Wednesday, November 23, 2016 1:34 PM /Vetiva Research
· Recession bites deeper as key sectors diverge further
· Growth in nominal Oil GDP belies real stagnation
· Secondary sector of economy the main Non-Oil laggard
Recession bites deeper as key sectors diverge further
Nigeria’s recession deepened in the third quarter of the year with a 2.24% year-on-year (y/y) contraction in real GDP (Bloomberg Consensus: -2.00%, Vetiva: -1.72%). Propelling this contraction, the oil sector shrank 22% y/y as this quarter paled in comparison to a year-best performance in Q3’15.
Meanwhile, the broad non-oil sector of the economy arrested recent declines to record a tepid 0.03% y/y growth. Within this, the Manufacturing and Services sectors actually contracted by 4.38% and 1.48% respectively, compared to 3.36% and 1.66% declines recorded in Q2’16. That left Agriculture to once again prop up the Non-Oil sector as it recorded a fine 4.54% y/y (Q2’16: 4.53%) expansion.
The data reveals three contrasting stories with Agriculture the only positive, Manufacturing and Services dragging in negative growth territory, and the Oil sector a serious laggard (accounting for 65% of this quarter’s shrinkage). In fact, Agriculture accounted for 29% of real output in the quarter, a post- rebasing high, demonstrating some success of policy moves to develop the sector.
Nominal GDP (which does not strip out inflation during the period) grew 9.23% y/y (fastest growth since Q4’14) primarily driven by the price surge witnessed this year. In fact, GDP deflator – a gauge of inflation using a comparison of real GDP and nominal GDP – rose 12% y/y (highest since Q2’12) showing that elevated price levels continue to erode the real value of output and incomes.
Real GDP performance was likely driven by a number of key developments during the quarter. Chief among them was the disruption in oil production amidst shutdowns at Forcados and Qua Iboe terminals. Furthermore, the hike in Monetary Policy Rate to 14% in mid-July is likely to have somewhat dampened lending growth at a time investment was sorely needed.
Finally, naira depreciation during the quarter (NGN/USD average of 308 in Q3 vs 210 in Q2) must have weighed heavily on the economy. On the other hand, we expect there was a positive impact of the deregulation of the petroleum downstream sector and rollout of fiscal spending (following full budget passage in May). Nevertheless, it is clear that the magnitude of these improvements was insufficient to counter the adverse developments mentioned above.
Rut in oil sector persists amidst devaluation boost
Notably, the Oil sector grew 7.4% y/y on a nominal basis despite recent negative real growth rates and relatively flat global oil prices during the quarter. This surge was as a result of the 42% devaluation of the naira at the end of June which inflated the nominal value of oil liftings and eroded the effect of fall in global oil prices.
Recently, lower oil prices meant that real Oil GDP was usually greater than nominal Oil GDP with an implicit price deflator less than 100 (meaning current prices < base year prices). However, this changed in Q3 as naira weakness pushed the implicit price deflator above 100, with nominal Oil GDP registering above real Oil GDP for the first time since Q2’15.
Oil sector real GDP rose 8% q/q (Q2’16: -19%) but this is below seasonal trend as Q3 is traditionally the strongest quarter for the Oil sector with an average q/q growth of 12% since 2012.
This poor performance can be explained by a fall in oil production during the quarter, touching a low of 1.5 mbpd in August, following a spate of militant attacks on oil infrastructure in the Niger Delta region.
Similarly, natural gas production was down, with NNPC reporting a 12% decline in natural gas production during the quarter. Finally, Oil refining (categorized under Manufacturing) shrank 0.89% y/y in Q3’16 as average refinery capacity utilization fell from 15.9% to 13.2% during the quarter.
Agriculture blooms at harvest
Year-on-year growth in the Agriculture sector was once again very impressive though quarterly movement was in line with usual trend – Q3’16 GDP up 38% q/q – as Q3 marks the main part of harvest season.
Within the Agriculture sector, Crop Production continues to be the key driver, this time rising 4.88% y/y (Q2’16: 4.72%) and at its fastest pace since Q1’14 (5.42%). This increase is likely due to a bumper harvest this year, especially with rice and grains. In contrast, fishing contracted for the second straight quarter albeit at a slower pace (Q3’16: -0.34% y/y, Q2’16: -6.85% y/y).
