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Nigeria Strategy Report H1 2017 (10) - Feeble Steps Out Of Recession

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Friday, January 20, 2017 04:48 PM / ARM Research

Key Developments in Domestic Economic and Policy Environment 
We continue with our series of excerpts from our core strategy document – The Nigeria Strategy Report, but direct our focus towards a review of the performance of Gross Domestic Product over 9M 2016 and outline our view on  the economic landscape for 2017.

Extending the pattern in H1 16, when output shrank 1.2% YoY, the economic landscape deteriorated further in Q3 16 with NBS reporting that real GDP contracted 2.24% YoY which places Nigeria on track for a first annual output contraction since 1991 (9M 16: -1.6% YoY). Breakdowns reveal a sharp contraction in oil GDP (9M 16: -14%) relative to non-oil output (9M 16: -0.2% YoY), which a rudimentary conclusion would be quick to link overall output weakness  to oil production woes – a view which indeed hugged headlines. However, our attribution analysis reveals that oil sector contribution to overall growth has been broadly negative over the past five years – on average a quarterly contraction of 5%.

Nonetheless, robust growth in the larger non-oil sector of 5.4% YoY per quarter helped ensure resilience in overall output growth which averaged 4% over the period leaving developments in oil as more of a side show. Thus, in our views, in explaining Nigeria’s descent into recession, emphasis should be rightfully placed in the non-oil picture.

Over 2017, we see improvements in agricultural output as well as stabilizing oil production and higher crude oil prices driving flat real GDP growth at 0.1% YoY, with a potential for the country to exit recession in Q2 17. However, given the scale of oil GDP woes in 2016, we would like to point out that in the event of a lasting truce in the creeks which returns production to 2.2mbpd, and assuming non-oil constant, growth could rebound 2.7% YoY by our estimates which corresponds to a bull scenario. In terms of downside, in the event of breakout of militant unrest, production could drop to as low as 800kbpd – which corresponds to output produced on offshore crude platforms less susceptible to militant attacks, which would translate to 6.6% contraction in growth, in our view. 

Nigeria slides deeper into recession as non-oil growth disappears
Extending the pattern in H1 16, when output shrank 1.2% YoY, the economic landscape deteriorated further in Q3 16 with NBS reporting that real GDP contracted 2.24% YoY which places Nigeria on track for a first annual output contraction since 1991 (9M 16: -1.6% YoY). Following the tame growth reading in 2015— slowest since 1999—the quick markdown in Nigeria’s growth fortunes suggests deeper lying issues at work.

Looking at breakdowns, which reveal a sharp contraction in oil GDP (9M 16: -14% YoY) relative to non-oil output (9M 16: -0.2% YoY), a rudimentary conclusion would be to link overall output weakness to the oil production woes – a view which indeed hugged headlines. However, taking the relative weights of oil and non-oil into consideration and examining patterns over the last five years, a different picture emerges. Specifically, our attribution analysis reveals that oil sector contribution to overall growth has been broadly negative – on average a quarterly contraction of 5%.

Nonetheless, robust growth in the larger non-oil sector of 5.4% YoY per quarter helped ensure resilience in overall output growth which averaged 4% over the period leaving developments in oil as more of a side show

Figure 1: Attribution analysis of real GDP growth



Thus, in our view, in explaining Nigeria’s descent into recession, emphasis should be rightfully placed in the non-oil picture, which we proceed to undertake in our analysis of growth trends in 2016, and its likely evolution over 2017 in charting overall growth trajectory in 2017.

ICT and Real estate weakness swing Services GDP into recession
Starting off with the largest component of non-oil GDP, Services1, continued deceleration in heavyweight ICT (32% of Services) combined with cutback in the real estate subsector (21% of Services) in dragging sector growth into negative territory (Q3 16: -1.1% YoY, 9M 16: -0.9% YoY). In line with recent trends, ICT slowdown mirrored growth deceleration in telecommunications GDP which reflects sector maturation2 with GSM subscriber growth shrinking to single digits (multi-year low).

On the other hand, the real estate sector went into recession in 2016 (Q1: -4.7% YoY, Q2: -5.3% YoY, Q3: -7.4% YoY) as slowdown across all sub-segments deepened. As n prior quarters, urban office rentals remained under pressure as more floor space on- streamed from a large construction pipeline applied downward pressure on rental yields in Lagos, even as shrinking corporate profitability reduced take-up. Importantly, the slowdown in real estate is reflective of weakness in ancillary sectors, building & construction, and cement.

