| Nigeria Economy |    1605 VIEWS  |
| Nigeria Economy | |
| 1605 VIEWS | |
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Thursday,
March 12, 2020 / 3:54 PM / By CardinalStone Research
Executive Summary
The rapid spread of COVID-19 has clearly altered
global economic outlook for 2020. Recently, the World Health Organisation (WHO)
classified COVID-19 as a pandemic, suggesting a possibility of further shutdown
across economies with knock-on effects likely to negatively distort global
trade and mobility. This risk is further accentuated by the ongoing oil price
war stoked by the failed OPEC+ resolution on oil production cuts.
The domestic economy is not immune to the impact of deteriorating global macros and collapse of major commodity prices. As it stands, global crude oil price is now c.38.3% lower than Nigeria's budget benchmark crude price of $57.00/barrel. While the country is currently reeling from the second-order effect of the ongoing crises, we highlight the risk that a graver first-order effect can be unleashed by further spread of Coronavirus in the country. In this report, we expatiate on the likely implications of these developments on Nigeria, vis-a-vis:
COVID-19: Global growth on the balance
The
unexpected outbreak of the Corona Virus Disease (COVID-19) has adversely
impacted the world order, with China (the second largest economy) on course to
record its worst growth in a decade. Major central banks are now enacting
looser monetary policies as global equities reverse earlier gains and safe
haven assets rally amid investors' flight to safety. Partly justifying the
panic is the reduction in global economic activities as businesses and
consumers pull back on consumption and investment. Commodity prices have not
been left out in the downturn as prices of energy, industrial metals, and
agricultural commodities succumbed to a COVID-19-induced demand dip. The prices
of crude oil, gasoline, natural gas, copper, crude palm oil, and wheat have
heavily declined, adversely impacting revenue generation in producing
countries.
COVID-19 and Oil shocks: Domestic economy to reel from impact
As it
stands, global crude oil price is now materially lower than Nigeria's budget
benchmark crude price of $57.00/barrel. The impact of COVID-19 on demand
outlook and fresh oil price wars, stoked by the failed OPEC+ resolution on
production cut, have also led to material reviews of oil price projections. By
our estimates, a base case average oil price projection of $42.50/barrel could
result in a N726.68 billion loss in projected oil revenue for 2020 even if
government successfully meets its oil production target of 2.18mbpd. This,
alongside a possible reduction in capex intensity to 17.0% (vs. over 35.0% in
the approved budget), and 90.0% realization of non-oil revenue target could
result in a fiscal deficit of c.N2.73 trillion in 2020 (vs. N1.91 trillion in
annualized 9M'19 figures).
FX: Weaker fundamentals may force currency repricing in 2020
The
fundamental case for the naira is now materially weaker, with twin deficits
across current account and fiscal balances combining with higher inflation
expectations to bolster the argument for a currency repricing. Clearly,
Nigeria's external buffers are lower, with reserves and excess crude accounts
now at $36.2 billion and $71.0 million apiece compared to $62.0 billion and
$20.0 billion, respectively, before the 2008 global economic crisis.
This
comes with significantly higher vulnerability to external shocks as foreign
portfolio flows into the apex bank's Open Market Operations (OMO) now
constitutes c.32.7% of reserves amidst, arguably, one of the worst oil market
crises since the Gulf war of 1990/1991. Aided by marked deterioration in oil
economics, we expect the CBN's unorthodox currency management to capitulate
before the end of 2020 if oil prices continue to go south.
By our
base case projection, the naira is likely to be repriced closer to its fair
value of c.N437.20, which reflects an average inflation of c.13.0% for Nigeria
and 2.0% for USA, in 2020. We also note that a delayed response by the CBN
(which is likely) could stoke further panic buying and hoarding in the black
markets. The CBN may eventually adopt a stepwise approach to naira repricing in
2020 in view of the politically hot nature of devaluation discourse and the
potential knock-on effect on the populace, who are also bracing up for
electricity tariff adjustments.
Equities: Brace up for another negative close; but strategic positioning
could rescue the proactive
Nigeria's
equity market has been adversely affected by concerns about the quick spread of
the coronavirus since mid-January, mirroring sentiments in other global
markets. The bourse has since eroded earlier gains recorded after a startling
start to the year which saw it standout as one of the best performing equity
markets globally. In addition to health-related concerns, a failed OPEC+
attempt to extend production cut agreement cascaded to an oil price war and the
worst Nigerian daily equity market performance in 2020. Clearly, our revision
of Nigeria's growth and inflation expectations for 2020 suggest that the
equities market may be set to close in the negative for a third straight year.
Considering the negative crude oil price outlook for Q2'20 and Q3'20, we again
bring to the fore the strong correlation between the ASI performance and crude
oil prices in the last four years.
Given
our base case expectations for naira devaluation and a slowdown in CAPEX in
2020, we note that brewers, other manufacturers reliant on imported raw
materials, and cement producers are likely to be directly impacted. Notably,
following the 2016 devaluation and recession, these set of producers
experienced the sharpest contraction in operating profits in Nigeria.
Elsewhere, we see scope for FX gains in banks with net-long dollar positions.
These gains may however be capped by impairments on oil & gas and other
associated loans. In the downstream oil & gas sector, operators are likely
to book higher lubricant margins (on falling crude oil price) that could
slightly offset cost of importation. Real value could, however, be unlocked by
a proper deregulation.
Overall,
we believe the market will likely remain bearish in the short term as investors
remain cautious amidst coronavirus concerns and depressed oil prices. However,
the sell-offs present bargain hunting opportunities for mid-to-long term
investors who look to take position in fundamentally justified counters ahead
of an inevitable change in tide. To this point, we highlight the stock market
rebound in 2017 following the 2015/2016 crisis.
Fixed Income: External shocks to drive yields higher
In the
fixed income market, domestic sovereign yields are likely to climb in near term
(quicker than our previous forecast of Q3'20) driven by a combination of recent
external shocks and prevailing domestic macros. The sizeable reduction in OMO
maturities (N618 billion on average in Q2'20 and Q3'20 pales in comparison to
average OMO inflows of N1.5 trillion since the OMO ban in October 2019), the
likelihood of higher fiscal borrowing (as oil revenues shrink), increased
pressure/speculation on FX, and heightened credit risk & inflation concerns
are likely to place upwards pressure on yields in the short term.
For OMO
bills, which are exclusively traded by foreign portfolio investors and banks,
we also see legroom for an uptick in yields as the CBN is likely to reprice
rates higher to compensate for the heightened risk. In addition to the recent
oil price war, the increased probability of a ratings downgrade, following
previous revisions from 'stable' to 'negative', is a key risk to yield outlook.
FPI's have largely been on the sell side in recent months, trimming their
holdings in OMO bills from $17.7 billion in August 2019 to $12.7 billion in
November 2019 as the CBN faces an uphill task of convincing investors to stick
as reserves continue to slide.
Asset Allocation
Given
the heightened risk environment, we think 75% and 25% weightings in favour of
fixed income and equity exposures, respectively, are ideal. We expect investors
to stay short in relatively safe fixed income instruments in anticipation of an
upward repricing of yields. While domestic fixed income instruments may provide
predictable returns if held to maturity, we believe that investments in
dollar-denominated fixed income assets provide both a return and a currency
hedge.
Long
term investors could also seize the opportunity to take advantage of low
valuations on fundamentally sound equity counters. Importantly, equity
purchases should be staggered to avoid 'catching a falling knife' as broad
based sell-offs may persist amid uncertainty over oil prices and COVID-19
outbreak in the near term.
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