Nigeria H2-16 Outlook: Misty Cloud on the Recovery Path


Monday, August 01, 2016 1:56pm/ United Capital Research

Executive Summary

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Global Economy: Growth momentum slows as vulnerabilities persist
Driven by a deceleration in economic activities in the developed and emerging markets, the global economy continued to see sluggish momentum in the first half of the year. The IMF projects global growth to slow for the rest of 2016, mostly due to weak growth prospects especially for the emerging economies. A key theme that dominated the latter part of H1-16 was Brexit. We anticipate the exit could cause the U.K. economy to significantly underperform in the near term, if not tip into recession.

Emerging markets seem to be an easing mode, and we expect a largely dovish monetary policies to continue to boost investors' appetite for riskier assets going forward.  For SSA, we hold a bearish view for H2-16, as we expect the combined impact of extended bearish trend in commodity prices, power supply constraints and FX related challenges to continue to stifle growth momentum continent wide, thus delaying recovery a little further.

We maintain our downbeat outlook for oil prices over H2-16, as shale production dynamics continues to act as a two edged sword – by shaping the cap and floor for crude prices.

Nigeria: in the eye of the storm, policy delays costing a fortune
The start of the Buhari regime was filled with euphoria and optimism, especially judging by the voting patterns from the 2014 elections which ousted the then incumbent even as the "change" mantra became increasingly popular. However, the reemergence of  economic cracks as well as delays to major economic decisions especially the make-up of the cabinet, and the 2016 budget "drama" have combined to reset expectations lower. On a positive note however, we have seen the implementation of laudable market-friendly policies that are clearly at variance with the erstwhile populist leaning of the government.

To our mind, the liberalization of the downstream oil sector, increase in electricity tariffs and implementation of a flexible exchange rate system are bold departures from the norm, even if instigated by macro challenges.  We believe they are indicative of the longer term policy direction that should engender market efficiency and ultimately boost productivity.

Macroeconomic environment: tougher days ahead?
The first half of the year saw one of the most severe shocks to economic activities that Nigeria has experienced in years. Looking ahead, the structural rigidities that plagued the non-oil sector for the better part of H1-16 is expected to tell on Q2-16 non-oil GDP while lower production volumes and depressed oil prices continue to impact oil GDP.

While the recent liberalization of FX policy and the clearance of demand backlog is likely to give a reprieve, we think it may take a bit of time for capacity utilization to recover to pre-crisis level even as expected further depreciation in the currency at the interbank market is likely to present additional constraints.

After testing the upper band of CBN's target in the second half of 2015, headline inflation rate finally crossed into the double digit territory in the first half of the year, as both core and food CPI continued to see pressure from cost-push factors.  We expect headline inflation will remain firmly rooted in the double digit territory over 2016, peaking at c.18.5%. However, we note that higher 2016 base effect will likely see headline inflation numbers gradually moderate over 2017.

Monetary Policy: Balancing stability and growth with an eye on FPI
Although current strength of domestic macro variables appears more supportive of a dovish monetary policy stance, the MPC in its last meeting voted to increase the MPR by 200bps to 14.0%.

In line with its recent "body language", the MPC has chosen the path of policy tightening reinforcing its propensity to attract foreign portfolio inflows (FPIs) in an apparent move to provide liquidity to the fledgling flexible  FX policy regime. What is more instructive is the MPC's tacit admission of its inability to spur real economic activities without complementary fiscal liquidity.

This, we believe could create a floor of 14.0% for policy rate over H2. While we think these latest decisions limit the FX-pass-through to   inflation, it is at best a short term fix for addressing current naira weakness. Any ensuing carry trade on fixed naira will likely be short-dated as FPIs keep an eye on longer term structural competitiveness of the economy particularly in light of persistently low oil prices and government revenue, as well as the attendant slow build-up in external reserves.

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