natal care. The BFP programme targets poor and extremely poor families throughout the country. The adopted income ceilings for eligibility were set at a fixed monthly per capita family income of R$100 (US$48) for moderately poor families and R$50 (US$25) for extremely poor families.

The amount of transfer is basic; preventing recipients from making a substantial living on it

In setting the monthly amount, a number of factors were considered and the adopted value was set to ensure that the resulting benefits are simple to administer, favour the extremely poor, favour families with children – but with limits to avoid promoting fertility, and prevent eligible beneficiaries of the old programmes from losing out on the new programme. The BFP provides two types of benefits: basic and variable, according to family composition and income. All families in extreme poverty get the basic benefit regardless of demographic composition. Both extremely poor and moderately poor families receive a variable benefit based on the number of children in the family with a maximum of coverage for three and whether the mother is pregnant or breast-feeding.

Although the assistance unit is defined as the family as a whole, payments are made preferentially to the woman in each family as the legally-responsible beneficiary, as established by the BFP law. Hence, 93% of legally responsible beneficiaries are women. This preference reflects international experience that suggests that women are more likely to invest additional income in improving the education, health and welfare of their family, particularly their children, than men. 

Implementation of the BFP leads to improvement in Brazil’s economy and welfare status

The level of support is low, as it is designed to supplement income from jobs; however studies have shown that the injection of this cash into particularly poor communities is helping stimulate the local economy. According to the Fundaçao Getulio Vargas (FGV), a university in Brazil, the number of Brazilians with incomes below R$800 (US$440) a month has fallen more than 8% every year since 2003. The Gini index, a measure of income inequality, fell from 0.58 to 0.54, a significant fall by this measure.

Studies have also shown that the bulk of the money is spent on necessities such as food, school supplies, clothing and shoes. This is in contrast to the anti-cash transfer arguments that if you gave money to the poor, they wouldsimply spend it on alcohol. While only an 8% poverty reduction can be attributed to BFP benefits, the impact on the poverty gap and the severity of poverty has been stronger, and these have fallen 18% and 22% respectively. FGV and the World Bank argued that the BFP has also been efficient considering it has similar impact on poverty with the public pension scheme but at far lower cost.  On the broad indicators of education and health which form the core of the conditionalities in the BFP, Brazil parades one of the most impressive figures globally, especially on health.

Nigeria can benefit immensely by adopting the Bolsa Familia model

Nigeria may need to urgently review the myriads of poverty and employment programmes that benefit only a few, which currently run, and consider revising them into only one or a few effective ones that benefit many. Since Nigeria’s rank on the health and education performance scale is at the lower rung of the table and there is currently no social safety net to direct transfers to the poor, adopting a model similar to BFP could be hugely beneficial.

However, it must be noted that a transparent national identity database must precede any form of implementation of this programme as a functional requirement so as to minimise the likelihood of benefits ending up in the wrong hands. 

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Fighting high inflation rate at the expense of high unemployment and poverty rates is not approprate

On the one hand, recession hurts the ability of an economy to operate at its full potential. Firms are forced to operate below capacity as aggregate demand dwindles; pushing down the level of equilibrium aggregate production below full employment. A recessionary gap is thus created; a scenario in Keynesian Model, implying a contractionary business cycle. On the other hand, economies experience boom during expansionary business cycle. Expansionary cycle creates inflationary gap resulting from higher aggregate demand level above aggregate production and consequently overheating rapidly rising prices before leading to a ‘burst’. Due to these opposing circumstances, there is need for stabilization.  A counter-cyclical stabilization works to smoothen out business cycle fluctuations by expansionary public spending or tax cuts in recessions and/or contractionary policy in boom periods. These policies generally encompass both discretionary changes in monetary policy resulting from specific policy decisions and automatic stabilizers that occur when policy thrust automatically respond to changes in economic activity.

Some economists argue that the monetary policy should flexible enough so as to implement discretionary counter-cyclical policy when they are most needed.  A situation of  tight monetary regime where monetary easing is required will only lead to further growth contraction as high interest rate constrain local production capacity. The avoidable scarcity of these  domestic items will be created with serious consequences for inflation; in addition to defeating the domestic capacity development objectives of the government.

