Wednesday, September 14, 2016 7:02pm /fdc
With Nigeria’s current economic weakness, the word ‘recession’ is on everyone's lips, but not many understand what it really means. The general rule of the thumb is that a country is officially in a re-cession after two consecutive quarters of negative growth. According to this definition, Nigeria was officially in a recession in Q2’2016. Another school of thought states that recession begins after a prolonged period (six months or longer) of slowing growth and economic contraction. This period is marked by a significant decline in aggregate demand, widespread retrenchment of business activity and rising unemployment. Using this definition, Nigeria slipped into a recession in January 2016, as growth slowed in the second half of 2015 (Chart 1). A third definition proposes that recession also occurs when growth in a country’s economic output is below its potential. This potential growth rate is the output level a country would achieve if all inputs of labor and capital where fully maximized. Accordingly, Nigeria has been in a recession since 2012, when economic output declined to suboptimal levels (Chart 2).
Whichever way you look at it, and regardless of economic definitions and rhetoric, we are in a recession. All that matters now is the strategies and policies implemented to bring the economy out.
The news of a recession has a psychological effect that can ultimately work to lower morale and confidence, discourage investments and push a country further into recession. In such an in-stance, investors are more willing to pull out from failing or slow projects, managers are more willing to downsize and carry out massive retrenchment. Understanding the increased risk of unemployment, consumers reduce consumption and save more. This leads to a reduction in aggregate demand, and reduces sales and profitability of doing business. To avoid this chain reaction, inves-tors, managers and consumers must prepare accordingly.
The first course of action in the wake of a recession is to develop a financial plan. Companies should focus on managing extraneous expenses where possible. Finance charges are bound to increase owing to the 200 basis points (bps) hike in interest rates to 14%. Reducing interest-bearing debt levels will significantly lower expenses.
Secondly, companies should consider liquidating cash from alter-native investments to strengthen the cash position of the business. The Nigerian Stock Exchange All Share Index (NSE ASI) has returned -3.64% year-to-date (YTD).3 There has been a steady decline in Q2’16 and the announcement of the recession could further impact stock prices and values. At N9.47 trillion, market capitalization also declined by -3.77% YTD Companies and individuals need to consider the risks. One option might be to cash in on investments now to be in a better position to buy them back during the recovery.
The next consideration should be the business’ operational strategy. Examples include staff, overhead, inventory and marketing activities. Training staff in several aspects of the business could help prevent work stoppages in the event of absenteeism or downsizing. Businesses should also attempt to reduce overhead costs and waste in areas like utilities, administration, and materials. These areas can contribute significantly to the bottom-line. Be careful when reviewing costs and remember: “the most powerful leadership tool you have is your personal example”.5 If management is deliberating cutting pay checks or increasing working hours, it should lead by example. That way staff will not feel un-appreciated and will maintain satisfactory levels of productivity.
Reconsidering marketing strategies as part of the operational re-view could also be of value. Diesel prices are on the rise (figure III). So it is important to keep logistics under control.
We do not suggest that businesses go into hiding by reducing marketing. Instead, business should consider less expensive advertising channels such as social media. While good social media still costs money, the cost of media buying and content production can be significantly reduced.
Finally, do not forget the customer. Worsening rates of unemployment and underemployment (figure IV) mean reduced household income. This puts a strain on disposable income to pay for goods and services. Do not punish customers further for their lack of funds. Instead businesses should focus on customer retention. Acquiring new customers is more expensive then retaining old ones and they will be harder to find in a recession. Existing customers will remain loyal, in spite of challenges, if they feel appreciated. Safeguarding the repeat business of these existing customers will be critical in ensuring a business’ long-term stability. Also, a satisfied customer is an essential marketing and advertising asset. Their referral will always be more valuable than a com-pany’s marketing spending. Staff training should therefore include regular sessions on customer service delivery, as they are the face of the company.
A company should never compromise on the quality of its product or service in a bid to remain profitable. A business is more likely to keep and acquire new customers by standing out with quality output as others cut back to stay afloat. In the long run, quality always thrives as customers drift to brands that offer the greatest value for money. By the time the economy is recovering, the business would have acquired a substantial gain in its customer base.
The ability to expect and prepare for the challenges of recession is critical. We hope to have provided some insight into what a recession is, what should be expected, and the possible approaches companies can take. Each company will have to figure out which strategies work best to prepare for the storm, while we hope for clear skies.
A Cartel in Crisis – Is OPEC Still Relevant?
OPEC Losing Control
It has been nearly two years since the Organisation of Petroleum Exporting Countries (OPEC) changed its strategy from protecting a fair market price to recapturing market share from U.S. producers. This shift in strategy has seen member countries routinely exceeding their production quotas with OPEC’s total production exceeding its 30 million barrels per day (mbpd) production ceiling by up to two mbpd.
Abandoning the quota system has come with a problem – it has become almost impossible to re-install and enforce it. OPEC was formed with the objective to "co-ordinate and unify petroleum policies among Member Countries, in order to secure fair and sta-ble prices for petroleum producers”. After two failed attempts in the last six months to freeze output and address the lingering oversupply in the oil market, OPEC – the once feared cartel – may be losing its relevance.
