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2017 Budget - Navigating Through A Cloudy Atmosphere

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Friday, January 06, 2017 6.28 PM/ by Babalola Temitope* 

Global Development and Macro Prospect in 2017
The General election in America is over, which has led to an ease off in earlier political headwinds. While the president elect is pushing for a slash in corporate and personal taxes, so as to stir up both household spending and real investment spending by firms.

Simultaneously he wants to increase capital spending, to enable a transition from budget balancing to budget expansion. Such proposal have bolstered the market confidence: This has pushed the VIX volatility index to cave inwards.

While another macro gauge, such as the greenback (Dollar) index rose to 1.044, as it gradually seeks parity with the Euro. In reaction to the chain event, the Federal Reserve Bank has pitched its rate higher by 25 basis, point; eventually putting the federal open rate at 0.5. 

Figure 1: A table illustration of United States macro projections


The Federal Reserve Bank revised its outlook for both growth and inflation; its new outlook showed that macro fundamentals are stronger than initially assumed (Fig 1). Revised, inflation still remained below the 2% threshold, regardless the Federal Reserve Bank was quick to defend its long run position.

By defending such position, the Federal Reserve Bank pushed further into hawkish territory; while been soft spotted at it. Obviously, the Federal Reserve Bank is more concerned at offsetting anticipatory inflation that will be triggered by possible expansionary spending.

Certainly the divergence between monetary and fiscal policy is taking shape in the United States. Such divergence also hinges substantially on the senate ditching the “sequester” plan.

Therefore the possible headwinds from the foreign end moving forward into 2017, is either a strong Dollar due to rate hike or political risk emanating from Capitol Hill.

Holistically both weak fundamentals and negative price shock: Which have been responsible for the snail pace growth in developed economies and volatility in emerging economies respectively in 2016, have not waned largely.

Certainly, the fiscal bourses in Nigeria, find themselves once again navigating the economy through a cloudy atmosphere

Domestic Economy (Fiscal)  

Figure 2: A table illustration of three different budgets



Macro Preamble
Macro assumptions are parameters created, to achieve some specific objectives for a particular period. In addition they provide guidance to how quantitative variables such as revenue, expenditure and deficit can best be managed in a budget.

When such parameters are disconnected from the existing macro reality, such disconnection will weigh down the quantity and quality of the outcome (growth). Many times such disconnection create dislocation, causing an abrupt deviation from its original long run path (Angola, Venezuela in 2016).

Therefore do the macro assumptions above in the proposed 2017 budget, (Fig 2) align with today’s reality? On the back of recent cut in production by the OPEC and Russia, which have triggered a rise in the crude prices.

The position of many, analyst is that the present oversupply in the market will completely fade off by the end of the first half of 2017; which will make, the price of crude to rove between 55 Dollars to 60 Dollars.

This will improve oil revenue when taking into account the cost of production and the actual average price of crude oil in the first half of the 2016, respectively (Fig 3). The macro reality in 2017 will not be indifferent to a 42 Dollar per barrel.

Figure 3:  A table displaying the cost of production and average price of certain reference crude including the bonny light


The 2017 budget prone down the naira, from 290 to 305: implying a 54% and  5.17% fall in the value of the nominal currency, when compare to the 2016 and 2017 midterm framework.(Fig 2).

Regardless there is still a differential of 59% between the BDC and interbank rate. This is as a result of both cyclical and structural factors. This put the macro assumption of 305 Naira to a Dollar on shaky grounds and a distance- off from macro reality.

The correlation between foreign portfolio investment and capital importation stand at 0.91, which ends up leaving capital importation with little resistance against capital reversals. Emphatically, the size of foreign financial asset (PFI) is not the problem here but the size of foreign real asset (FDI) is the problem.

While it is important to note that neither whips of regulation nor the command and control posture of Dollar repatriation will solve liquidity problems. It only creates a trapped Dollar scenario, foreign exchange asymmetries and overshoots.

From a fiscal point, policies that support foreign direct investment such as an improved degree of openness and specifically   broadening the absorption capacity of capital importation (India and Indonesia). Such policies are needed desperately at this point of the cycle order to create the right momentum for an “escape velocity” and make capital importation less pro-cycle on the medium term.         

Revenue
Forecasted oil revenue in the 2017 budget, rose by 142% and 30% compared to the previous year and 2017 midterm framework (Fig 2). The increase in oil revenue is as a result of 54% and 5.17% fall in the value of the Naira. When compared to the 2016 budget and the 2017 midterm framework respectively.

Thereby the casualty effect of an exchange rate gain from devaluation is responsible for the rise in the amount of oil revenue. Therefore making oil revenue to account for 40% of total revenue in the 2017 budget, when compared to the 2016 and 2017 midterm framework; oil revenue made up 21.6% and 33% of total revenue respectively (Fig 2).

While oil revenue in the forecasted 2017 budget stands at both 26% and 1.85% of oil GDP and total GDP mosaic respectively. Petroleum profit tax and royalties usually make up to 48% to 55% of total oil revenue.

Recently, petroleum profit taxes and royalty have declined to 42% of the total oil revenue, due to shrinking in oil production. With the presence of an already sliding exponential growth of petroleum profit taxes and royalty to total oil revenue due to low oil prices. Shrinking oil production levels have further exacerbated an already diminishing exponential growth.

This is reflective in the sharp nose dive in its exponential growth (Fig 5). Considerably, production will be a strong headwind in 2017. As diminishing effect on economics of scale due to production headwinds will pose as a friction to the total revenue mosaic for some time in 2017.

