Sense of Urgency to Reflate the Economy - FDC

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Thursday, August 25, 2016 6:02am /fdc  

After several months of very little to show for its efforts, the gov-ernment appears to have sensed the urgency to reflate the econ-omy. The President is reportedly seeking for emergency powers to fast track the government’s stimulus plans. The objectives of the bill to be presented to Parliament include supporting the currency value, job creation, external reserves accretion and reviving the real sector. 

This is occurring weeks after the Economic Management Team met with some key stakeholders of the economy. The questions on everyone’s mind are why now? And would the plan work? While the first is easy to answer, one can only speculate about the second.  

Why Now? 

Why not now? Economic growth contracted in Q1 to -0.36% and it is very likely that Nigeria is in a recession. Economic activities have slowed to a near standstill while the government continues to struggle to finance its capital projects amidst sharply depleting fiscal and external buffers. The economy is in a dire state and desperate times call for desperate measures. The government not only needs to fix the economy, but also needs a few quick wins to restore its image in the public eye. 

Nigeria is not the only country that has tried such a move. Venezuela, another oil producer is facing its own share of macro-economic headwinds. In fact, one can safely say that Venezuela is a basket case. This is a country with 30.6 million people, the world’s largest proven oil reserves of 297,740million barrels and the 12th largest global producer of oil (6th largest OPEC producer). The economic tailspin started in 2014, a fallout of lower oil prices. Since then the Venezuelan economy has tumbled into its deepest recession in over a decade, with a triple digit inflation rate of 180.9%, the second highest globally, that is projected by the IMF to spiral further to 720% in 2016. To address this, the Venezuelan President submitted an emergency economic decree bill to Congress for executive powers. The Bill was initially rejected by the Congress but overruled by the Supreme Court. 

Will it work? 

The bill, if passed by the Nigerian Legislative arm, would mitigate regulatory drawbacks. It would also expedite private and public spending required to implement key capital projects that would stimulate the economy. The success of the plan is subject to the government’s ability to select some quick wins that are tangible. If not, the government could be perceived as backtracking into the military era. 

There are risks involved with assigning one person with so much power and authority. The President could be seen as a democratic dictator. It could also breed political infighting especially in frac-tions that already believe the government of change has done very little to fulfill its mandate. 

Fiscal – Monetary Policy Dichotomy  

Nigeria has had a rough and patchy year so far. The macro-economic headwinds have been more severe and lingering than analysts anticipated. With a gross domestic product (GDP) growth rate of -0.36% in the first quarter of 2016 and a further contraction estimated in Q2, Nigeria is technically in a recession. The International Monetary Fund (IMF) is also projecting a negative growth rate of 1.8% for the full year of 2016, down from 2.79% in 2015. The supply shocks and shortages in the foreign exchange (forex) and energy markets have led to both fiscal and external imbalances. Inflation is at an 11-year high of 16.5% and the premium between the forex market rates widened to as high as N184 in February, before narrowing to as low as N47 in July. The naira also tested new lows at both markets before retreating - N330 in the Interbank Foreign Exchange Market (IFEM) and N400 in the parallel market. The trade balance is negative while the current account deficit is estimated to have deteriorated further. Consumer demand has also declined substantially, further depressing the profitability level of companies that are already strained due to rising operational costs. Investors’ confidence in the economy is dim especially due to the inconsistencies and lack of clarity in policy direction. One can safely deduce that the economic condition of Nigeria is stark; the picture is anything but pretty at the moment. 

Nigeria’s major problem, and probably the reason why it has remained on this course of hardship and pain, is the delay in key policy implementations. For policy decisions to be effective and efficient in achieving goals they have to be opportune, strategic and well planned. Nigeria has experienced quite the opposite in 2016. The budget impasse delayed significant measures required to stabilize the economy. On the whole, policy decisions have been reactive to economic events rather than in anticipation of them. For example, the removal of the fuel subsidy and the 67.63% hike in the pump price of fuel in May was done in reaction to the lingering fuel scarcity. Likewise, the liberalization of the forex market in June only occurred after several calls for a cur-rency adjustment from renowned economists, both domestic and international. 

While these are laudable policies, the economy might not have deteriorated to its present state if they had been implemented much earlier. There also appears to be a lack of coordination be-tween the fiscal and monetary policies currently being implemented. This is self-defeating, as the economy can only move for-ward when these policies complement one another. It is no sur-prise that Nigeria is battling a perfect storm of contracting growth, rising inflation and high interest rates.  