As we highlighted in our NSR H2 2016, revenue constraints, with actual revenue receipts 25% shy of budgeted estimate as at 9M 2016, worked to dampen FGN’s ability to implement its N2 trillion 2016 expansionary capital spending plans. Though state level data is unavailable for 9M 16, we believe state governments likewise struggled to meet 2015 aggregate capital spending of N2 trillion on account of revenue pressures (10M 16: -30% YoY). The reduced public sector infrastructure spending combined with weak private demand in driving subdued construction activity across board.

Away from real estate and ICT, the financial services sector (8% of Services) shrank 7% over 9M 2016 largely due to weak activity in the banking sector. Here, the deadbeat macroeconomic picture and concerns over capital adequacy drove muted loan growth, ex NGN depreciation, as banks adopted a highly selective approach to loan origination.

Figure 2: Telecommunications GDP and GSM Subscriber growth



Figure 3: Trends in Real Estate, Building & Construction, and cement GDP


Manufacturing buckles under the strain of negative wage growth and supply issues
After exiting a three-quarter recession in Q4 15, manufacturing sector resumed the negative pattern in 2016 (-5.3% YoY) with key segments: food, beverage, and tobacco (FBT) alongside Textile, Apparel and Footwear (TAF) contracting 7.5% YoY and 1.9% YoY respectively3. The sore reading is consistent with listed manufacturing companies which have relied on price increases to drive revenue growth ,and PMI data which have remained below 50. Focusing on the PMI data, manufacturing slack reflects difficulty in clearing inventory, which has resulted in cutback in new factory orders, difficulty in obtaining forex for imported raw materials and factory downtime from incessant disruptions to gas supply. Whilst the latter two factors appear self-evident given the continuing dollar illiquidity at the interbank FX market and militant attacks on oil and gas installations, the former stems from continued erosion in purchasing power with NBS data revealing that real wage growth remained negative (H1 16: -14%, 2015: -9%). In addition to slack compensation growth, delayed salary payments at state government level and higher unemployment exacerbated the aggregate demand picture for manufacturing GDP.


Figure 4: Trends in Manufacturing GDP growth and real wage growth



Agriculture finds firm footing amidst the growth turmoil
In contrast to the negative picture elsewhere, agriculture GDP growth over the first three quarters remained robust (9M 16: +4.1% YoY, 2015: +3.7% YoY). Expansion in the sector output mirrored record cereal production (+14% YoY to 20.8million MT) with FEWSNET reporting double-digit growth across: maize (+10% YoY), millet & sorghum (+18% YoY) and rice (+15% YoY). In its report, FEWSNET linked above average harvests to increased cultivation as fall-out of NGN depreciation which induced import substitution on the part of Nigerian manufacturers and sizable cross border demand resulted in higher domestic prices. Aided by policy support in the form of low cost financing for certain crops and import curtailment measures, agriculture is proving to be the biggest beneficiary from the NGN depreciation which posed problems to other segments of non-oil GDP.

Figure 5: Trends in cereal production and Agric GDP growth



Overall, a myriad of factors across aggregate demand (contraction in real income, slowing corporate profitability and weak fiscal spending) and aggregate supply (energy bottlenecks and extended dollar shortages for imports of critical foreign inputs) adversely impacted non-oil GDP in 2016.

Militant attacks beset oil production
As earlier stated, oil GDP maintained its contractionary trend, (-22% YoY) as insecurity in the Niger Delta, following a resumption of militant attacks, left existing force majeure along key export terminals intact over Q3 16. The renewed hostilities which drove oil production to multi-decade lows of 1.5mbpd in Q3 16, also adversely impacted gas production (-20% YoY to 591bcf) and largely accounted for depressed output levels for the sector. In terms of exploratory activity, though the NNPC acting under presidential directives renewed search for oil deposits along the Chad basin, IOC activity remained mute due to lack of clarity on fiscal terms. On the policy front, after silence over much of H2 16, the National Assembly revived progress on the two successor bills to the PIB which scaled first and second reading while public hearings have commenced as at the time of writing this report. Furthermore, the Ministry of Petroleum Resources (MPR) worked out a deal with the IOCs on legacy JV debt of $6.8 billion which would see the NNPC payback $5.1billion over a five-year period from incremental production above 2.2mbpd with the rest written off. In addition, the MPR announced that JV operations, which account for 40% of total oil production, would now be financed under a new funding arrangement4 that would permit cost recovery for IOCs in a model similar to PSC operations. Under the new system, IOCs no longer need to wait for JV cash calls to fund exploration work on JV assets, rather, the JVs would independently source funding with recourse to crude sales before profits.


