Revenue collection risks hidden behind inflation victory

Nigeria's inflation plunge from 34.8% to 15.10% between December 2024 and January 2026 creates a dangerous illusion for fiscal policy. While the Central Bank celebrates ten consecutive months of decline, the real story is what this means for tax collection capacity in an economy where most workers operate outside formal payrolls.

The Consumer Price Index dropped 3.8 points to 127.4 in January 2026. Lower inflation typically boosts real incomes, but Nigeria's Federal Inland Revenue Service faces a structural problem: most beneficiaries of this purchasing power recovery pay minimal income tax. Street vendors, artisans, and small-scale traders who drive consumption rarely file returns.

Foreign reserves climbing to $46.8 billion helped anchor naira stability, but this masks the government's continued dependence on oil revenues rather than diversified tax collection. The informal sector that benefits most from stable exchange rates contributes least to federal coffers. Angola faces similar challenges, where oil windfalls mask weak non-oil revenue mobilization despite monetary stability.

Rate cuts risk worsening fiscal imbalance

The Monetary Policy Committee meets February 23-24, with Reuters noting that moderation "could encourage the central bank to cut interest rates." This creates a fiscal trap.

Lower rates will stimulate economic activity, but Nigeria's tax-to-GDP ratio remains well below regional averages. More economic activity in the informal sector means more untaxed transactions. Monetary policy transmission through lower borrowing costs could paradoxically worsen the federal government's revenue position.

Consider the implications: if inflation stays at 15% while the MPR drops from current levels, real borrowing costs turn negative for businesses. This should boost investment and job creation. But new jobs in Nigeria typically emerge in the informal sector, where tax compliance is voluntary and enforcement is weak.

The inflation victory narrative ignores persistent structural weaknesses in revenue administration. VAT refund backlogs create substantial burdens, while compliance costs for formal businesses remain punitive. Companies spend excessive time on tax compliance - resources that could generate taxable profits.

This creates perverse incentives. As inflation moderates and business conditions improve, rational entrepreneurs still prefer informal operations to avoid the compliance burden. The result: economic growth that doesn't translate to proportional revenue growth.

Structural reforms enhanced FX stability, but parallel reforms in tax administration lag badly. Digital payment adoption could help capture informal transactions, but current policies discourage electronic payments through multiple taxation layers.

Policy coordination challenges ahead

The inflation decline from 27.61% in January 2024 represents genuine monetary policy success. But fiscal policy hasn't kept pace. Nigeria needs tax system reforms as aggressive as the central bank's FX interventions.

Without broader revenue mobilization, the government will remain vulnerable to oil price shocks despite monetary stability. The informal sector that benefits from lower inflation will continue free-riding on public services funded by formal businesses and oil revenues.

The challenge extends beyond simple tax collection. Nigeria's revenue administration struggles with capacity constraints, outdated systems, and limited coverage of the expanding informal economy. While monetary policy tools can quickly adjust to changing conditions, tax system reforms require longer implementation timelines.

Investors should watch the February MPC decision carefully. Rate cuts that boost informal sector activity without corresponding tax policy reforms will widen the fiscal deficit. That eventually forces either higher formal sector taxes or renewed borrowing - both negative for business investment returns.

The monetary policy success in bringing inflation down from extreme levels deserves recognition. However, sustainable fiscal health requires complementary reforms that expand the tax base beyond oil revenues and formal sector businesses. Without this coordination, Nigeria risks repeating cycles where monetary stability masks underlying fiscal vulnerabilities that eventually resurface during external shocks.