Elections and the Economy: Fear of Flight


Monday, September 17, 2018 / 04:29 PM /Investment-One Research 

Fear of Flight 

Political risk has historically been the focus for domestic and foreign investors in the year preceding elections in Nigeria. It is often said to contribute to capital flight, instability of the local currency and a distraction from economic reforms. Systematic to most election cycles is some level of political instability amongst and between rival parties and in some cases violence, increased government spending skewed towards campaigning and winning the popular vote, often at the expense of capital expenditure and economic progression. 

However, what is unclear is whether these factors alone account for the volatilities in foreign currency and capital markets in the run up to elections or whether the movement in Brent oil prices, Monetary Policy decisions in developed economies and other exogenous factors play a role. To better understand the potential implications of electioneering and political risk on the economy as a whole we look at the last five elections (1999, 2003, 2007, 2011 and 2015), specifically the 12month period either side of the elections. 

In diagnosing political risk, we analyzed the political climate and how close the elections were in those years while scrutinizing changes in the nation’s foreign exchange reserves; capital importation (as a gauge of foreign investor participation); headline Inflation, benchmark interest; foreign exchange rate (both Inter-bank & Parallel market); yields in the fixed income market (91-day T-bill); and movement in the equities market. In addition to this, we incorporated movements in global Brent oil prices and the U.S. Federal Reserve rate over the same period, given the importance to the Nigerian economy and foreign investor participation. 

1999 Elections - The First Democratic Election since Military Rule 

The 1999 elections between Olusegun Obasanjo (PDP) and Olu Falae (Alliance for Democracy (AD) – a coalition between AD & All People's Party (APP)) was met with skepticism by both local and international stakeholders given that it was the first democratic election since the military took over the helms of affairs of the governments in 1983. 

Nonetheless, it was a contest between two candidates from the South Western part of the country, which many people perceived to be the case of soothing the pain of the Western part of the country following the annulled June 12, 1993 General election. Since it was an election between two people from the same tribe, the political risk may have been conceived to be less severe. 

Obasanjo eventually won the election. On the economic front, while the U.S. Fed rate trended down to 4.75% in the midst of the Long Term Capital Management Hedge Fund crisis, oil prices were heading north, from a low of c.US$10/ barrel to US$26/barrel over the period. 

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However, oil production levels were falling rapidly, which may have contributed to foreign currency reserves sinking as low as US$4.7billion and the local currency weakening in both the interbank and parallel market by 20-24% to N105/USD. The decline in oil revenues, reserves and depreciation in the local currency may have contributed to the equities market falling by as much as 18% over the period.

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2003 Elections – Elevated political risk 

Unlike 1999, political risk could be said to be high during the 2003 elections, which was won by the incumbent President Obasanjo. The run up to voting was marred by violence, with several top politicians murdered; prominent among them was the assassination of key leader of the AD, Chief Bola Ige who was the serving Federal

Attorney General and Minister of Justice. 

This generated a lot of tension especially in the Western part of the country. On the global front, the U.S. Fed cut interest rates from 1.75% to as low as 1% as the U.S. economy struggled with the aftermath of the dot com bubble. It would also appear as though the Central Bank of Nigeria’s (CBN) decision to reduce interest rate were in line with the U.S. Fed’s timing. 

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Also, Brent oil prices gained as much as 52% over the period to US$30/b while domestic oil production inched up from lows of about 2mbpd to 2.5mbpd. On a negative note, foreign currency reserves fell by 27% to US$7.5billion with the Naira shedding 19% against the USD to N140/USD at the interbank market. 

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With this said, it would appear as though investors were bullish in the equities market, which may not be unconnected with the moderations in interest rates by both local and foreign central banks as well as improved oil revenues. As such, we believe the decline in reserves could have been the result of election spending as the macro economic conditions appeared strong. The sudden rise in headline inflation to a high of 11% in January 2003, from 5% in October 2002, and the steep rise in money supply, further supports this ideology.

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2007 Elections – The Third Term Agenda 

Political risk was also high during the 2007 elections with President Obasanjo attempting to run for a third term, which generated a lot of conflict especially from the National Assembly with allegations of bribery and corruption reported during the period. The President’s third term agenda also led to a personality clash with the then Vice President, Alhaji Atiku Abubakar, which further added to the political risks as elections drew closer. It is also worthy of note that the eventual President elect, Alhaji Umaru Musa Yaradua confirmed that the April elections had flaws and shortcomings. 

In the U.S., the Fed gradually began moderating interest rates with GDP growth slowing as the credit crisis loomed. The CBN followed suit, reducing its own benchmark interest rate as headline inflation slowed. This, as well as high oil prices (up 55%) supported the Nigerian economy. Although oil production levels were volatile, foreign exchange reserves jumped 82% to US$52billion, which could have aided the appreciation of the Naira at the parallel market by as much as 17% to N122/USD. Furthermore, the change in money supply was fairly stable as inflation trended south. 