The Nigerian situation calls for a review of the tight monetary regime

Although the principal object of the Central Bank of Nigeria (CBN)  is to ensure monetary and price stability, it also has developmental functions in addition to providing economic and financial advice to the federal Government. In that case, the monetary authority has responsibility for economic growth as much as it has price stability  mandate. Declining growth rate, growing unemployment and poverty rate should be a concern as much as inflation is. The impact of the high interest is unfriendly to the situation of the economy.

Aggregate demand channel has been negatively impacted

Economic theory and research outcomes have identified a number of ways through which monetary actions are transmitted to the real economy by altering the amount of money in the economy; directly or indirectly. Directly through the sale and purchase of short term government securities in open market operations or indirectly through the use of the short term benchmark interest rate. The first channel of impact is through the aggregate demand on both the output and prices; a process called the demand channel. When monetary policy is contractionary or tight as is currently the case in Nigeria, borrowing costs increase, making it less likely for consumers to demand commodities they would normally finance such as houses or cars. And for businesses, they become less likely to invest in new equipment, projects, or buildings. Theoretically, the reduction in the level of economic activities will push inflation lower because lower demand usually leads to lower prices. 

The retail lending rate rose from an average of 18.36% in 2007 to 23.5% in 2012. During the same period, the monetary policy rate (MPR) rose from an average of 9.13% to 12%. However, the MPR declined to as low as 6.08% in 2010 before the commencement of the current spate of monetary tightening. The retail lending rate has however trended upward even at the low MPR in 2010; indicating a disconnect between the MPR and the retail lending rate at this point. This could be blamed partly on the curtailment of lending by banks during the global financial crisis as asset prices collapsed. The period was characterised by a sharp dry up of bank credit to both the corporate and retail consumers, as the regulator battled to sanitise the banking system. While the monetary policy approach to resolving these issues has worked to stabilise the industry, the punitive classification of risk assets may have raised the bar on credit evaluation thereby weeding out some classes of borrowers. An important parameter in that process is the dynamics of the retail lending rate in which the prime lending rate declined compared to an increase in the maximum lending rate between 2009 and 2012. The decline in prime lending rates indicates an increased preference to supply credit to select prime customers, usually corporates.

The balance sheets, bank lending and exchange rate channels were also not spared

An increase in interest rates also tends to reduce the net worth of businesses and individuals. This is called the balance sheet channel of impact; that makes it tougher for them to qualify for loans at any interest rate, thus reducing spending and increasing price pressures. This occurs by making many erstwhile feasible projects unprofitable at a higher hurdle rate as the weighted average cost of capital (WACC) increases with each interest rate hike. It therefore introduces the problem of adverse selection to the lending process - a situation where the level of interest rate weeds out likely quality credits leaving only the potentially bad ones; a scenario that may be playing out in Nigeria.

An interest rate hike also makes banks less profitable in general and thus less willing to lend. This is called the bank lending channel. This is because the fall in credit demand accompanying a monetary contraction robs the bank of the credit margin which cannot always be substituted for by trading/holding of liquid assets, including government securities. However, where monetary tightening results in higher real yields on secured and liquid assets and is followed by widespread deleveraging, the fall in deposit rates could allow for a substantial spread which would enable banks remain profitable.

High rates normally lead to an appreciation of the currency, as foreign investors seek higher returns and increase their demand for domestic assets. The recent surge in foreign portfolio investment alludes to this. At over 12% yields on government securities, Nigeria appears to be the only country with a sovereign risk rating of BB- that offers such a significant return on risk free assets. This is in addition to the sustained positive real return over the last 2 years as the monetary authority keeps it so at every level of inflation. In return, the surge in FPI has resulted in an increase in the value of the naira in recent times. 

However, through the exchange rate channel, exports become less competitive with their volumes reduced as they become more expensive, and the level of imports rise as they become cheaper. While it can be argued that our non-oil export industry is small, the naira value of oil export earnings, the major source of government revenue, becomes lower with implications for fiscal expenditure profile and outlook. For instance, the adoption of a N160/US$ exchange rate for the budget 2013 revenue assumption may weaken the government revenue profile in 2013 if the current monetary policy stance sustains the exchange rate at N155/US$, a very strong possibility.

