Thursday, April 30, 2020 05:12
PM / by CardinalStone Research/ Header Image Credit: CardinalStone
A shocking start to the year
According to the International Monetary Fund (IMF), Sub-Saharan Africa (SSA) is likely to face a GDP contraction of 1.6% YoY in 2020-the region's worst reading on record-as a result of the current health and economic crisis. Less diversified SSA oil economies, such as Nigeria, are also likely to face significant pressures. For Nigeria, the viral spread came at a time when budgetary space to absorb shocks is limited and external financing conditions are tighter. COVID-19 threatens to overwhelm domestic healthcare infrastructure, upend livelihoods, deteriorate social conditions, and cripple business activities if left unchecked. So far, Nigeria's reaction has been largely in sync with IMF's suggested response to the viral spread and its fallouts even though the scale of the measures adopted appear insufficient to prevent materially negative distortions to domestic macro variables in the current year.
In this report, we analyze the implications of recent policy responses and revisit our macroeconomic expectations for the year. Our revisions are made in cognizance that projections under current conditions are subject to an unusually large degree of uncertainty because economic outcomes depend on several fluctuating factors. These factors include the length and effectiveness of COVID-19 containment measures across the country; the interaction between the outbreak and the vulnerabilities in local health systems; the longevity of global oil demand decimation; as well as the resumption of global travel and trade. Our base case assumption is that the peak of economic and health disruptions will occur in Q2'20, leaving legroom for improvements in business activities in the second half of the year as more containment measures are eased and stimulus injections begin to alleviate economic pressures.
Economic growth is likely to swing negative in Q2'20
Disruptions caused by social distancing measures and low oil prices are likely to drive oil and non-oil GDP lower in coming quarters. For oil, we expect substantially lower domestic output on account of the plunge in global crude consumption1 and compliance to OPEC+ cut. The non-oil sector is likely to be negatively impacted by currency adjustment, weaker consumer discretionary income, and demand deficits due to containment measures. Cascading to sectors, we note that supply chain disruptions and border closures are likely to adversely impact trade and manufacturing just as a slowdown in budget implementation is likely to drive contractions in construction and real estate sectors. We note, however, that the recently announced expansion of the 'special public works programme' to all states may provide some support to construction GDP. In contrast to the last recession episode in Nigeria, wherein agriculture provided the major offset to the economic crisis, we expect greater resistance from telecommunications and financial sectors (in addition to agriculture), this time out. The former is likely to be supported by higher data usage and subscriptions due to social distancing measures, while the latter could be driven by knock-on effect of cumulative loan growth since H2'19. All in, we revise our 2020 GDP growth estimate lower to -0.8% (vs. 2.0% previously; and the -3.4% forecast of the IMF), consisting of c.12.0% contraction in the oil sector and c.0.2% expansion in the non-oil sector. We expect the Nigerian economy to grow by 2.4% in Q1'20, and contract by an average of 1.8% in the other three quarters of 2020. Nigeria is likely to plunge into a second technical recession in 5 years by Q3'20, in our view. In addition, tightening global financing conditions (especially for oil exporters) and strong capital outflows are likely to leave Nigeria's growth stimulation prospects at the mercy of providers of concessionary budget support funds in 2020.
Weaknesses in oil earnings, FDIs, and FPIs may eventually necessitate naira repricing
In our view, Nigeria is likely to record a current account (CA) deficit of $13.5 billion in 2020 (vs. $17.0 billion in 2019). The recovery in CA could reflect reductions in services and income deficits that might offset weaknesses in goods and transfer accounts. Goods account is likely to swing into a deficit in 2020 on collapse of oil export earnings to c.$25.0 billion (versus $48.0 billion in FY'19). However, a corresponding reduction in imports, due to supply chain disruptions and weaker naira, is likely to lead to a trade deficit of only $1.5 billion in 2020 (vs surplus of $2.9 billion in 2019). Similarly, we envisage lower receipts from the current transfers sub account of CA, as we foresee a contraction in foreign workers' remittances to $19.0 billion in 2020 (versus $23.5 billion in 2019) as the pandemic reduces earnings outcomes from key contributing zones such as USA, Canada, and UK. However, services and income deficits are likely to moderate on reduced spending on travels (due to global travel restrictions) and lower dividend & income repatriation due to weaker company performances in Nigeria.