OPEC in Dire Straights
According to the Energy Information Agency (EIA), low oil prices cut OPEC revenues by almost half in 2015 to its lowest levels in 11 years – from $753bn in 2014 to $404bn in 2015. This is projected to plunge further to $341bn as oil prices fell to as low as $26 per barrel (pb) in the first quarter of 2016 and have averaged just over $42pb so far in 2016 – significantly lower than the 2015 average of $53.7pb. OPEC members posted a current account deficit of $99.6bn in 2015 – the first since 1998 – compared to a $238.1bn surplus in 2014 and Saudi Arabia, accounting for a third of OPEC’s earnings, saw its revenues plunge to $130bn in 2015. from $247bn just a year before.
Iran Playing the Spoiler
In addition to the dismal performance, Iran is poised for a come-back after years of devastating economic and financial sanctions. The Iran Nuclear Deal, effective from January 2016, reopened the international market to, potentially, 1.5mbpd of Iranian oil as well as the return of billions in frozen oil revenue to Iran. Iran vowed to increase production to pre-sanction levels and has left no one in doubt over its intentions to make good on that promise.
However, the timing of the deal could not have been worse. It came when the global oil market had been oversupplied for over two years owing to a surge in shale oil production by the US. Oil prices fell from $106pb in June 2014 to current prices hovering between the $40-50pb range. This also came at a time of growing global economic concerns that have dampened the outlook for global oil demand.
In February, less than a month after sanctions were lifted, a deal to cap production was proposed. A meeting in April ended with Iran refusing any production cut backs even after Saudi Arabia, Venezuela, Qatar and OPEC non-member Russia pledged to freeze output at January levels. In June, another meeting ended with Iran’s insistence that there would be no restrictions to its revival. In a show of defiance, Iran has said that its production levels are still below the level that it would need to attain to justify any cooperation with OPEC.
OPEC rules require that every member must agree before any adjustments to output can be made. This leaves it in a situation where Iran has to agree to a freeze or there will be no freeze. Iran is effectively playing the role of a spoiler within OPEC and in the global oil market.
What Next for OPEC?
The 14-nation cartel is planning to meet informally at a conference in Algiers between September 26 and 28 to discuss production levels and, of course, the recent decline in oil prices. Even non-members like Russia will be in attendance. Desperate times are calling for desperate measures. OPEC members are faced with the clear and present dangers of budget shortfalls and the grow-ing risk of civilian unrest.
But as long as Iran refuses to play along, which it most likely will not, then OPEC meetings will be regarded by many on the outside as nothing more than a gathering of desperate third world oil ex-porters in competition with themselves for market share. The financial strain as a result of lower prices has induced price cuts for many members who are seeking to undercut the competition and sell as much oil as possible to meet cash flow obligations. Saudi Arabia’s quest to transition away from oil-dependence hinges on the successful listing of the state oil company – ARAMCO. Gaining efficiency and as much market share as possible are all part of its preparation for the listing.
In addition, heightened tensions between the Saudi’s and the Iranians make reaching any consensus on cutting production difficult to envisage. OPEC is just another stage for both countries to en-act their on-going battle for regional supremacy and religious superiority. This acrimony has fed power struggles in the Middle East and beyond.
With members of the cartel ignoring quotas and undercutting one another, and given that the markets barely reacted after each of its previous two botched meetings, it is clear that OPEC will struggle to be taken seriously going forward.
If OPEC is dead, then it has been the architect of its own demise. Cause of death: Suicide – its decision to flood the market with oil in an attempt to squeeze out the competition failed to take into consideration the disruptive nature of technological innovation. Its decision to push down oil prices forced American Shale producers to become increasingly more efficient and competitive to survive. Innovation has driven shale oil production costs down while OPEC production costs have remained largely the same. Many shale producers are now globally competitive even at a lower oil price of $40pb. With more innovation and increasingly lower costs of production, the American oil industry is set to overtake OPEC and snatch the title of “swing producer” from the Saudis.
At current oil prices of $40-50pb, most OPEC members are really gasping for breath. But any production cuts to shore up prices will be the equivalent of relinquishing market share to non-OPEC producers and further lower OPEC’s already battered revenues. In more ways than one, OPEC is damned if it does and damned if it doesn’t.
Protectionism during a Recession: to Protect or not to Protect?
In the face of a recession, Nigeria has always opted to move to-wards being a protectionist state in an effort to curb forex demand and stabilise external reserves. Over the past two years, the government has returned to this familiar policy ground, initiating a number of protectionist policies. The import restrictions on automobiles, agricultural items and more recently the 41 items ineligible for transactions at the official market are but a few examples. Historically, countries tend to adopt protectionist policies during an economic downturn. Nigeria is not an exception to the norm. However, it is not clear that this course of action is the best course of action for Nigeria given its fundamentals. While other countries have certainly benefited from protectionist policies they tend to only work in specific economic contexts which support suf-ficient local production. For an economy like Nigeria’s, that is de-pendent on imports, protectionism can do more harm than good.
