Nigeria: Looking beyond Oil


Friday, March 18, 2016 3:20PM /PWC

Executive Summary
Nigeria is the largest economy in Africa and 22nd globally. We project that the economy could rise through the world rankings to top 10 in 2050 with a projected GDP of US$6.4 trillion, surpassing Germany, the United Kingdom, France and Saudi Arabia. To achieve this however, diversification from the economic over dependence on crude oil is required.  

Nigeria’s intrinsic potential lies beyond oil; harnessing this potential has become an imperative given the expectations of lower for longer oil prices. Based on recent trends, our report reviews the impact of low oil prices on key economic indicators and the real sector through an industry survey. In addition, this report addresses the question of priority sectors that Nigeria should target for diversification efforts. Our analysis identifies Agriculture, Petroleum (Petrochemical and Refining), Retail, and ICT as priority sectors with the most dominant transmission links to the overall economy.  

These sectors in the medium-to-long term are key to boosting other sectors like manufacturing. Forward linkages to agroprocessing and other services such as logistics as well as backward integration to input supply sectors could improve farm incomes, increase employment and improve domestic food security. Potentially, Nigeria’s global agriculture exports could take-off at a rate similar to Brazil’s, with US$59 billion in export revenues by 2030.  

Similarly, value added to Oil and Gas output needs to urgently improve by implementing diversification within the sector. This requires investments across the downstream sector to develop petrochemicals, fertilisers, methanol and refining, industries relevant in both industrial and consumer products which Nigeria currently imports. Consumer spending is the largest driver of the economy, accounting for c. 70% of GDP and we expect that this will be the boost for the retail sector growth even as population continues to expand.  

Thus, as incomes rise along with rapid urbanisation, we project that household consumption expenditure could reach US$1.1 trillion by 2030, from US$317 billion in 2014, which implies a growth of 9% through 2030. With teledensity at 107.871 , a large population of young urban people and massive scope to improve internet broadband penetration, Nigeria is likely to see accelerated growth of its digital economy. More importantly, the opportunity to leverage technology to generate improved social and economic outcomes across other sectors has been created.  

However, the transition to a non-oil economy will not be an easy task. Based on a 2016 PwC interview of foreign companies across Nigeria, four concerns stand out as challenges with the business environment: corruption, inadequate infrastructure, low skill levels, and macroeconomic uncertainty. In the 2016 Ease of Doing Business ranking, Nigeria ranks 169th (2015:170th) out of 189 economies surveyed. Interestingly, Rwanda jumped through the rankings from being 143rd in 2009 to 62nd in 2016. Over that same period, Nigeria’s ranking worsened as it moved from 102nd to 169th.  

This emphasises that the economic and regulatory environment needs to be more conducive for business. This means simplifying complex regulation and processes, and eliminating the hurdles that stand in the way of a bigger and more productive private sector. Our survey highlights the exchange rate as one of the top challenges facing industries in recent times. Capital controls, FX rationing, and restrictions on the importation of certain items are measures the CBN has implemented to preserve the foreign reserves and maintain currency stability.  

Considering the outlook for the oil price is a lower for longer scenario, we think these measures if sustained over a prolonged period are negative for the economy as detailed in the first part of this report. Limitations to capital flows, the lack of transparency, liquidity and price discovery in the official foreign exchange market could deter competitiveness, limiting FDI and consequently growth.  

Sustaining the wide premium between the official and black market rates as well as ingenuity to circumvent economic restrictions could further breed corruption and revenue leakages with massive costs to the economy. The argument has gone beyond the need for an adjustment, to a more urgent need to re-liberalise capital flows for a resurgence in foreign investments which Nigeria needs to buffer its foreign reserves.  

Significant reforms across the labour market, business environment and fiscal management will be required. A skilled workforce is critical to improving Nigeria’s productivity and efficiency. Considering the services sector is projected to be the key driver of the Nigerian economy going forward, measures have to be implemented to improve the value-add of labour in this sector.  

A comprehensive approach is needed; sound and quality education provides a solid foundation to develop the relevant skills for the workplace. In addition, a collaboration among all stakeholders to design and implement education and training tailored to market needs is required. Nigeria needs to ensure sustainable fiscal management that is resilient to global oil price cycles.  

Improving tax collection and administration have become imperative for achieving national growth objectives. Nigeria is a low-taxed economy compared to its peers; in addition, challenges with arbitrary exemptions and enforcement have further constrained tax receipts. The framework for tax exemptions should be reviewed and approvals targeted at growth inducing sectors as the government improves collection.  

Efficiency in government spending has to improve; there is room for substantial savings in capital outlays and operating expenditure across the three tiers of government. In addition, the government needs to be deliberate about increasing fiscal savings through a higher accretion to the Sovereign Wealth Fund which has investment objectives of diversification and improving long term economic prospects.

Economic background
Nigeria is the largest economy in Africa with US$4782 billion and is one of the fastest growing economies in the world with a longterm average growth of 7.7%. As the world’s 7th most populous country, Nigeria is home to about 177 million people and is Africa’s largest market, with a young, growing and vibrant population. Since mid-2014, the price of oil has declined sharply by c.70% from US$114.60/bbl in June 2014 to under US$30/ bbl by February 2016, owing to excess supply.  

Supply has increased significantly following strong growth in non-OPEC production whilst oil consumption has weakened with slower economic growth in China and Europe. We estimate that the government could have lost around US$18 billion in oil revenues in 2015 forcing the introduction of raft measures to shore up revenues, maintain currency and foreign reserves stability as well as support the economy through fiscal policy.

