Thursday, May 04, 2017 03.25PM / ARM Research
Key Developments in Domestic Economic and Policy Environment
Nigeria attempts mission complicated amidst fragile socio-political milieu
After overcoming wrangling over the contentious 2016 budget, which was undermined by delayed presidential assent that left it ham-fisted to lift the country out of recession, Nigeria appears to be facing fresh challenges with the successor appropriation bill. Specifically, the National Assembly only recently communicated intentions to pass the 2017 budget before May 2017- one and two months later than in 2016 and 2015 respectively with hard realities also threatening to taper optimism for early budget passage even further.
First, as at the last working day of April, the Senate committee on Appropriation was yet to get reports from all standing committees on the 2017 budget with the legislature quick to pin the delay to the seizure of essential documents by the police high command following a reported whistle blowing. The ongoing fracas assumes extra importance when viewed against the backdrop of traditional delays in obtaining executive approvals for budget documents—especially after wholesale amendments by the Nigerian National Assembly. Indeed, the delays could gradually stifle optimism over the execution of major programmes and projects in the current year with forward indicators (such as PMI) suggesting that a whole lot more needs to be done to attain what now appears like an overly ambitious ERGP growth target of 2.17% YoY over 2017.
This is even as the sustained saga over the president’s health offered ample distraction to overall policy direction with the vice viewed to be more pro-market inclined.
On growth, perhaps a more compelling concern is the sustained militant activities in the Niger Delta Creeks. For one, the Trans Forcados—Nigeria’s largest crude export terminal—is yet to re-open even after long-winded guarantees and assurances from major stakeholders. Elsewhere, latest NNPC reports12 indicate further onslaught on oil and gas infrastructure with shutdowns in Trans Niger Pipeline (TNP) and Nembe Creek Trunk Line (NCTL) as well as subsisting force majeure at Brass Terminal providing scanty support for FG’s campaign. Although more recent releases from OPEC indicate steady increases in Nigeria’s rig count relative to Q4 16 (+11% to 25.5 over Q1 1713), the level of activities in the oil and gas space remain considerably muted (-6% YoY) relative to 2016 with stakeholders still skeptical of the volatile oil-rich region.
Added to the highlighted challenges is the build up to the coming governorship election in Anambra state which promises to be equally enthralling if the heightened political shenanigans at the last Ondo and Edo gubernatorial elections are anything to go by. On the Niger Delta, while we still see enough in FG’s current efforts to suggest that further improvements in Niger Delta security may not be farfetched—given the declines in pipeline vandalized points, we remain wary of the security situation in the volatile region with key onshore and shallow water assets still within purview of militant attacks.
Revenue slippages drag fiscal deficit to six year high
In line with prior eight quarters, Q4 16 gross federally collected revenue fell 14.4% YoY to N1.2 trillion as oil and non-oil proceeds maintained a contractionary trend over the period. Fallout of the weak receipts from both sources was fairly evident on FY 16 gross federally collected revenue which declined 17.4% YoY to N5.0 trillion lowest in over six years. Across income sources, oil receipts dipped 19.4% YoY to N654 billion (FY 16: -28.2% YoY to N2.7 trillion) in Q4 16– as production shortfalls (-18% YoY) springing from continued attacks on oil installations more than offset the combined effect of higher than projected crude oil prices (+13.8% YoY to $49.91.bbl vs. budgeted $38/bbl.) and weaker exchange rate (-21.5% to N253.49/$ vs. assumed N199/$). Elsewhere, though weaker corporate taxes in Q4 16 drove a contraction in gross non-oil revenue (-7.8% YoY toN525 billion), however improved picture over 9M 16 kept FY 16 reading in the positive territory (+0.1% YoY to N2.2 trillion).