Protectionism that Boosts Local Production Leads to Sound Economies
It is no secret that the largest economies have developed with the help of protectionist policies. At the inception of the industrial revolution, Britain was extremely protectionist.8 In 1699, Britain banned the imports of Irish wool and in 1700; cotton cloth from India was banned. Ferocious tariffs were imposed on almost all manufactured goods to protect infant industries. Britain only be-came more open to trade in the middle of the 19th century, after its national industries were strong enough to complete globally. Similarly, in 1816, the US imposed a 35% tax on imported manufactured goods, which later increased to 50% in 1832. It maintained its protectionist policies until after the Second World War. The same strategy was adopted amongst the Asian tigers. In South Korea, foreign automobile manufacturers were barred from operating in Korea, except in joint ventures with local business entities. Today, the South Korean automobile industry is the 5th largest in the world measured by automobile unit production
Protectionism on Shaky Fundamentals Falls Flat
However, not all countries have benefited in the same way as these shining examples for protectionism. A century ago, Argentina was ranked amongst the top 10 richest countries in the world. In the aftermath of the Second World War, however, the country implemented an economic system which stressed economic self-sufficiency. By so doing, Argentina refused to participate in the expansion of international trade which followed the Second World War. The protectionist approach steadily deteriorated the domestic economy and transformed a once wealthy and fast growing nation into a quasi 'third world' country. Protectionist policies were eventually dismantled after a substantial deterioration of economic conditions, which was one of the major factors that begot Argentina’s economic crisis of 1999-2001.
Nigeria’s Shaky Fundamentals make Protectionism A Poor Candidate For Policy Reform
Unfortunately, Nigeria’s present economic circumstances have more in common with Argentina than those that successfully implemented protectionist policies. The majority of Nigeria’s domes-tic needs are satisfied through imports with little or no local substitutes in place to bridge the gap if imports are eliminated. The recent restrictions by the government have resulted in a surge in goods and services. The price of a bag of rice has more than doubled from N8,000 in 2015 to N19,000 in 2016 and basic automobiles are sold at luxury prices. This is largely driven by the de-valuation of the currency coupled with the high import tariffs imposed on these goods. Nigeria simply does not have the infra-structure in place to support local production.
Nigeria’s overreliance on oil is a factor. It relies on rebounding oil prices, not improved industries, to put it back on its feet. This was the case in the 1980’s when the government banned the importation of rice to reduce demand pressure on external reserves. Once oil prices recovered and the economy was back on its feet, the government removed the import bans. It is important to note that the ban was lifted because imports were affordable as opposed to a more competitive domestic industry, which should be the only justification for opening borders after having implemented protectionist policies.
Today’s economic reality is no different. Domestic production does not meet domestic demand and farmers are wary of government promises of support, knowing they are often disregarded once oil fundamentals improve. Lacking the necessary local production, Nigeria’s protectionist policies instead result in supply shortages and aberrational spikes in inflation rates. Power outages are frequent, alternative energy prices are growing at a geometric progression and investors are wary of a lack of clarity on policy direction. The hope is that the pain is short lived while the Nigeria rallies its local production capabilities and develops competitive industries. Unfortunately, this has yet to be the case. Presently, domestic production of rice is at 2.3 million metric tons while demand is at 6.3 million metric tons and Nigeria spends $1bn annually on the importation of rice. This is the trend amongst most agricultural commodities as revealed in the table below.
The Way Forward for Nigerian Protectionism
The government can protect infant industries without blocking out international competitors. Government intervention via subsidizing domestic production and imposing import restrictions to encourage infant industries is the traditional Keynesian approach. However, modern day Keynesians are of the opinion that government interventions need not restrict imports as such restrictions worsen growth rather than boost it. Instead, the government should subsidies both production and consumption of domestic products while foreign players are left to improve quality and standard to remain more competitive. This is a win-win situation for all economic agents considered. The consumers have cheap varieties to select from while the international firms and domestic firms are able to compete on a leveled field.
In summary, protectionism during a recessionary era in an import dependent economy will contract economic activities further rather than stimulate, as seen in Nigeria. Economic indicators have taken a beating due to the import restrictions and capital controls introduced by the government. The inflation rate is at an 11-year high and external reserves are heading towards the psychological level of $25bn.Trade is one of the key drivers of economic growth. Hence, protectionism should be approached with caution and implemented at the appropriate time to avoid retaliation and public back lash.
In any case, it appears the government is likely to maintain its stance on protectionism. External reserves are depleting to levels that are worrisome for the economy going forward. The restriction placed on 41 items is still in place and is not likely to be lifted in the near term given the policy stance of the monetary authorities. Other restrictions are seen mostly in the agricultural sector and manufacturing sector (e.g. automobiles). Protectionist policies are likely to remain in the short term pending a recovery in economic activities. Unfortunately, the protectionist policies, as presently implemented, are more likely to elongate the economic woes rather than quicken improvements.
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