Our projection for a deficit in Nigeria's current account balance suggests FG will likely prioritize its attempt to raise over $6.9 billion (c. N2.48 trillion at N360/$) in concessionary funding from the World Bank, AFDB, and IMF. This view is supported by Nigeria's weak FPI and FDI inflows (2.0% and 0.7% of GDP respectively, in 2019) and the tighter external financing conditions that have resulted in the widening of Eurobond spreads. While IMF's recent approval of Nigeria's $3.4 billion facility under the RFI raises hopes for a realization of targeted external borrowings, FPIs, in short term government securities, are likely to largely exit at maturity in H1'20 as was the case in Q1'20 (the I&E window recorded net outflows of $4.0 billion and $3.6 billion in February and March respectively, despite average CBN interventions of $2.5 billion over the two months). We expect FPI outflows to be driven by low oil prices, currency repricing overhang, and expectations of further capital controls. Similarly, FDIs are likely to be limited to reinvestments of retained earnings as investors stay on the sidelines amidst uncertainties in domestic macroenvironment. All in, we believe planned external borrowing of c.$6.9 billion (assuming everything is realized) and other flows (FDI & FPIs inclusive) would still lag projected current account deficit of $13.5 billion in 2020E. That said, the fresh $3.4 billion RFI loan as well as debt suspensions from multilaterals would provide temporary reprieve for reserves in the short term even though further deterioration of oil earnings, pent up FPI demand for FX, and renewed import drive (when economies reopen) are likely to cascade to pressures on reserves and naira repricing eventually.
Nigeria in the aftermath of COVID-19
In the wake recent external shocks, both monetary and fiscal authorities have resorted to measures to drive recovery. The intervention measures have been largely targeted at funding fiscal shortfalls at both the state and federal levels, improving existing healthcare infrastructure, providing welfare palliatives to economically vulnerable groups, and easing debt burden on the private sector. The current size of approved fiscal interventions (COVID-19 intervention fund plus support to states and NCDC) is N672 billion or 0.4% of GDP, while CBN's N1.1 trillion intervention represents a modest 0.8% of GDP. However, a further N2.4 trillion intervention through commercial bank credit could take the apex bank's intervention to as high as 2.4% of GDP. Cumulatively, fiscal and monetary interventions could account for c.2.8 % of GDP. To bankroll these stimulus and augment budget shortfall, Nigeria has already obtained IMF's approval for a $3.4 billion (c.N1.2 trillion at N360/$) financing under the RFI programme. This facility amounts to c.24.0% of Nigeria's retained revenue in 2019E. This borrowing will likely be complemented by the â‚¬21.0 million grant from the EU and the debt service suspension by the World Bank. Debt service suspension should lighten external debt service burden (last year, 24.7% of debt service payments went to multilaterals like the World Bank and the AFDB) and slightly free up fiscal space. With the recent conversion of previous external borrowing plan to domestic issuance target of c.N850 billion (planned 2020 total: N1.7 trillion) and the $3.4 billion IMF fund alone, FG is effectively provisioning for 47.0% of our projected deficit (given that part of the IMF borrowing will finance the N500 billion COVID-19 fund). Assuming the expected loans from World Bank and AFDB are meant solely for budget support, total deficit cover could rise to 71.0% of our projected deficit, suggesting the likelihood for more domestic borrowing than guided. Thus, although external borrowings may be insufficient to negate the likelihood of greater than budgeted domestic borrowing and higher yields, we believe the rise in yields could be lower than previously expected given limited investment outlets for domestic investors.
Policy response should focus on alleviation of private sector burden and welfare
Faced with the inevitability of a recession, the response of the fiscal authorities should be tuned towards facilitating a v-shaped economic recovery. Such a recovery may be attained if scarce resources are deployed strategically to quickly arrest the disruption to household consumption (which accounts for c.76.0% of GDP) and production. To achieve this, intervention spending should be targeted at preserving operational viability and payroll spending by the private sector. The importance of conserving spending power is heightened when considered against the backdrop of projected higher inflation.
Never let a good crisis go to waste
Nigeria could utilize the unique situation created by the lockdown to embark on structural and administrative changes that could have positive ramifications for years to come. The FG appears to have tilted along this line with the alleged removal of PMS subsidy. However, given the history of retractions around previous subsidy removal drives, only time will tell whether the government is steadfast on going all the way this time out. If sustained, we believe subsidy removal could complement efforts to improve fiscal discipline in Nigeria. On fiscal discipline, we note that FAAC agreed to distribute only N661.4 billion (vs. the N780.9 billion available for March 2020) and save N119.550 billion in the Excess Oil Revenue Account in view of the highly uncertain revenue profile in the immediate future. The president also approved the implementation of the report of the presidential committee on reform of government agencies, which seeks to reduce cost of governance. Elsewhere, the nationwide lockdown creates legroom for Improved data gathering across states, which could improve informal sector capturing, future welfare provision, national security, credit scoring, and tax collection. The lockdown provides a unique situation, under which households can be counted and business owners compelled to share their accounting books with relevant authorities if contingent on relief support. The crisis also presents the opportunity to look inwards to upgrade capacity and service provision across several essential areas including health, power, tech infrastructure, welfare, and education.