Nigeria Macro Outlook for 2017 - Policy in the Limelight


Wednesday, January 11, 2017/ 2:25 PM /Vetiva Research

2016 took Nigeria into unchartered waters, with the country likely to have suffered its first full-year recession in two decades. Whilst rising inflation and foreign exchange market rigidity constrained monetary policy, a delayed passage of the 2016 “Budget of Change” limited the impact of fiscal policy during the year.

Many determining themes from the last year are likely to filter through to 2017. Redress of the foreign exchange (FX) market, security of oil production infrastructure, and the efficiency of budget implementation will play significant roles in shaping the year. With 2016 providing a low base, we forecast GDP growth of 1.8% for 2017, supported by expansionary fiscal policy, relatively strong growth in agriculture, and an improvement in oil production.

Rolling the policy dice

Policy will resume centre stage this year – with a smaller margin for error. The Federal Government will hope to lead from the front by providing a fiscal boost to the economy through the 2017 Budget. Notwithstanding the projected ramp up in spending with another record budget, actual implementation and revenue generation remain of greater significance.

Added to a conservative oil price benchmark, projected higher oil prices during the year should secure revenues, barring further hits to oil production levels. For this reason, a definitive solution to the militant uprising in the Niger Delta is sorely needed. Meanwhile, the size of the fiscal multiplier will hinge on the scale and speed of disbursements for capital projects, legacy debts, and special intervention schemes.

The monetary policy challenge is more layered this year. Inflation is expected to remain high but may trend downwards due to base effects (Vetiva average inflation forecast: 13% vs. average FY’16E: 15.6%), giving the monetary authorities breathing room to lower rates.

However, the evolution of the FX market will be a key factor: significant erosion in currency value could demand hawkish monetary policy. Based on recent experience, we foresee some rigidity in the exchange rate for most of the year and highlight that this could hamper efforts towards economic recovery.

The emergence of stagflation, and a prevailing disconnect between expansionary fiscal policy and contractionary monetary policy underscore the depth and complexity of Nigeria’s economic turmoil.

2017 provides another opportunity to attempt a few simple measures to kick-start the recovery process: Improved liquidity in the FX market – either by moving to a properly managed float system or through larger Federal Government dollar earnings – is one key step. Haste on the fiscal front – with militancy negotiations and budget passage, remain just as important.

Minor economic recovery within reach in 2017

Stagflation bites amidst policy disappointments
It is almost certain that Nigeria will attain a quadruple of quarterly GDP contractions in 2016, setting up the country’s first full year recession since 1991 when rebased GDP growth was -0.6%.

In tandem, the simultaneous emergence of decade-high levels of inflation dragged the economy into unchartered territory of stagflation from which it must now arise in 2017. Central to the capitulation was a severe slump in oil production caused by increased level and sophistication of militant activity in the oil-producing Niger Delta region.

Linked to this, persistent currency weakness, as a result of negative terms of trade shock traced from the oil price crash of 2014, was amplified by a liquidity crunch in the foreign exchange (FX) market amidst tighter Central Bank of Nigeria (CBN) supply management.

Meanwhile, delayed fiscal policy and limited monetary policy failed to arrest the economic decline witnessed during the year. We estimate growth at -1.4% for the final quarter of the year, bringing FY GDP growth to -1.5%.

Base expectations point to a slight improvement in economic conditions in 2017 as government spending ramps up and the volume and value of oil production recover slightly, both to be supported by the low base of 2016.

Thus, we expect a minor growth rebound of 1.8% in 2017.

One storyline from the past year likely to further shape future proceedings is the consolidation of a 3-speed economy. The diverse fortunes of Agriculture – leading from the front with consistent growth, Manufacturing & Services – cornerstones of the economy entering worrying ruts, and Oil & Gas – in the doldrums following both price and volume shocks, offer varying avenues for an economic recovery.

Agriculture and Oil & Gas provide the quickest routes to economic recovery although robust long-term growth hinges on a substantially improved outlook for both Manufacturing and Services.

Agriculture to blossom further during the year
Agriculture was the sole bright spot in 2016, notching up 4.1% growth in the first 9 months of the year. This resoluteness amidst the broader economic malaise was mainly driven by increased local patronage (due to rising price of imported alternatives) and higher productivity due to better than expected weather over the course of the year.

Furthermore, fiscal initiatives indicate greater support for the sector in 2017. Building on the progress made via the 2011-2015 Agriculture Transformation Agenda (ATA), the Federal Ministry of Agriculture and Rural Development (FMARD) rolled out the 2016-2020 Agriculture Promotion Policy (APP).