Interestingly, despite the steep contraction in gross federally collected receipts in Q4 16, FG’s retained revenue rose 8% YoY to N804.6billion (FY 16: -7% YoY). On the expenditure leg, total expenditure in Q4 16 was largely unchanged from the prior year at N1.5 trillion as cutback in CAPEX (-12.8% YoY to N404 billion) neutered effect of higher recurrent expenses (+12.9% YoY to N997 billion). Hence, largely reflecting improved FGN retained revenue, the fiscal deficit over Q4 16 declined 7% YoY to N681 billion. That said, full year 2016 fiscal deficit of N2.3 trillion (+51% YoY) is the highest in six years. The record deficit reflected the impact of lower retained revenue (-6.5% YoY to N3 trillion) on one hand and higher capital (+12.3% YoY to N919 billion) and recurrent (+7.4% YoY to N3.9 trillion) expenditure on the other.
Going forward, rising oil prices (Q1 17: $51.77 vs Q4 16: $49.91) and gains from a weaker currency (-38.1% YoY, budget estimates: N305) and improved crude production point to higher oil receipts relative to 2016 levels. On the non-oil leg, prevailing macroeconomic headwinds should underpin weaker corporate profitability in 2017 and translate to lower receipts from Company’s Income Tax.
The same applies to incomes from Customs and Excise Duties as well as Value Added Taxes (VAT) where below-trend import levels and economic activities underpin our bleak outlook. In line with Q1 17, we expect soft revenues in the non-oil sector to filter through to retained revenues which placed alongside projected FG expenditure of N7.3trillion culminates in a deficit of ₦3.2trillion (N3.2 trillion previously).
Table 1: 2017 Federation revenue budget vs ARM revised estimates
Figure 3: Nigeria’s oil and non-revenues in 2016
Economic Review and Outlook
Economic recovery still underway
Following the release of Q4 16 GDP numbers (-1.3% YoY), emerging signals indicated that the pace of recession was slowing and we look for growth to eventually return from Q2. Precisely, over Q4 16, the pace of Nigeria’s economic contraction slowed from the 2.2% YoY decline recorded in the preceding quarter to only -1.3%, as slower contraction in oil GDP (-12.4% YoY) tapered pass-through from reversal to negative growth in the non-oil front (-0.33% YoY).
Tamer contraction in the former was consistent with a fragile truce in the Niger Delta which supported repair works on some key oil and gas pipelines and bolstered crude production (+16.5% QoQ to 1.9mbpd). This was even as the FG intensified conciliatory efforts that led to a nosedive in the number of vandalized pipeline points to 18 (from over 200 in January 2016). At the other end, after eking out a tepid expansion in Q3 16 (+0.03% YoY), Non-oil GDP was hauled back to negative growth by steeper decline in Services (Q4 16: -1.6% YoY, Q3 16: -1.1% YoY) and slower growth in Agriculture (Q4 16: +4.0% YoY, Q3 16: +4.5% YoY). Services contraction stemmed from a sharper weakening in real estate at -9.3% YoY (Q3 16: -7.4% YoY) which is reflective of the pressures in ancillary sectors: Building & Construction, and Cement even as Urban office rentals remained under chains. Overall, the dip over Q4 brings 2016 real GDP growth to -1.5% YoY—the first contraction in 25 years.
Over Q1 17, a charm offensive by the FGN in the Niger Delta region, in lieu of a military option in 2016, reportedly drove stability in oil production from the setback in December (-20% MoM to 1.57mbpd). In addition, the FGN raised proposed amnesty payments in the 2017 budget by over two-fold YoY to N65 billion. For us, both tactics should support stability in the volatile region and leave crude production at an average of 1.98mbpd with the possibility of a return to prior year’s level of 2.2mbpd in the latter half of 2017 still in the cards.
Consequently though, noting that average oil production would have need to surmount the high base of 2.16mbpd—recorded in Q1 16—for GDP to swing back to the positive, we expect another negative growth on the oil front in Q1 17. Unfortunately, dour PMI readings over the first few months of the year also suggest sustained deceleration in non-oil GDP over the last quarter. On the back of the strong correlation between past PMI readings and GDP performances therefore, we see scope for an extension in GDP contraction over Q1 17.
Pertinently, given seasonality patterns of quarterly GDP growth in the last three years which suggest that Q1 numbers have printed at an average discount of 13% relative to Q4 numbers, we see legroom for another contraction in GDP in Q1 17 despite gains on the oil front. To be clear, our base case scenario of a 13% discount would imply a 0.5% YoY contraction in real GDP over Q1 17.