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Contrary to this, major economic indicators were positive while capital importation dipped significantly, falling by US$560million to a year low of US$220million in the month preceding the 2007 elections. However, as pointed out the equities market was very bullish, which was most likely due to the margin loans that fueled local investor participation.

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2011 Elections – North vs South

Following the death of President Yar’Adua in 2010, the 2011 elections were mired by controversy within the ruling PDP as to whether a Northerner or Southerner should be allowed to contest the Presidential election. This led to agitations from the North on the belief that they were still supposed to be in power as the late President Yar’Adua did not finish his tenure. 

Consequently, violence erupted in the region with the Human Rights Watch stating about 140 people were killed in political violence. This increased violence and political risk may have sparked capital flight as both the equities and treasury markets were relatively bearish. It may also have been partly induced by CBN’s hawkish stance and possible capital flight as capital importation slowed during the period. 

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Despite oil prices rising to US$117/barrel and oil production above 2.4million barrel, foreign currency reserves fell by 23% to US32.6billion. However, inflation moderated, which could signal that the drain in reserves may not have been the result of election spending but more in defence of the Naira, which lost 8% to N165/USD.

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2015 Elections – Peaceful Transition 

The 2015 elections were centered on increasing insecurity (Boko Haram) and economic strains. Buhari and the All Progressives Congress (APC) were viewed as more equipped to fight insecurity and corruption against the incumbent President Jonathan. The elections and the transition of power were both stable and peaceful. Although political risk was relatively low with no threat from external environment as the U.S. Fed maintained interest rates, the Nigeria economy was negatively impacted by falling Brent oil prices (down about 50%) despite oil production rising to 2.5million barrels per day.

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Lower oil revenues, on the back of the decline in oil prices, government spending and capital outflows led to the slide in foreign currency reserves to below US$30billion and consequently the depreciation of the Naira to N197/USD at the interbank market. This and the uncertainty regarding the outcome of the elections may have contributed to the bearish sentiment in the equities market.

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Our Outlook for key parameters examined in past elections


·         US Fed is likely to remain hawkish while there is potential for CBN to shift to an accommodative monetary policy

·         Oil price to remain high (above US$70/barrel)

·         Oil production fairly stable at 2mbpd on stability in the Niger Delta

·         FX reserves could reach US$50billion with budget financing and oil proceeds

·         Expect headline inflation to trend upwards towards 12-13% levels on election spending


What does this say about the potential impact of electioneering on the capital and foreign exchange markets? 

From our analysis of the last four presidential elections, there appears to be a slight correlation between political risk and capital flight. However, the extent of this is dependent on the intensity of the elections and conflicts within the country. It is also worthy to note that exogenous factors such as decline in oil prices tend to exaggerate the capital flight, decline in foreign currency reserves and the slowdown in economic activities. 

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While the political tension has gradually been escalating in the run up to the 2019 elections, we expect this to intensify as parties step up their respective campaigns and spending, particularly as we approach and move past the primaries in October 2018. Although there is a chance for an accelerated budget implementation particularly short term projects and recurrent expenditure, we expect electioneering to detract from much needed economic reforms to spur growth while we should see headline inflation trend upwards. 

2019 Election Timetable


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Furthermore, we are concerned about the escalating violence in the North between Farmers and Herdsmen, which could negatively impact food supply and inflation, as well as spreading to other parts of the nation. Although calm, the potential for a resurgence of unrest in the Niger Delta remains, which is key to oil production and revenues; and handling of Boko Haram insurgence could be even more delicate as electioneering intensifies. 

However, what is clear is that we are already seeing a level of capital flight but this has largely been systematic to most emerging market economies as a result of ‘risk off’ sentiment by foreign investors due to concerns on geopolitical tensions, U.S. Fed’s rate hikes and trade war. 

This contributed to the lackluster performance in the domestic equities and fixed income markets in Q2 2018 and Q3 2018 despite Brent oil prices remaining high, oil production levels improving, although volatile, and the nation’s foreign exchange reserves remaining above US$45billion. 

Even though the outlook for key economic indicators appears positive, we could see further capital outflows in H2 2018, with an estimated US$9billion of local treasury bills held by foreign investors at the end of August 2018, due to uncertainty on the outcome of the elections. 

The level of outflows could be amplified by increased violence in the North as well as an escalation of trade tensions in the global space. Nonetheless, we expect that the accretion to reserves (+50% y/y) over the last 12months should aid the Central Bank of Nigeria in the defence and stability of the Naira amidst capital outflows as witnessed in recent months. 

Upside Risks

·         Oil prices continue to rise on Middle East tension

·         JP Morgan re-includes Nigerian government bonds in the emerging market index


Downside Risks

·         Trade wars and geopolitical tension slowdown global growth

·         Oil prices crash on slowdown in global growth and higher production levels in US

·         Strong presidential candidate joins the election race.

·         Heightening uncertainty regarding outcome of elections

·         Faster than expected US rate hikes


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