Tuesday, March 28, 2017 4:53 PM/ Proshare Research
Twin Glut: Financial and commodity divergence
The present, supply glut in commodities market has led to a depression in commodity prices. Whereby, lower commodity prices have trigged thinner foreign portfolio investment in developing economies, especially Nigeria.
Such scenario implies that Nigeria is not immune from multiple transitions afoot in the global economy. Thereby the casualty of falling revenue from low commodity price, calls for a policy tinkering.
Even though commodity prices are weak, the global economy is still awash with cheap money; presenting a commodity and liquidity divergence. As Central banks like the European Central Bank and the Bank of Japan are employing unconventional quantitative easing policies such as negative interest rate and a persistent asset purchase programme to support their individual economies. The ripple effect is an excess liquidity scenario accompanied with monetary neutrality.
Certainly low commodity prices will stick around for some time and will cause lighter fiscal revenue. No doubt the presence of excess liquidity in the global economy will provide the right tool to bridge the shortfall in fiscal revenue.
Fig 1: Transaction vs. Portfolio investment
The ongoing price friction experienced by commodities will affect the income optimality from other commodities: therefore diversification into other commodities will be hit by low prices just like oil. Therefore, the problem of Nigeria is not diversification of exports but diversification of external finance.
The inability to hewn income from capital account has made Nigerian external finance very volatile. Nigerian external financing mix, which is made up of oil revenue and foreign portfolio investment is responsible for the volatile nature of foreign inflows.
Thereby more emphasis should be placed on foreign direct investment; they are long term committed funds which are driven by profit from real asset and have strong implicit effect on labour productivity: Compared to oil revenue and foreign portfolio, which are shock prone. Foreign direct investment makes the revenue stream less volatile compared to foreign portfolio investment and oil earnings.
Thereby, courting Diaspora remittances so as to beef up capital account and provide the needed policy reset at this point of the cycle.
More importantly, a multi corridor capital account which comprises of a private to private window and private to nation, is best applicable e.g. China. The ability to bridge the shortfall in finance by broadening the universe of the nations’s capital account is important to solve long term difficulties. It also increases the absorption capacity due to increased foreign direct investment.
Fig 2: Size and volatility of current and capital inflow of Nigeria
The success of the Euro bond underlines the fact that the world is ready to engage with Nigeria but Nigeria must show some wiliness too. Therefore tapping into external financing and removing restrictions to foreign direct investment will enhance the supply of foreign inflow. Which have been done in Indonesia and India .
Growth divergence: big sectors vs big push
Nigeria nominal gross domestic product stood at 101 trillion Naira at the end of 2016. The service sector contributed 64.9 trillion naira, making up 65% of gross domestic product. The Agricultural sector contributed 21.5 trillion Naira to nominal gross domestic product at end of 2016, which consisted of 21% of gross domestic product.
While both oil and the non-oil sector contributed 5.5 trillion and 9.75 trillion naira respectively: Therefore making up 5% and 9.75% of nominal gross domestic product. Nominal gross domestic product increased by 7.45 trillion naira, reflective of an 8% increase. While the service sector increased by 6.14 trillion naira, which is a 10.4% growth in the service sector and contributing 84% of total growth to nominal gross domestic product.
While the agricultural sector increased by 1.89 trillion, which is a 9.6% increase in the agricultural sector and 25.3% of total nominal growth of gross domestic product.
While both oil and non-oil (manufacturing) loss 500 billion and 60 billion Naira. While weakness in certain sectors highlighted in fig 3 drag down growth.
The presence of a poor road network is largely responsible for making agriculture largely uncompetitive. Therefore the ability to ensure that inputs and outputs leave their places of production to designated markets will be important so as to drive down cost, reduce wastage and also reduce economic exposure.
Moving forward there will be a need to transit from resource driven sectors to those that is transformational in nature: setting the ground between big sectors and big push.
Sectors like agriculture and oil were regarded as big sectors, given the premium and the contribution to the economy already. While sectors like real estate, information, power and communication technology and infrastructure are believed to form the big push. They have a narrow penetration and largely remained untapped making them the big push sectors.
Therefore economies can handle resource growth but can’t handle transformational growth, will be vulnerable to multiple transition effects. While economies that can handle transformation growth will unleash their full potential through a mix of wider external financing, strong emphasis on micro prudential’s and improved investment spending.
Macroeconomic policy response and Economic recovery and growth plan
The Nigerian foreign earnings have a direct relationship with the prices of commodity, while domestic price have an indirect relationship with commodity price.
Therefore when there is a softening in the prices of oil revenue fall in and inflation takes up an upward trajectory. Metamorphosing into a negative divergence, this led to a slowdown in growth and a rise in inflation: popularly referred to as stag- inflation.
In response to the shock, the Central bank opted for a pro cyclical response to combat cyclical reversals. Eventually leading to an exacerbation in the trough effect: Pro cyclical measures combined with delayed capital expenditure inflamed a stag inflation into a recession: Which was forced the nominal currency to lose value both externally and internally.
In order to pull the economy out of a recession an economic recovery plan has been created, the inability to set targets which includes dates makes it illusive. Moreover the economic recovery and growth plan should be backed by legislation.
Therefore there is a need to set dates and ensure the recovery plan is backed by law. A swift measure that will make the Economic recovery plan a law is needed. Regardless the Economic recovery plan is in need of the following policy tools.
Outlooks in 2017 cycles vs. policies
Earlier pressure which forced the economy into a contraction is easing off, while production in oil has also improved. Oil has swung between 50-55 dollars per barrel compared to the corresponding quarter of 2016, where oil stuck to 38 dollars per barrel.
The improvement in oil price and production will improve government finances and widen monetary maneuvering. The apex bank after two devaluations has tilted more towards demand restrictive policies, which forced a roundabout effect. It is important that the apex bank lean more on capital account ahead of the current account, by boosting foreign inflows
The economy is on an upturn, even though the vacuum between cyclical pressure and the needed policy response still exist. Regardless there is a need for more proper policy response to the cyclical upturn: Such as diversifying external financing and prompt countercyclical spending.
Conclusive review by Proshare
One cannot write off the effect of delayed policy response, which has created substantial lag effects on the economy. Recently there has been an exogenous increase in the value of imports, substantial leveraging is needed to compensate such increase.
By broadening external financing, forward looking monetary policy and reducing government hold on critical sectors. Policies aimed at boosting aggregate foreign exchange is needed more than ever to re-address the foreign exchange recoil on the long term.
There is a need to be more growth accommodative and less price weary, so as to replenish the fillers of the economy such as labour productivity. Moreover the need for policy specifics and targets, which is time set, should be embedded in the ERPG. At the same time a feasibility study on the required cost of the ERPG is needed.
The economy is in dire need of such policies, the inability to replenish the fillers of the economy will make the escape velocity more cumbersome to achieve. Positive momentum achieved so far is driven by both increased government spending and easing of downturn effects coupled with a positive base effects.
A lot more is needed in terms of policy, to cause resurgence in private and foreign investment, such support embolden the recovery.
12. A Cursory Look at Nigeria's Economic Recovery and Growth Plan