NNPC estimates that the removal would save $2billion per annum and incentivize IOCs to raise oil production from JV operations.

Figure 6: Oil production and Oil GDP



Nigeria exit recession in 2017 as non-oil contraction slows and oil production stabilizes
Having laid out our thoughts on drivers of trends in the various sectors in 2016, two questions are thus central in clarifying outlook. First, can Nigeria obtain peace in the Niger Delta to boost oil production above 2mbpd? Second, can non-oil recover from the combination of energy issues, and negative real wage growth? For oil GDP, the adoption of a more conciliatory approach, after the initial belligerence in H1 16, which ended with a truce announcement by the Niger Delta Avengers and increased amnesty allocations in the 2017 budget (N65billion vs N20billion in 2016) there appears some cause for optimism. That said, copy-cat attacks by new groups in Q4 16 suggest the carrot approach could incentivize adoption of more militant approaches which leaves security in the region precarious. Thus, we are pessimistic over production in 2017, which would need to surmount 2mbpd for oil GDP to swing positive and forecast limited upside to output from the mean 1.8-1.9mbpd which should see sector growth flat from 2016 – an improvement from the steep decline. Over the medium term, the deal between the Ministry of Petroleum Resources and IOCs on legacy JV debt under which the latter would repay itself from proceeds of oil production over 2.2mbpd over a 5-year period buoys production outlook. Longer term, though conclusion on the policy front does not appear in sight, we take note of the progress on the successor bills to the PIB which should move to the critical committee stage in 2017 post the public hearings in December 2016.

Examining likely developments on the non-oil side, with tele density over 100%, tepid subscriber growth should continue to underpin deceleration in telecommunications GDP. Furthermore, recent regulatory action which reversed the planned upward review on data prices should work to constrain growth in voice and internet services.

Overall, ICT GDP growth should remain slack in 2017. Elsewhere, whilst the FG plans another bite at economic reflation with the 2017 budget, as we noted in our fiscal analysis, the revenue hurdles would work to thwart such efforts. Thus, we see limited respite for real estate which is already grappling with over-supply across most segments. Lastly, for the financial sector, an unclear macroeconomic picture, shrinking capital levels and persisting asset quality issues should continue to constrain loan growth in the banking industry. Overall, Services growth should remain soft in 2017.

For manufacturing GDP, across the demand and supply side, pressures remain. On the heels of upward sales price adjustments across most sectors, as producers transmit cost pressures, we see depressed real wages driving subdued volume growth.

Furthermore, scant prospects for improvement in the FX picture raises scope of collapse in some segments of manufacturing more reliant on foreign inputs. Overall, we see enough in the outlook to suggest that manufacturing will lag most sectors in recovering from the recession.

However, as in 2016, agriculture GDP growth should remain strong in 2017 as beyond any policy initiatives deployed, the combined effect of increased export competitiveness following NGN depreciation and elevated grain prices should spur expansion in acreage in 2017. Complemented by more targeted financing initiatives and subsisting import controls, we think the agriculture sector should overshoot trend growth in 2017 assuming rainfall patterns remain constant. Given its weight, agriculture GDP should help nudge non-oil GDP away from contraction but overall non-oil growth should remain well below trend levels.

Tying our views across oil and non-oil GDP, we project that Nigeria should exit recession in Q2 17 as our view regarding oil production cascade unto the low Q2’ 16 base resulting in a positive swing in oil GDP. Over 2017, we see stabilizing oil production and improvements in agricultural output driving flat real GDP growth at 0.1% YoY. However, given the scale of oil GDP woes in 2016, we would like to point out that in the event of a lasting truce in the creeks which returns production to 2.2mbpd, and assuming non-oil constant, growth could rebound 2.7% YoY by our estimates which corresponds to a bull scenario. In terms of downside, in the event of breakout of militant unrest, production could drop to as low as 800kbpd – which corresponds to output produced on offshore crude platforms less susceptible to militant attacks, which would translate to 6.6% contraction in growth, in our view. 

Figure 7: Annual real GDP growth



ARM Securities | 1, Mekunwen Road, Off Oyinkan Abayomi Drive, Ikoyi, Lagos, W:www.armsecurities.com.ng | M: 234 (1) 2701653 

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