Wednesday, January 25, 2017 9.38 AM / FBNQuest Research
The Buhari presidency may have disappointed many Nigerians with the slow pace of change since the formal handover in May 2015. However, it has not changed tack and has persisted with its core policies (diversification of the economy away from oil, fiscal expansion and social interventions). It is not in a hurry to back down in these areas although we think that it will have to give way a second time on its preference for a stable exchange rate.
The administration does not believe that every challenge has a free-market solution: far from it, and the private sector should not be surprised by an increase in regulation of some industries. We also see a further expansion of the CBN balance sheet through new lending schemes for segments of the economy where the deposit money banks (DMBs) have been reluctant to tread.
The presidential term is just four years and pre-election positioning starts early in Nigeria, so there is pressure on the FGN to deliver some results in the next year. Its best bet is fiscal, particularly if the passage of the 2017 budget is more rapid than in recent years.
Since the Dutch disease has manifested itself in Nigeria since the slide in the oil price from mid-2014 and household demand has therefore been squeezed, the FGN has rightly opted for fiscal expansion as the route to lifting the country out of recession and meeting its employment objectives.
The 2017 budget proposals are ambitious: aggregate spending of N7.30trn including unprecedented capital releases of N2.24trn, aggregate revenues of N4.94trn and a mouth-watering FGN deficit of N2.36trn. These are hefty increases on the 2016 budget and even larger increases on the likely outturn for 2016.
One change for the better is that the FGN has produced more realistic projections for non-oil revenue collection, and assumed that the oil economy will generate more revenue than the non-oil.
The fiscal expansion is the base of our GDP growth forecast of 2.0% for this year. We hear that we are being overly hopeful: we would reply that the population is said to be growing at 3.2% per year and that we are forecasting a decline in per head incomes. Our forecast is supported by selective private-sector investment (as in agriculture and petrochemicals) and by a pick-up in oil production.
Our thinking is that the FGN has no choice but to reach a compromise to restore stability to the Niger Delta. It has said repeatedly that the diversification of the economy hinges ironically upon healthy oil revenues. Initially, it did not want to continue paying the allowances to militants in the delta but has reluctantly changed its position.
We see a rise in crude production including condensates to 2.10 mbpd this year from an estimated 1.82 mbpd. The FGN is assuming 2.20 mbpd in its proposals.
On the average oil price assumption of US$44.50/b for this year, in contrast, the proposals are conservative. Our expectation is US$57/b with some upside. The FGN therefore should have some welcome headroom, which it will value if production underperforms. Our thinking is based on hints from OPEC that, when it next meets in May, it may make further cuts in production quotas if it is not happy with the direction of the price.
The signals from the CBN, the MPC and the political leadership indicate otherwise but we think that there will be devaluation in Nigeria in 2017. The economy has need of sizeable autonomous fx inflows to meet legitimate import demand, close the gap between the interbank and other fx markets, and create a market in which the CBN is not the dominant player.
Our view is that these flows will not materialise without a devaluation: some will (such as the Eurobond launch, an asset sale or two, and perhaps some advance payments for crude oil) but not enough. They would materialise if the FGN was prepared to take IMF money but for whatever reason it will not. So we come to devaluation.
We doubt that it will be accompanied by a genuine float, as indicated by the CBN at the time of the liberalisation/last devaluation in June 2016, because the urge to manage the rate is very strong. It is worth mentioning that the CBN has no experience of a floating exchange-rate regime. We have an end-year rate of N365 per dollar and an average for 2017 of N320.
As for interest rates, the other arm of monetary policy, the MPC hiked twice in 2016 but failed to boost economic activity or lure offshore portfolio investors back to local markets. Our take is that the committee feels powerless in the face of GDP contraction and rising inflation. Help is on its way in our forecasts however, with positive (if modest) growth and declining headline inflation due to favourable base effects, which will allow the committee to trim its policy rate to 12.00% at end-year.
As for equities, we expect the market to trade sideways for the most part until some clarity on the fx situation emerges. If a resolution leads to a free float regime (or very close to it), we expect a surge in capital inflows. Our base case scenario is a 10% rise in the ASI for 2017 based on our fair value forecasts. A resolution of the fx situation could lead to a gain of at least 20%.
We see upside potential of up to 10% for the banks sector on average; a marked resumption of capital inflows from offshore portfolio investors could lead to a much stronger performance. We forecast the average ROAE for our universe of banks to move up to 18.3% in 2016E, thanks to fx-related gains, but subsequently fall sharply to 11.2% in 2017E (assuming fx-related gains are not material in 2017E).
Among the non-financials, we prefer the cement and palm oil names for which we see upside potential of 56% and 6% respectively on average. The other sectors continue to struggle with the headwinds stemming from fx devaluation given their high dependence on imported raw materials and/or FCY loans.
Fiscal policy in the driving seat
The 2017 budget proposals are still more expansionary than the previous year’s, set a heady target for capital releases and maintain the level of personnel costs. If the FGN is able to hit its revenue targets and implement its proposals, we will see a sizeable fiscal stimulus. We could have the rare bonus of a relatively fast passage of the budget.
An end to the recession
The economy is set to emerge from recession this year and grow by 2.0%. The fiscal stimulus will be the main driver, supported by a recovery in oil production and selective private investment. Beyond our forecast horizon, household consumption will recover, leading to an acceleration in growth.
Monetary easing on lower inflation
The monetary authorities are not equipped to counter both GDP contraction and rising inflation. Their task will be clearer when positive growth returns and inflation starts to slow on positive base effects. The next rate moves by the MPC should be downwards, in line with (or perhaps anticipating) steady declines in headline inflation.
Exchange rate to give under pressure
While we cannot detect any changes in the official mindset on the exchange rate, we see another devaluation this year in the “last resort” category. The CBN will struggle to resist the urge to manage the rate in some way.
FGN bond yields to widen; potential 10% return for equities
FGN bond yields are likely to drift higher before the policy rate cuts due to the fiscal expansion and substantial issuance programme. Active investors will prefer the better returns on longer tenor NTBs. After three years of consecutive losses, we expect equities to regain some lost ground this year. We forecast the ASI to return 10%, implying an end-year target of 29,560.
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- Year in Review 2016 and Outlook 2017
1. Nigeria Strategy Report H1 2017 (10) - Feeble Steps Out Of Recession
2. Beyond Recession, Towards A Resilient Economy
3. Nigeria Strategy Report H1 2017 (9) - Pension Reforms Set Sights On Infrastructure Investing
4. Nigeria Strategy Report H1 2017 (8) - FG Fiscal Expansion: Once Bitten, But Not Shy
5. Nigeria Strategy Report H1 2017 (7) - Energy Sector Reforms: An Unbalanced Score Card
6. Nigeria Strategy Report H1 2017 (5) - Broadly Bearish Twist For Soft Commodities
7. Nigeria Strategy Report H1 2017 (4) - Crude Oil Prices On Verge Of A Breakout?
8. Nigeria Strategy Report H1 2017 (3)-Tightening US Monetary Policy Stokes Prospect For Portfolio Flow
9. Nigeria Strategy Report H1 2017 (2) - Commodity Price Shocks Dim Growth Lights Across Africa
10. Nigeria Strategy Report H1 2017 (1) - Optimism on US GDP Buoys Global Growth Prospects