Robust growth in the Agriculture sector should continue considering it is a key element in the macroeconomic policy of the government but insecurity in the north-East and marauding Fulani herdsmen remain risks.
Soaring costs rock Manufacturing
The Manufacturing sector remains the worst Non-Oil performer. Manufacturing was the only sector to record negative y/y nominal growth (- 2.9%) and in real terms, cumulative 9M’16 GDP is 4.93% lower than in the preceding year.
Again, the malaise was driven by the Cement and Food, Beverage & Tobacco sectors which were down 6.26% and 5.75% respectively, accounting for 12% and 54% of the contraction in Manufacturing. Indeed, this is reflected in the performance of the Consumer Goods and Industrial Goods sectors of the Nigerian Stock Exchange which shed 8% and 15% of their respective values over the course of the third quarter.
One key impediment faced by the Manufacturing sector is perpetual Foreign Exchange (FX) scarcity and currency weakness. The sector has particularly struggled with a depreciating naira and challenges with sourcing dollars to facilitate import of raw materials and inter-mediate items.
As a result of this, the Central Bank of Nigeria conducted two special naira forward auctions targeted mainly at manufacturers in October. Though a positive development going forward, the effect of this is tempered by the fact that a significant part of manufacturers’ FX demand remains unmet.
On another note, the higher interest rate environment in Q3 (following the 200bps MPR hike in July) is likely to have further squeezed producer margins during the period. As long as these two conditions last, the outlook for the sector is bleak. In particular, a sustainable solution to the dollar illiquidity problem is required given the import dependency of the sector and the slow rate of import substitution.
Mixed performance within Services
Still by far the largest component of GDP (61% in Q3’16), the Services sector slipped into a recession as this quarter’s 1.48% y/y decline trailed Q2’16 reading of -1.66%. The Real Estate sub-sector was a chief culprit here as it declined 7.37% y/y, accounting for 47% of the decline in Services.
This is unsurprising considering that the housing market tends to suffer during periods of recession as house prices fall, consumer spending power diminishes, and construction activities stall. Construction shrank 6.13% y/y, contributing 17% of the decline in Services as the sector suffered from implementation lag following full 2016 budget passage in May.
Importantly, Trade which historically had been a star performer, showed a wider contraction of 1.38% y/y (Q2: -0.03%), accounting for 19% of the decline in Services amidst a paltry 2% disbursement of allocated capital expenditure.
Meanwhile, growth in Finance & Insurance turned positive (2.64% y/y) following consecutive quarters of negative growth. Though traditionally a weak quarter for the industry, real GDP actually increased 3.8% q/q (Q3’15: -9.9%).
Nominal growth was even stronger – 21% y/y and 13.8% q/q as larger financial institutions benefited from naira depreciation and the higher interest rate environment which pushed up yields on fixed income products.
With consumer spending likely to remain depressed till year-end, Trade and Real Estate will continue to drag down the Services sector although the outlook looks more positive for the Finance & Insurance sub-sector. In this regard, fiscal policy is urgently needed to stimulate aggregate demand and arrest the decline of the most significant sector of the economy.
Nigeria faces first full-year recession in two decades
With the MPC likely to maintain a tight monetary stance at its final meeting of the year, the responsibility for spurring growth in Q4 lies with the fiscal authorities. However, with the fiscal lag and delays in executing key capital and social investment schemes, we expect efforts here to fall short and Q4’16 GDP growth to come in negative (Vetiva forecast: -1.37%), bringing full year estimated contraction to -1.52% (Previous: -1.32%).
Beyond this year, three issues jump out. Firstly, ongoing challenges around the FX market amidst a botched attempt at floating are expected to further constrain economic performance. Proper and transparent reform is needed to revitalize confidence and boost liquidity in the market.
Secondly, the efficacy of government spending will be a key driver of economic recovery. Even within capital expenditure, a greater focus on projects and schemes with larger potential fiscal multipliers will maximize the effect of policy action whilst minimizing the impact on government finances.
Finally, the security of oil infrastructure remains paramount. The effect of this year’s contraction in the Oil sector demonstrates the importance of the sector, making current efforts to resolve conflict in the region of huge significance.
Progress made in these areas should set Nigeria firmly in the path to recovery, supplemented by increased import substitution (reducing exposure to currency movement), down-trending inflation (allowing MPC wiggle room to loosen monetary policy) and a low base effect coming from a dismal 2016. As a result, we expect FY’17 growth of 1.59%.