Fiscal Policy Not Moving Fast Enough to Spur Growth?  

The 2016 budget of N6.07trn is expansionary, with an increased focus on capital expenditure (CAPEX), infrastructure development, job creation and improved fiscal discipline. The thrust of the budget is stimulus, hence, the bump in capital expenditure to 30% of the budget, up from 20% of last year’s budget. So far, approximately N400bn has been released for the execution of some capital projects out of a budget of N1.75trn for CAPEX. Some of the projects that are in the pipeline include the Lagos-Ibadan railway modernization project, Lagos-Kano railway con-struction, Lagos-Calabar and Abuja-Kaduna railway projects. The government has also set aside N90bn as bailout funds for insol-vent states. 

To address the gaping fiscal hole, the federal government has em-barked on several road shows to raise funds in the international market. The first option that usually comes to the forefront is bor-rowing from multilaterals, such as the IMF or the African Develop-ment Bank (AfDB). This strategy takes time and with weak inves-tor confidence in the country, the government needs to have some short term options. One is the sale of some of the joint ven-ture assets in the oil and gas sector such as refineries that are performing below optimality. This would create quick funds which the government needs. 

The fiscal stimulus required to set Nigeria back on its recovery path is trickling in bits and pieces. The delay in implementation of the budget is also crippling the pace at which projects are ex-pected to yield dividends that would trigger the much needed re-covery. Now a potent risk is looming - the non-completion of the 2016 capital projects due to reduced fiscal revenue.  

Is Monetary Policy Stifling Growth? 

The monetary policy committee (MPC) of the Central Bank of Nigeria (CBN) has held four meetings so far in 2016. The policy stance has shifted from maintaining the status quo to further tightening and ad-dressing forex market concerns. A move that stifles any plans to stimulate growth. 

In its most recent meeting in July, the MPC decided to increase the monetary policy rate (MPR) by 200bps to 14% pa, a decision that stirred mixed reactions in the markets because it appeared to be tar-geting inflation. When faced with a dilemma of tackling growth or inflation, the conventional logic is to choose growth. However, the CBN’s primary objective is in fact, price stability. One of its main concerns was the declining real return on investment, which has been in negative terrain for the last six months due to the ever rising inflation rate. The committee also wanted to address the decline in foreign portfolio inflows (FPIs) which have drastically affected the pace of gradual growth in the external reserves. Another underlying concern was the dollar illiquidity and the uncertainty premium which is pushing the naira towards N400/$ (at the parallel market). 

Thus, a further tightening of monetary policy is expected to address these major challenges. However, this is subject to one major fac-tor: that FPIs will start trickling in. With capital inflows, dollar illiq-uidity is addressed. The naira will strengthen as a result and inflation will taper off as the supply shocks are handled. The question is when will this happen? When will investors, who have been on the side-lines waiting for clarity, start responding? Nigeria has a perception problem. The investor community, especially in the international market, views the CBN as indecisive, self-contradictory and some-what unsure of itself. This is keeping investors at bay until confi-dence in the policy decision making process is restored. 

While there is logic in the CBN’s decision to hike rates, the impact is yet to be felt on the markets. Banks continue to struggle with thin-ner margins while companies are under pressure to remain profit-able, finding it increasingly difficult to borrow to purchase the re-quired forex to bring in their raw materials. Hence, it appears this new stance of monetary policy may further stifle growth.  

The Perception Problem: Policy Inconsistency 

The MPC will meet on September 19th and 20th to decide on its course of action with regards to monetary policy. The first school of thought is for the status quo to be maintained, to allow for recent policy decisions to impact the market. The second scenario is a reduction in interest rates, as higher interest rates stifle growth and the much needed FPIs are not coming in as fast as desired. 

While maintaining the status quo is logical to allow for the impact of the interest rate hike to reflect on the markets, the cost of higher interest rates is crippling the real sector, increasing defaults in loans and resulting in no economic growth. 

The drop in Treasury Bill rates at the primary market auction of August 17th could hint towards a possible change in the CBN’s posture. Treasury Bill rates, which were trading at a new high of 15.44% (91-day T/bill), dropped sharply to 14.99% for the same tenor. However, the problem with reducing interest rates is again one of perception. Adopting an accommodative stance two months after a 200bps hike could be seen as policy inconsistency. 