Exports switch gear on rising organic propellant
According to data provided by the nation’s statistical agency (NBS), Nigeria exited trade deficit in the last quarter of 2016 after posting trade surplus of N671 billion (FY 16 deficit: N290 billion). This resurgence, which tapered impact of deficits from preceding three quarters, was aided by 53% YoY surge in value of exports to N2.98 trillion. Effect of the foregoing neutered impact of sustained rise in imports (+46% YoY to N2.308 trillion). At the export end, growth was aided by a 59% YoY jump in value of mineral products exports to N2.87 trillion (or +3pps YoY to 96% of total exports) which rendered impact of declines across Vehicles, Aircraft and Parts thereof”; Vegetable products; Prepared foodstuff & Beverages, Spirits & Vinegar and Tobacco exports immaterial.
Unsurprisingly, gains in mineral products reflected 58% rise in crude oil exports to N2.43 trillion as resurgence in global crude prices (+6% YoY to $49.91) and the revenue amplifying impact of 55%-naira depreciation trumped continued weakness in oil production (-12% YoY to 1.9mbpd).
Elsewhere, movement in import value was characteristically triggered by currency-induced sturdy growth in value of imported mineral products (+128% YoY to N724 billion), including refined crude, in the review quarter. In passing, we note that the steep depreciation of the NGN relative to only 46% rise in overall imports suggest that actual imported volume contracted in the review period. Elsewhere though, a similar analysis suggests only slight decline in overall export volumes which could be linked to prevailing motivation from a potential to obtain the expensive greenback. Going forward however, recent production numbers (-12% YoY to 1.9mbpd in our estimates) and recovery in crude prices (+53% YoY to $51.18 on average) are indicative of a potential return to strong organic growth in Nigeria’s exports in the coming reading. At the other end, improving liquidity in Nigeria—an offshoot of continued CBN dollar sales—should gradually lead to rebound in volume of imports as well as sustain gains in the implied naira value of imports. That said, with most of the gains in dollar availability having trickled in March, the increase in imports is likely to be relatively subdued. On the strength of these, we now see scope for another round of balance of trade surplus in Q1 17.
Food inflation defies the dollar spree…
Over the first three months of 2016, Nigeria experienced a moderation in headline CPI (-132bps to 17.25% YoY) as hurdle from 2016 high base took center stage. Notably, the decline was ubiquitous across a few core constituents, with energy related inflation (-879bps to 22.5% YoY), which houses electricity prices, pulling core inflation to a 10-month low of 15.38% YoY in March. Meanwhile, food inflation (+103bps to 18.44%) tracked higher despite efforts by the FG and CBN to curtail the soaring prices.
We had expected FG’s imposition of a maize export ban but more importantly naira gains (+21.4% to N385/$) at the parallel FX market—following increased dollar sales (monthly average of $1 billion since the turn of the year)—to inhibit demand from neighbouring West African countries, and consequently drive food prices lower in March. However, propelled by structural challenges, restriction on use of foreign exchange reserve for food imports as well as higher transactions and transportation cost (March transport inflation: +1.2% MoM)14, MoM food inflation printed at a ten-month peak of 2.21% (vs. 1.99% in the preceding reading) in NBS’ latest filling.
Going forward, we expect impact of high base effect to continue to dictate core inflation and overall headline trajectory despite concerns on the food front.
Precisely, high base effect from the 68% hike in PMS prices in 2016 which should completely wane in May 2017 as well as recent gains in Kerosene, and Diesel prices suggest a much-tempered core reading over the rest of the year. However, we are less sanguine on the food side of things over the near term owing to recent pressures from higher transactions and transportation costs. That said, a more recent retrace in diesel prices suggest that pressures on the transport front would be less impactful in coming readings. In addition, the allure of higher domestic prices, cheap financing, as well as FG’s continued push on the Anchor Borrowers Program which should incentivize production are notable signposts of gradual near and medium term gains relating to domestic food availability respectively. On the balance, we hold out for mean inflation of 15.4% over 2017 (2016: 15.6%)).
Figure 4: Inflation forecasts
Convergence on the horizon?