Inflation in Nigeria is structural and high interest rates appear to be compounding the problem

The debate on whether inflation is a structural or monetary phenomenon has been on-going for some time. The constrained business environment which continues to keep the economy well below its production possibility frontier is also worthy of note. Another factor is the structural disconnect that allows fiscal excesses to create systemic liquidity without any productive impact with strong implications for price stability. The resolution of these issues is at the heart of a balanced monetary policy framework.

The implications of this is that the proportion of and rise in costs caused by the myriads of supply side constraints, especially infrastructural challenges, in the prices of goods and services is very high. We believe that this effect is big enough to sustain inflation rate in the double digit region if the monetary contraction continue to add to the supply side problems. One argument that highlights this conclusion is the fact that inflation rate were at their lowest during the period of accommodating monetary policy in 2007-08. And in those periods, economic growth was also high.Since the monetary authority has recognised the structural nature of inflation and the improvement in fiscal policy, we believewhat the Nigerian economy requires at this crossroad of structural reforms, is a complementary interest rate environment that supports the reduction of retail lending rates to single digit levels.

Period of monetary easing has coincided with declining inflation suggesting productive use of liquidity

The 2007/08 period was preceded by strong institutional development and fiscal commitment to economic liberalisation. Investment in infrastructure was also modest with high expectations upon which long term productive investments could be made. And investment was growing alongside aggregate demand in an environment of both high liquidity and monetary accommodation. Monetary aggregates- broad money, net credit to the economy, and credit to the private sector grew at an average annual rate of 52.8%, 176.9% and 72.1% per month respectively between 2007 and 2008, while inflation, although rising remained in single digits for most of the period. The global recession which started in 2008 and the oil production shock caused by the Niger Delta insurgence arguably contributed to the volatile economic conditions afterward.

The periods of monetary easing through 2009-2010 coincided with a peak in inflation; perhaps a lag effect of earlier monetary expansion and primarily due to the sharp depreciation of the naira. It was also the period of major moderation in inflation from the peak of 15.6% to 11.8% as the exchange rate stabilised and the adjustment was priced into costs; it might as well be a result of the global economic recession. This suggests that barring structural constraints, given the typically high the marginal propensity to consume in an economy with vast idle resources and high absorptive capacity, high liquidity will not necessarily cause inflation. In the presence of heavy structural constraints, what monetary tightening does is to simply add to the constraints and force down aggregate demand and prices with limited impact.

The credit channel of monetary policy transmission mechanism may be more effective at inflation management

Since the 1980s, the hitherto established view that the cost of capital is the key link in the transmission mechanism of monetary policy has come under intense challenge by the modern view which saw the supply of credit to firms as the key factor.The traditional Keynesian ISLM view of the monetary transmission mechanism indicates that an expansionary monetary policy will lead to a fall in real interest rates, which in turn lowers the cost of capital, causing a rise in investment spending, thereby leading to an increase in aggregate demand and a rise in output.

The simplified assumption that a firm’s cost of capital is determined by a single interest rate is consistent with the Modigliani and Miller theorem that a firm’s cost of capital is not affected by its leverage based on the assumptions of a perfect market and no transaction costs. The asymmetry of information due to market imperfection and thus the presence of agency and bankruptcy costs have led theorists to the consideration of the credit channel as an alternative transmission mechanism of monetary policy. The liquidity preference theory shifted monetary economists’ focus from interest rate to the money supply as the key link in the transmission mechanism.

We recognise the problem of unproductive liquidity injections from fiscal excesses which could compound systemic liquidity and pose a threat to exchange rate stability and hence price levels. It is a product of the structural disconnect in our economy which allocates the highest financial flows to the smallest contributor to growth. However, we are of the opinion that targeted market rules and regulations as well as quantitative monetary interventions and incentives, as proven by the positive outcomes of some of the recent rules around interbank and foreign exchange market activities would suffice at managing such liquidity.

We believe that a supply of money approach otherwise known as quantity based anchor, which regulates aggregate demand, may be more effective. This is because a monetary policy system that monitors the flow of liquidity and uses the open market operation to mop up any excessive and unproductive injections directly will do better than a generalised benchmark interest rate that punishes all sectors of the economy regardless of whether they benefit from the liquidity flow. While they tend to have the same effect on short term market rates, a targeted approach will have a more positive impact on economic activities as businesses can access longer term finances (through the capital market) at relatively cheap rates.