Import substitution and boosting agriculture export earnings are two central aims of the APP. Tied to these are self-sufficiency targets in key crops such as rice (2018) and wheat (2019). In 2017, we expect to see fiscal and monetary policy working together to achieve these aims, possibly through increased credit expansion to farmers, higher tariffs on imported produce, or subsidised inputs.

Whilst we expect the sector to blossom further in 2017 (Agriculture GDP growth forecast of 3.9%), we highlight some risks. Firstly, marauding Fulani herdsmen remain unchecked.

Furthermore, agricultural output is vulnerable to weather shocks and health scares such as the “Tomato Ebola” pandemic. Finally, there is a potential clash between the aims of import substitution and increased export earnings. The parlous state of transport in the country and likely direction of the currency means it may become more profitable for farmers to export produce rather than sell locally if they are not allowed to raise prices.

This unlikely scenario would result in domestic scarcity amidst thriving export earnings. Rigorous administrative oversight of agric-focused schemes is needed to ensure full gains of government support of the sector.

Stubbornly low commodity prices should guarantee a continued focus on the sector in the medium term, but scale and sophistication are key given underlying population growth, financial exclusion, and climate change. Meanwhile, export of staples could become increasingly important for Nigeria’s foreign exchange earnings through the year.

Oil sector loses lustre but recovery could be imminent
The Oil sector had a dismal 2016. Currency depreciation during the year inflated the value of oil liftings – wiping out the price effect, leading to a healthy 7.4% y/y growth in nominal GDP in Q3’16. Beyond that, the numbers are telling.

In real terms, the Oil sector has shed over 40% of its value from 2010 (base year). Already reeling from a crash in global oil prices, the industry took a hit from curtailed domestic oil production in 2016.

The volume of pipeline attacks spiked during 2016 and although most incidents were minor, more targeted attacks grounded production in key terminals. The attack and subsequent shut-in of the Forcados Terminal in February set the tone for a spate of attacks on export pipelines during the year.

The Forcados Terminal is key as it is used by mainly indigenous firms and is also a critical cog in domestic gas supply, contributing over a third of gas used for power generation. Further attacks on Qua Iboe and Brass Terminals severely curtailed production.

Attacks have subsided slightly as the FG engages with the militants at the negotiating table. Early indications suggest an agreement may not be forthcoming anytime soon yet a peaceful compromise looks to be the most reasonable resolution for all parties.

It remains to be seen whether the FG is prepared to stomach some of the proposed amnesty concessions in order to safeguard what remains Nigeria’s key economic resource.

As a result, a dark cloud still hovers over this issue. More positively, higher oil prices in the wake of the OPEC deal should ease pressure on heavily-indebted upstream producers. Furthermore, the recent agreement between FG and International Oil Companies (IOCs) over Joint-Venture (JV) cash call arrears could unlock investment in the sector.

Taking the view that average daily oil production over the year should reach 2 million barrels, we expect sectoral growth of 4.3% which will contribute to wider economic recovery in 2017.

Nevertheless, we also note that under bearish conditions, a sustained slump in oil production is likely to keep Nigeria in recession through 2017.

New JV funding mechanism enacted for January 2017
The year is set to bring significant change to the Oil & gas sector in light of the recent Federal Government (FG) decision to scrap the aforementioned JV cash call arrangements.

Under the new regime, commercial banks will help bridge the funding gap to ensure stable production whilst recovering funds through oil sales with the Federal Government earning dividends on profits. This mechanism shifts funding responsibility away from the FG, a welcome move given a history of funding shortfalls even during periods of high oil prices.

We also note that this mechanism is a likely step towards a (partial) incorporation of the JVs, in line with the intended National Oil and Gas policy. We expect the gradual shift towards the power sector to unlock the potential of the industry, contingent on the necessary legislature.

In this regard, it is hoped that ongoing efforts are married to changes in legislature, whether through a restructured Petroleum Industry Bill(s) or another alternative.

FX challenges to bear on Manufacturing
Nigeria’s manufacturing sector contracted 4.9% in the first nine months of 2016 as FX scarcity weighed on a sector heavily dependent on the use of imported inputs. Going forward, a more liquid FX market is needed for the sector to thrive even as manufacturers slowly substitute to now cheaper domestic alternatives.

In this regard, there are some positive signs. Special FX forward auctions were conducted primarily for manufacturers in the final quarter of 2016 complementing the CBN’s directive of ensuring that 60% of FX sales are allocated to imports of raw materials and machinery.

Moreover, some signs of life were apparent at the end of 2016 as the Purchasing Managers’ Index (PMI) reading for manufacturing rose to 52, indicating the only month on month improvement in the sector in 2016. However, the FX market remains rigid and is likely to remain so in early-2017.

