Friday, October 14, 2016 10.37AM / Preston Consults August 2016 Issue
In April 2014, it was assessed that Nigeria’s economy was the largest in Africa after a rebasing exercise nearly doubled its Gross Domestic Product. Prior to this South Africa was regarded as having the largest economy, but the rebasing exercise put Nigeria’s economy at about 30% larger than South Africa’s with the 2013 Nigerian GDP valued at $509.9 billion while that of South Africa was valued at $372 billion. The large increase in Nigeria’s GDP was attributed to the inclusion of sectors such as telecommunications, e-commerce and the film industry which did not exist during the previous rebasing exercise carried out in 1990.
The recent ranking results
The 2015 GDP figures published by the IMF show that South Africa’s economy has again surpassed Nigeria’s, thus, regaining its former spot as the largest economy in the continent. The figures put South Arica’s 2015 GDP at $301 billion at the rand’s current exchange rate, with Nigeria’s standing at $296 billion at the naira’s current exchange rate.
Countries’ economies are measured using their nominal GDP figures at their current exchange rate with a common international currency, such as the dollar, in order to provide a common base for comparison. Therefore, although the relative sizes of their actual nominal GDPs may remain the same when measured in their domestic currencies, the exchange rate of the dollar plays a major role in determining the estimated size of a country’s economy and, thus, its ranking.
Bloomberg noted that the rand has gained more than 16% against the US dollar since the start of 2016, with the recent vote for a Brexit attracting foreign investors in search of emerging economies with liquid capital markets to invest in. In contrast, Nigeria’s naira has lost more than a third of its value after the Central Bank removed the 197-199 naira per dollar currency peg in June 2016. These exchange rate movements have, thus, led to a relative increase in the US dollar value of the South African GDP, vis-à-vis that of Nigeria.
What do the new rankings mean?
Although higher-ranked economies will attract more foreign investors, these rankings do not mean much and are not really useful for economic policy and investment decisions. This is because the rankings are heavily dependent on exchange rate fluctuations, which can be very volatile. Thus, international investors pay less attention to the relative size of economies than they do to growth prospects. For instance, investors want to know if there will be economic growth and improvement in standard of living as measured by GDP per capita increase which then increases the returns on their investment in an economy.
Unfortunately, the current economic growth prospects of both South Africa and Nigeria are poor, with both countries facing the risk of a recession after their economies contracted in the first quarter of 2016. While Nigeria’s contracted by 0.4%, South Africa’s contracted by 0.2%. The South African Reserve Bank has forecast that there would be no economic growth in the country in 2016, and that the economy would grow at a rate lower than the population growth rate in 2017 and 2018. The implication is that the country’s standard of living is expected to worsen over the next two years. Nigeria’s economic prospects also remain dim due to the country’s over-dependence on oil whose price in the international market has remained under intense pressure.
Looking past the GDP Rankings and towards the Maturity of the Countries’ Economies
It is a bit unrealistic to compare the Nigerian GDP produced by a population of about 187 million people with that of South Africa generated by just about 54.9 million people. While Nigeria’s larger potential workforce and consumer base increases its attractiveness as an investment destination, with the likelihood of producing a larger GDP, it also means that the country has a long way to go in order to reach the standard of living that obtains in South Africa. According to the World Bank, Nigeria's GDP per capita in 2015 was $2,640.3 while South Africa's was $5,691.7. The former's GDP would therefore need to be substantially larger before the average citizen can be as prosperous as the average South African, even if Nigeria was ranked as the largest economy in Africa.
While the 2014 rebasing exercise gave some insight into the magnitude and increasing diversity of Nigeria’s economy, the country still has a long way to go to reach South Africa’s level of economic maturity. This explains why South Africa has always attracted more FDI projects than Nigeria. According to the EY 2015 Africa Attractiveness Survey, in the last five years South Africa received twice as many FDI projects as any other African country as investors are attracted by a diverse economy, solid infrastructure, and ease of doing business. In addition, the World Economic Forum ranked South Africa and Nigeria 49th and 124th respectively out of 144 countries in the Competitiveness Index.
It is not hard to see why Nigeria’s economy lags behind that of South Africa when one considers the fact that the former is more reliant on commodity exports than the latter. Nigeria receives more than 90% of its foreign income from oil exports, while South Africa has only 65% of total exports as commodities, which is diversified over several different commodities. South Africa therefore generates much more through its manufacturing and service industries.
In addition, South Africa surpasses Nigeria in terms of the quality of regulation and supervision of the financial services sector, which enhances the ease of doing business in a country. Although there have been recent improvements in the regulation of the Nigeria banking sector, it is still very much a cash-based economy as less than 35% of Nigerians have a formal bank account compared to 70% in South Africa.
The fact that Nigeria is less developed than South Africa means that there are more growth prospects in it. Minor investments can lead to substantial economic gains and growth in Nigeria compared to South Africa that already has lots of economic infrastructure in place. Similarly, Nigeria's significantly higher population size can be harnessed to contribute positively to economic growth.
While Nigeria is likely to regain its position as the largest economy in Africa due to its population advantage in the medium to long term, the ranking of African economies is likely to be determined by exchange rate movements in the short term.