On the back of 53% NGN nosedive over 2016 which had provoked CBN’s tilt back to a managed float regime, naira remained stable at Nigeria’s interbank market (-0.5% from 2016 end to N306.40/$) in Q1 17. Whilst the policy reversion (from a fully floating regime) should ordinarily have worsened dollar illiquidity in the FX market—as foreigners’ become increasingly worried of clogs to capital repatriation, the apex bank’s policy tweaks to the FX market including suspension of the 60:40 FX allocation rule in favour of the manufacturing sector and resumption of direct dollar injection to the so called “invincible market” (BTAs, PTAs, medical and educational fees) helped reduce dollar scarcity over the review period. More importantly, riding the relative comfort of steady gains in the FX reserve, amid higher crude oil proceeds and inflows from inorganic sources, the apex bank raised its dollar sales (forward, interbank spot market and BDCs) which underpinned a 21% naira appreciation at the parallel market over Q1 17.
Consequently, the premium between the interbank and parallel market plunged to 26% (from 61% at the end of 2016). However, amidst calls from international organizations including the IMF and World Bank for a further depreciation (10%-20%) in the interbank naira rate of N305/$—a move that should further discourage portfolio flows to naira assets—, a key question to investors is what the realistic fair value of the greenback is.
To answer this question, we re-invoke quarterly REER data on the NGN from IMF over the last three decades to apply the Purchasing Power Parity (PPP) concept which holds that currencies gravitate towards their long run mean over time. On extrapolating into nominal terms, the long run REER average for the naira would correspond to an exchange rate of N351.07/$, which confirms that the current interbank naira rate, which falls outside the acceptable EM/frontier market band of +/-10%, is slightly overvalued. On this wise, CBN’s execution of an increasing number of FX interventions at N360/$ suggest that it may well have realistically assessed the possibility of a naira devaluation to levels consistent with this long run naira REER—providing some backing to our oft noted expectation for an eventual naira devaluation (to ~N360/$) by YE 2017.
At the other end, the apex bank in late April introduced a new FX window for investors and exporters (IEW), which seeks to deepen FX market and ensure timely settlement of eligible obligations via FX supplies from portfolio investors, authorized dealers, and other parties. In addition, the apex bank expects the launching of the window to help formalize and properly re-channel autonomous dollar inflows (~56% and ~19% of total dollar inflows and outflows respectively).
Given that the rate at this window is expected to be market determined with ongoing rates of N380/$ close to the parallel market rate, —a mark that investors reference rates in the parallel market for fair valuing the naira— we believe the apex bank has a greater incentive to ensure currency stability in the parallel market, hence the need for sustained dollar sales. In analyzing the potential quantum of CBN’s FX sales, we reviewed dollar inflow and outflow patterns over prior years, as well as expectations for same going forward, with a view to ascertaining impact on the nation’s reserve—a partial indicator of how deep down the rabbit hole the apex bank could be willing to travel, in our view.
As per specific assumptions, we believe that, in addition to the potential $2.2billion inflow from external borrowings (Eurobond: $1.5 billion, Diaspora: $300 million, AfDB: $400million), Nigeria should be able to rake in $12.5 billion in oil inflow over 2017 (+23% YoY), reflecting a base case oil production for 2017 to 1.98mbpd (2016 average: 1.83mbpd) and an oil price target of $55/bbl. (2016 average: $43.87/bbl.). In addition, assuming a $9.3billion non-oil inflow (average over the prior four years), we estimate total 2017 inflow of $25.2 billion, with the implied monthly average of $2.1 billion providing the apex bank with enough ammunition to sustain its aggressive FX sales without significantly depleting the FX reserves.
Particularly, assuming an average monthly sale of $2billion (April 2017: $1.9 billion by our estimate) to the FX market together with $500 million (average over 2017) sold to non-WDAS sources, we expect the net FX19 reserves to only fall by $3 billion to $24 billion by the end of the year—a time period, we believe is sufficient to return confidence to the interbank market.
Figure 5: 2017 FX reserves projection ($’billion)
Related News from ARM’s Q2 2017 Nigeria Strategy Report
Related News from ARM’s H1 2017 Nigeria Strategy Report