This will further suffocate manufacturers who are already hampered by epileptic power and shoddy infrastructure. The cost environment should be slightly more favourable this year (as inflation and interest rates come down), but FX challenges are likely to outweigh all positives. 2017 should be another year of contraction (-1.2%) for the sector barring significant fiscal support.

Services: Modest rebound expected

By far the largest component of GDP, the sector slipped into recession in Q3’16 following consecutive contractions of 1.66% and 1.48%. A noxious cocktail of dollar scarcity, high inflation, low consumer confidence, and sluggish government spending contributed to the contraction.

Moreover, weakness emerged across key sub-sectors: Trade, Real Estate, and Construction (roughly half of Services GDP) have all contracted recently, reflecting a tough operating environment. Notwithstanding the above, we expect a slight improvement in the Services Sector.

This would be driven largely by slowing inflation with eased pressure on consumer wallets whilst a fiscal multiplier supports aggregate. One relevant headwind is the likely increase in petroleum prices. We expect modest growth of 1.2% in 2017, up from an estimated -1.0% in 2016, but a far cry from average of 6.1% between 2011 and 2015.

Extended recessionary consumer behaviour

In expenditure terms, consumer spending forms the largest component of Nigeria’s GDP. Therefore, it comes as no surprise that consumer wallets came under severe strain as the economy eventually succumbed to stagflation in 2016.

Whilst real Household Consumption declined by 3.6% in H1’16, nominal expenditure climbed 7.7%, meaning consumers are now paying more for less. This did not come as a shock considering the inflationary trends seen in 2016 (average inflation: 15.6%).

A number of inflationary winds can be expected to persist in 2017, though to varying degrees. Specifically, possible naira depreciation and a rise in petroleum prices could further stoke inflation and intensify pressure on consumer purchasing power.

Consumer confidence remains weak – CBN consumer expectations report shows a gradual deterioration in confidence over 2016 – but is more upbeat for the future, the consumer outlook for the next 12 months tracks higher than for the current or next quarter.

Meanwhile, Nigeria’s Misery Index stood at a staggering 43.4 in November 2016, up from 33.1 at the end of 2015. Amidst this, we can expect to see extended recessionary consumer behaviour in 2017 and cash-strapped buyers to continue to trade off foreign products for local substitutes.

Current account to return to surplus

In 2014, Nigeria ran a current account surplus equivalent to 10% of that year’s GDP. In 2016, we estimate a current account deficit amounting to 1.1% of total GDP. Though this slump has roots in the oil price crash (since summer of 2014) that decimated export earnings, in 2016 it was paired with a negative shock to oil production which crashed crude oil earnings (oil exports earnings in Q1’16 were barely 25% of the corresponding value in 2014).

With crude exports even more dominant this year (c.85% of export earnings in Q3’16 vs. 71% in 2015) and currency weakness feeding through to nominal import values, current account deficit (as % of GDP) fell as low as -2.1% in Q2’16 (compared to 4.2% in the corresponding quarter of 2015).

However, 2016 is likely to be an anomaly as an expected rebound in oil production coupled with anticipated higher oil prices in 2017 should significantly lift export earnings. Meanwhile, import substitution will continue this year, possibly at a faster pace as consumers continue to adapt to the recessionary environment.

Underlying all this, any currency depreciation will feed through to both exports and imports but, all things remaining equal, is likely to boost exports more considering oil is priced in dollars (so demand will be unaffected) while import substitution should accelerate in response. As a result, we anticipate a return to a current account surplus in 2017 (0.3% of GDP).

Made in Nigeria drive expected to stimulate policy action

Negative terms of trade shock caused by low oil prices have exposed Nigeria’s high import inelasticity. A widening current account deficit and excess demand for foreign exchange (FX) instigated a local content drive with the list of 41 FX barred items the most significant initiative. If sustained, this push is likely to generate other protectionist policies with the agriculture and manufacturing sectors being the most likely beneficiaries.

We expect the current administration will intensify efforts to ensure stricter border control and tariff enforcement. Such policies would serve to influence demand for imported products and encourage import substitution.

However, such initiatives have proven difficult in the past and are likely to remain challenging. Nevertheless, supply-side policies to boost domestic capacity can also be expected. For example, meeting Federal Government self-sufficiency targets for rice (2018) and wheat (2019) will require further support for farmers of these products.

For manufacturing, maintaining stable access to foreign exchange to import raw materials will help further the “Made in Nigeria” agenda. This is particularly important considering the prevailing FX market illiquidity and the continued reliance on imported capital goods. Finally, fiscal support should come in the form of proposed Special Economic Zones alongside a ₦20 billion export expansion grant.

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