Nigeria needs monetary policy easing to prevent the economy from an economic cliff

Monetary policy has a strong role to play in expanding financial inclusion and ensuring that proper financial intermediation other than securities trading remains the hallmark of the banking system. An important task in this regard is working with the fiscal authority on the roles of the monetary authority in the development strategy of the government. The current weakness of that handshake is constraining the monetary authority to a reactive stance at the expense of a supportive monetary policy direction particularly in relation to interest rates.

We must note that the Nigerian economy faces its own economic cliff to which a commencement of monetary tightening reversal and a comprehensive review of the financial intermediation process and policy transmission channels is important. Such a review will increase access to finance for small scale businesses who are major employment creators. Other sectors, especially light manufacturing in food and beverages, housing, and construction would increase their share of GDP while the increasing aggregate supply is likely to create competition that would have a positive inflationary effect.

In our opinion, monetary policy dynamics are not static and the market understands this. More importantly, the positive edge which monetary policy has over fiscal policy is the short term flexibility and usefulness at providing cyclical and countercyclical solutions. Therefore to forestall pushing the economy down the growth slope, and to help boost economic activities going forward, we recommend that the monetary authority should limit the use of OMO for to support the short term rate at the current level. In addition, at the shortest possible  time, the Central Bank of Nigeria should signal the commencement of monetary easing so as to boost economic activities, save the economic from free-fall and reduce unemployment.

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Take away the fuel subsidy, but give us Bolsa Familia

The harsh reality of a deregulated petroleum regime is that it will hurt the poorest in the land especially in the short to medium term.  The abolition of the subsidy would increase gasoline prices to between N150 and N180 a litre. This could stoke inflation, weaken disposable income and further aggravate economic inequalities. In Nigeria, food accounts for 52% of household spending, 45% live below the poverty line, and the World Bank puts the country’s Gini Index at 0.43 (Gini index is a measure of income inequality where 0 represents perfect equality in a society, while an index of 1 implies perfect inequality). Nigeria lacks the most basic social welfare niceties even to those genuinely deserving of it and the removal of the petroleum subsidy which has helped provide cheap fossil fuels will be hotly contested. Removing the fuel subsidy will save the country about N1.8 trillion annually for the next five years and reformers will help their case by pushing for good causes to channel these savings into.

We highly admire the good works of the “Bolsa Familia”, a conditional cash-transfer programme (CCT) which goes to 13m families in Brazil (about one in four) as long as the children stay in school and get medical check-ups. Bolsa Familia, according to its most recent progress report, published in March, helped drop rural poverty by 15 points between 2003 and 2008. It has also won high praise from ever sceptical bodies like the World Bank whose former President described it as a “model of effective social policy” and has been exported to places like the United States. New York’s Opportunity NYC is partly based on it. Bolsa Familia has also come cheap, costing the Brazilian government only about 0.4% of GDP in contrast to our unwieldy fuel subsidy which is costing us about 3% of GDP. Nigeria can therefore benefit from replicating this model .

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Power Sector Reform : Nigeria must avoid the Indian path

India experienced a massive power outage earlier in August which threw over 600million people into darkness for two days. Hospitals, sanitation plants and offices grounded to a halt, airports and factories had to rely on backup generators which put smear on the country’s reputation as an emerging economy. The immediate explanation for the blackout is an overload of the national network that links together regional grids. Three of the five transmission grid collapsed; cutting power to about half of the country’s population.

The lesson for Nigeria in the foregoing includes the commitment to ensure that the entire privatisation process is completed unhindered with little or no vested interest. At the end of the process, it is important to ensure that government involvement has been minimised to the barest minimum but limited to regulation and consumer protection, without stifling market in the entire value chain.

In this regards, tackling the biggest problem of the process, which appears to be the gas to power section of the value chain requires increased transparency and coordination among stakeholders. The Petroleum Industry Bill (PIB) when passed into law should provide the required governance and incentive for increased private investment in oil and gas sector to support efficient utilisation of the gas resources of the nation.

In the meantime, it is important that a middle ground is created to bring all the stakeholders together, beyond the inter-ministerial committee which ensures that critical issues hindering gas distribution is tackled. Government investment and control of the gas to power sector in the immediate time until the cost reflective gas price is achieved may be required. However, there is no gainsaying that the reform is on course.

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