Crude petroleum accounts for c.75-80% of revenues with several transmission channels into incomes and economic output. In this chapter, we examine the impact of the oil price decline on Nigeria’s economic variables 

GDP has slowed, driven by lower oil sector growth and a weaker nonoil sector
Nigeria’s economy grew by 2.7%y/y in 2015, which represents the slowest growth in the past five years, much lower than the 5-year real GDP average of 4.8%y/y. Real growth decelerated sharply to 2.1%y/y in Q4’15, reflecting the weakest quarterly performance following a contraction in growth across industries and moderation in the services sector (77% of GDP).  

Despite slowing significantly, Nigeria’s economy remains driven by the non-oil sector which recorded growth of 3.7%y/y (2014: 7.1%y/y) as the oil sector continues to underperform. Real growth in the crude petroleum and natural gas sector was -5.4%y/y in 2015, even as oil exports declined c.49%y/y in 2015.  

Excluding this sector, the performance of the manufacturing sector was unimpressive with real growth at -1%y/y (2014:15%y/y) with the sector plagued by the deteriorating operational and macro backdrop; largely the impact of Foreign Exchange (FX) unavailability on raw materials and intermediate inputs.

Crude oil production waiting on sector reforms
The impact of the low oil price in terms of production has been relatively capped but remains high risk. Anecdotal evidence suggests the cost of production for most of the upstream companies to be around US$25-US$30/bbl as such, at current oil prices, many companies will be loss making especially where there are huge overheads and finance charges.  

With revenue projections underperforming and inadequate to meet payment obligations, such companies are unable to proceed with CAPEX plans which could potentially impact production volumes.  

Probably, the most important challenge to note with respect to oil production is the massive amount of investment being prevented by the delayed reform of the Petroleum Industry as envisaged in the Petroleum Industry Bill (PIB) and the uncertainty that the new fiscal terms could mean for the industry. Interestingly, the U.S. which had historically been the largest buyer of Nigeria’s crude now accounts for only 3% of exports with India now the largest importer at 20%. 

Balance of payments: Current account moves to deficit
The latest available data3 shows Nigeria recorded a trade deficit in Q1’2015 for the first time since 1998 owing to a 56%YtD decline in crude oil export earnings, following the sharp decline in the price of crude oil. Imports on the other hand fell sharply, 39%YtD as the tightness in the Foreign Exchange (FX) market continue to hamper importation.  

In addition, the Central Bank of Nigeria (CBN) imposed administrative controls in the FX market which has limited accessibility to US Dollars through the official window thus causing imports to contract. Importers of 41 items including rice are unable to access FX at the official rate. The alternative is the parallel market which has traded at a 30%-100% premium to the official rate of NGN199/USD since the start of 2016.  

The decline in imports has been positive for the current account with the trade deficit at US$1.7 billion. If imports had remained at the same pace as at 2014, the deficit could have been as large as US$25 billion with implications for foreign reserves. Foreign Direct Investments as well as Foreign Portfolio Investments have taken a hit largely as a result of the policies around capital mobility which have come across as controls. The Balance of Payments (BOP) report as at Q3’2015 shows a 28% and 73% decline in FDI and FPI respectively to US$2.5 billion and US$1.4 billion. 



Headline inflation inches higher on imported inflation
In 2015, headline inflation averaged at 8.6%y/y relative to 8%y/y recorded in 2014, driven by a sharp acceleration in imported inflation and tighter domestic food and fuel supplies. Food inflation accelerated sharply reaching a peak of 10.6% in December 2015 influenced by rising imported food inflation. At 10.3%y/y, food inflation peaked at a 34-month high with the impact of tight dollar supply pushing imported food prices higher and offsetting the impact of the early harvest on domestic food prices.

There have been other risks to inflation; the second and third quarters of 2015 were laden with intermittent fuel scarcity which pushed core inflation higher although this was offset by the impact of weaker aggregate demand on the CPI. However, there have been some recent relief from the decline in the oil price to the US$30/ bbl levels, which has reduced the landing cost of Premium Motor Spirit (PMS) to tolerable levels. But, this reverses very quickly if the price of oil starts to climb or the currency is further devalued.

Increasing unemployment in the formal sector
We expect unemployment to rise from 6.4% in 2014 to 9.4% in 2016 given the recent trends in the labour force. Similarly, we estimate underemployment will increase for the second consecutive year to 19.6% in 2016 from 14.8% in 2013. Whilst growth in the labour force has averaged 2.6% in the past 5 years, employment growth has lagged behind, averaging 1.3% despite an average real GDP growth rate of 5.3%.  

Clearly, economic growth has been unable to create sufficient jobs to fully absorb the growing labour force, suggesting that employment elasticity with respect to output is low. Whilst it is true that as an economy grows, employment elasticity may fall (assuming growth is led by capital intensive sectors), in Nigeria, that is not entirely the case - services represents a sizeable portion of the GDP contributing c.53%.  

Other factors affecting unemployment and underemployment include the presssure on the formal sector due to urbanisation, high churn out (relative to rate of job growth) of graduates from the Universities, and layoffs on slower economic growth.


State governments continue to be vulnerable
The downside of lower oil price on state government finances has been quite severe as most states have reportedly fallen back on wages owed to their workers due to lower revenues. Although total state government debt accounts for c.2% of 2015 GDP, debt service on both domestic and external debts have significant implications for the Budget.  

Total domestic debt outstanding by the states as at 31 December 2015 amounted to US$13.2 billion – most debt issuances by states are backed by the Irrevocable Standing Payment Order (ISPO) which serves as a first line charge on statutory revenues, leaving states with limited revenues after deductions are made on a monthly basis. In addition, states with external debt exposure could find it difficult to finance scheduled interest repayments owing to Naira devaluation.



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