Nigeria: A Struggling Economy Embraces Reform - Part I
Some Relief in Sight for 2017
It comes as no surprise that the biggest risks facing the economy continue to be (a) the price of oil and (b) the inability to attract hard currencies and manage the FX rate, two complex and deeply interrelated factors. The price of crude oil dropped from about US$102 per barrel at its peak in 2014 to US$37.80 in December 2015, leading to a massive contraction in hard currency revenues and government taxes; full-year estimates put US dollar reserves in Nigeria at just over US$25bn, down from US$34bn in 2014. The government deficit reached just over NGN2.2tn in 2016, manageable in real terms as a percentage of GDP but nearly double the deficit recorded from a year earlier. The shortage of hard currencies, due to lower oil revenues, has made it nearly impossible to import anything into the country, from food to textiles, and has caused some components of inflation to skyrocket. Food prices climbed 18.5% on average, up from 17.8% the month before.
Green shoots in the economy have started to emerge, however. Oil prices have increased from their December 2015 lows to reach close to US$55 per barrel in January this year, driven in part by OPEC-led production cuts and a weaker dollar during the first quarter of 2017, which has led to higher US dollar revenues and marginal easing of hard currency shortages in recent months. For the first time in 16 months, average inflation in the country shrank in January from 18.7% to 17.8%, according to the National Bureau of Statistics, a trend economists expect may continue in the absence of any large external shocks – and could even lead the Central Bank of Nigeria to adopt an easing bias later in the year.
The 2017 government budget and the recently published, long-anticipated Economic Recovery & Growth Plan (ERGP) 2017-2020, are also sources of optimism. The Federal Government has proposed spending a record NGN7.3tn in 2017, a 20.8% increase over 2016 levels, and it is looking to extend its borrowing to NGN2.23tn, to be finance through the capital markets, as well as development banks and large multilaterals. While the government fell short of its revenue absorption targets in 2016, it hopes to soak up about NGN4.94tn in 2017 – an increase of about 28%. It also plans to spend about 30% of budget revenues on developing the country’s infrastructure.
The ERGP 2017-2020 spells out the means by which the government hopes to restore growth in the medium-term, with some of the key outcomes and ambitions summarised below:
- Stabilise the macroeconomic environment: Bring inflation down into the single digits by 2020 by realigning monetary, fiscal and trade policies, with an emphasis on embracing policies that remove uncertainty in the exchange rate. This would help restore investor confidence in Nigeria’s economy
- Restoring growth: Restore GDP growth to 2.19% in 2017, and up to 7% of GDP in 2020, driven largely by a recovery and expansion of oil and gas production along with increasing investment in real sectors of the economy. Crude oil output is expected to rise from 1.8 million barrels per day to 2.2 million barrels per day in 2017, up to 2.5 million barrels per day in 2020
- Agricultural transformation and food security: Generate 6.9% average growth in the agricultural sector through 2020 through targeted investments that boost crop production and help the country achieve self-sufficiency in a number of foodstuffs including pasta, rice and wheat, and become a net exporter in a number of goods
- Power and petroleum sustainability: Bring another 10GW of operational capacity online by 2020 to help improve the energy mix, and boost its (a) renewable energy sector and (b) petroleum refining capabilities. The government hopes to become a net refined petroleum exporter in three years
- Improve transportation infrastructure: Invest heavily in road, rail and port infrastructure and boost PPPs to further develop strategically important rail networks to bolster connections between the country’s major economic centres
- Economic industrialisation: Target SMEs and the services sectors with strategic spending and incentives, including the agro-processing, food, beverage and manufacturing sectors, and improve ease of doing business
- Job creation: Reduce unemployment from 13.9% in Q3 2016 to 11.23% by 2020, creating an additional 3.7 million jobs by 2020 – with a focus on youth employment
- Improved foreign exchange inflows: Reduce petroleum imports and improve local refining capacity to ease demand for hard currencies, with economic diversification improving foreign currency inflows into non-oil sectors
Oil, FX, Reform Lag Remain Leading Threats
Reform on this scale is often easier said than done, of course, and it could take years to see them come to fruition. In the meantime, the country still struggles from a number of headwinds.
The biggest source of anxiety for investors is the country’s foreign exchange policy, which has come under heavy scrutiny since its introduction. The partial float in June 2016, which has since wiped up to 40% off the value of the naira against the US dollar, has made imports more expensive. With the regulator blocking importers from accessing official FX markets to bring in up to 41 different kinds of products, many have been pushed into the black market to access hard currencies. This has perpetuated a widening gap between the official exchange rate, which hovers at around NGN310 per US dollar, and the black-market rate, which hovers closer to NGN500 per US dollar. So far, the country’s regulators have seemed less willing to unwind its current policy for fear of stoking inflation, though successfully securing further funding from the World Bank as part of a US$2.5bn rescue package could encourage the Central Bank to liberalise its FX policy.
Oil, and economic diversification, are also primary concerns. With recent OPEC-agreed production cuts being unwound, analysts are unsure of the trajectory of oil prices. This is less of a short-term concern for the Federal Government, which uses a modest floor of US$42.5 per barrel as a baseline for its budget assumptions. But it does raise questions over its long-term ability raise the finances it needs to fund its ambitious infrastructure investment targets. At the same time, the government’s economic diversification plan is big on ambition but lighter on tactics. It wants to bring non-oil growth up from -0.07% of GDP to 4.83% of GDP in 2018, with the bulk of that growth shouldered by agriculture – a sector notoriously at the whim of precarious factors – and the service sector, driven by a stimulus-induced construction boom. Perhaps most risky of all is the longevity of the state’s conviction around economic diversification in the event oil prices rise dramatically over the coming period, and with fresh elections in 2019, the Buhari government may be tempted to stray from the reform path in favour of populism.
Finally, concerns over subdued global growth and interest rates persist. With a continued deceleration in Chinese growth – as its transitions from an export-led to a services-led economy –uncertainty around global commodity demand is rising. Rising interest rates in the US could also drive up dollar borrowing costs, which could weigh heavily on importers and manufacturers.
Concluding Thoughts
Despite the challenges ahead, analysts are optimistic about the country’s prospects. Both the Nigerian Stock Exchange and FMDQ have recorded increased foreign portfolio investor participation in equities and fixed income instruments, respectively, over the past few months. Nigerian lawmakers have set some ambitious reform targets for the next three years which, if successful, could pull the country out of one of the worst recessions it has ever experienced.
With more hard currency coming into the country, the country’s importers and dollar-dependent industries are likely to enjoy some respite from the challenges of 2016, and prompt further borrowing and investment. Credit growth in 2017, which is likely to be concentrated around the petroleum, construction, and infrastructure sectors, is looking more robust than in the previous two years – but volumes are likely to depend on continued spread compression.
The coming year will be wrought with challenges to be sure, but the potential for upside is significant; if policymakers play their cards right, there is a good chance many will look back on 2017 as a crucial turning point for the country’s fortunes.