On the external front, oil revenue will still be the major source for managing foreign net flow in 2017. A 42 Dollar per barrel still exposes the external economy, to a fragile foreign net flow.

Figure 4: A column displaying the total oil revenue from 2010 till second half of 2016

Source: CBN, Coffee Post

Although forecasted non-oil revenue in 2017 rose by 13.7% compared  to the 2017 Midterm framework, but it still fell below the 2016 approved budget by 8.9%.Non-oil revenue has been on an upward trend  as exponential growth of total oil revenue went on a nose dive.

Non-oil receipts so far as accounted for 49% of total revenue in the first half of 2016. Although recessionary effect do form blights on non-oil receipt as a result of declining spending by household and margin compression experienced by firms.

Regardless, non-oil receipts will maintain its upward trend as structural pediments such as narrow taxes compliance are been widened. The forecasted 2017 budget is cautious on the independent revenue stream.

Which is reflective of a  46.4% and 44.5% drop in proposed 2017 independent revenue compare to the 2016 budget and 2017 midterm framework; such drop underline a gradual  adjustment to the  random nature of independent revenue by the fiscal bourse.

The forecasted independent revenue also implies that less weight will be shed than initially tinkered in the 2017 midterm frame work. Whereby, the intended number of asset to be sold in the proposed 2017 budget will be reduced than initially thought in the 2017 midterm framework.

The  amount of total revenue rose by 28.12% and 15.6% compared to the 2016 budget and 2017 midterm frame work respectively. The blistering of the total revenue is majorly fuelled by exchange rate gain, when compare to the 2017 midterm framework.   

Figure 5: A graph illustration of the exponential growth of both oil revenue and non oi1 revenue from 2010 to second half of 2016

 


Source: CBN, Coffee Post 

Expenditure
Non- debt servicing recurrent expenditure in the 2017, budget accounts for 40% of total expenditure, while it rose by 16.23% and 27.02% compare to the 2016 and 2017 MTEF;   non debt servicing recurrent expenditure in 2017 stand at 2.7% of gross domestic product.  Given the reality, where the macro end finds itself.

There is a large consensus among frontline economist and financial gurus, that substantial spending will be needed; so as to provide the momentum for a recovery. The dawning reality, that households are already reeling from a sharp dwindling in purchasing parity, it is very hard to argue against strengthening consumption or propping demand.

Evidently the short run has been largely depressed by real shocks and some big swings in policy are needed to achieve a correction. In reality such correction, cannot take place without an increase in non-debt servicing recurrent expenditure: at least to counter the effects from negative price shocks.

Sincerely coming from a monetarist, some more Keynes is inevitable at this point of the cycle: “after all not all Keynes is a problem”. The bane is too much Keynes or sticking to Keynes for too long that it becomes opium (Brazil). 

Capital expenditure in the proposed 2017 budget accounts for 30% of total expenditure, while it rose by 27.6% and 41% compared to the 2016 and 2017 midterm framework:  Capital expenditure in 2017 stands at 2.06% of gross domestic product.

An increase in capital expenditure will provide support beyond increasing the amount of currency in circulation and smoothening net injection in the economy.

Rather, it will provide a springboard for supply side remedies, which will reverse evident shocks to the long term.  Proposed total expenditure in 2017 rose by 20% and 6.2%, compared to the 2016 budget and 2017 midterm frame work.

The forecasted total expenditure in 2017 stands at 6.7% of gross domestic product compared to 2016, which is 5.9%.  Trend so far have reflected that capital spending don’t take steam until after the 1st quarter of the year: which have continued to pose a drag down to growth. More than ever before, we need capital spending to take off as soon as possible.  

Fig 6: A column illustrating the various components Total expenditure from 2014 to 2016

Source: DMO Coffee Post 

Are There Early Signs of A Debt Hang Over? 
Debt servicing accounts for 22.7% of total expenditure, while it rose by 1.3% and 22% compare to the 2017 MTEF and 2016 budget. Presently the amount of debt servicing compare to 2014 (Fig 6) have risen by 133% (724 billion).

Forecasted debt servicing in budget 2017 to gross domestic product stand at 1.5%, compared to 2016 which stood at 1.32%. This is reflective of debt servicing   growing faster than gross domestic product.

Debt servicing is gradually becoming the elephant in the room, which is also depleting fiscal space. Budget deficit stands at 33% of the budget. Although the budget deficit in the proposed 2017 budget fell by 12.56% compare to the 2017 midterm framework, it still blistered by 7% when compared to the 2016 budget.

The increase in the quantity of money due to devaluation prone down the budget deficit: eventually keeping the budget deficit below the 3% threshold (3,262 billion Naira). Magnifying nominal variable through the exchange rate softened the budget deficit compare to 2017 midterm framework and tilt it further below the 3% threshold: after all it’s a quantitative variable.

Certainly, the need for counter cyclical spending is inevitable. At the same time we are giving up too much space for relatively little economics: too much debt and fiscal space for relatively little growth.

Sometime in no distant future, we will have to get off these prescriptions of  fast growing debt servicing coupled with high budget deficit (Fig 7), to avoid been forced to taking a hard landing.   

Fig 7: A chart illustration of deficit balance from 1st quarter 2014 to the second quarter 2016

Source: CBN, Coffee Post

*Babalola Temitope holds a post-graduate degree from Obafemi Awolowo University, Ile-Ife and is also privileged to be a student member of the Charted Institute of Stockbrokers. He can be reached via czar1267@yahoo.com  and temitopebabalola17@gmail.com

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