In an era of contracting economic activity adopting a tightening monetary policy stance can be likened to an ulcer patient asked to abstain from food. It worsens the situation. 

What is the Way Forward? 

The Nigerian economy has reached its trough and the process towards recovery has started. However, the country is battling policy uncertainty, inconsistency and a perception problem. Policymakers need to be able to walk the talk and stay the course.  

The opinion the markets and investor community have of Nigeria and its policymakers is that there is a dichotomy between fiscal and monetary policies. Nigeria needs to send a strong message and a united front, in addition to implementing a cocktail of policies.Timing is everything. 

Channelling Private Equity for Growth in Nigeria

Private equity (PE) in Nigeria has grown by leaps and bounds. With assets under management (AUM) increasing from below $100 million dollars1 in the early 2000s to about $2 billion dollars as of 2013, the industry’s growth trajectory is remarkable. There are three types of private equity transactions: venture capital, leveraged buy outs, and growth equity. While there have only been a few venture capital ransactions in Nigeria and leveraged buy outs are not common, growth equities are quite common in Nigeria and Africa more broadly. These are investments in relatively mature and budding companies seeking to scale operations, expand and enter new markets. The sectors that have courted most of the private equity investments in Nigeria and other African countries include financial services, telecommunications and consumer goods.  

Fundraising is an aspect that has improved tremendously in the African PE sphere. In 2015, about $4.3 billion was raised, the highest recorded since 2010, providing an improved capital base for investments. However, as available PE funds have grown, investment opportunities have declined in the country and continent due to currency volatility, weaker commodity prices, lack of talented management staff in many industries and few large investable companies. The dearth of attractive right-sized investable companies becomes a key issue when PE firms attempt to exit their investments upon attaining their investment goals as smaller -sized companies present limited opportunities to realize maximum returns upon sale. The decrease in transaction value, from $6.1 billion in Q2’2015 to $760 million in Q2’2016, underscores the slowdown in private equity transactions in sub-Saharan Africa (SSA). Given the decline in PE deals across SSA, and the possible negative impact on economic growth, it is important to address how companies can attract the dry powder (PE funds available for (investing). 

Impact of PE on Economic Growth       

The growth impact of PE cannot be ignored as several studies on emerging economies have shown its impact on economic growth and productivity. Increased PE activity contributes to the performance of PE investee firms by enhancing their financing and operating activities, thereby inducing economic growth.2 In the 2015-16 Transition Report (Rebalancing Finance)3, which studied the impact of PE on growth, several growth parameters were analyzed to investigate how much they were influenced by PE investment.The growth parameters were revenue, employment and efficiency.

The countries studied are in the regions in which the European Bank for Reconstruction and Development (EBRD) has a presence - Eastern Europe, Mediterranean Africa and central Asia.These EBRD countries are emerging and frontier markets like Nigeria.There was a demonstrable effect of PE investment on companies in these transition regions: 

  • Operating revenue increased by about 35% in companies that received PE relative to their peers. It is also noteworthy that the companies that experienced this revenue increase were not particularly high-growth companies. This increase occurred within three to five years following the initial PE injection. 
  • In terms of employment, investee companies’ labor forces grew by 20%, translating to an increase of an additional 30 jobs per investment. 
  • Investee companies became more efficient as sales per employee increased by about a third compared to companies that did not receive PE investments. This was probably driven by the improvement in operational efficiency due to an increase in capital expenditure, thereby increasing capital spent per employee. 

Furthermore, the receipt of PE funding sends a positive signal to the credit market about a company’s promising business prospects and its monitoring by investment professionals. Thus, investee companies become more credit worthy. 

Getting Nigerian Companies Ready to Receive More Private Equity Funding  

At a period when African-focused PE funds appear to be chasing scarcer investment opportunities, it is imperative to ensure that Nigerian firms become more investible and attractive to fund managers. Three main areas requiring urgent attention from stakeholders include the development of a robust regulatory framework, ensuring effective accountability and providing a solid economic foundation aimed at enhancing growth. These require leadership from both the government and the private sector. 

Firstly, a robust regulatory framework is necessary because an im-proved corporate governance structure, a reliable legal environment and a structured capital market are factors that could improve investor confidence. It is imperative for companies to abide by the code of corporate governance issued by the Security Exchange Commission (SEC) applicable to public companies. Furthermore, the government still has to work towards reducing the multiplicity of governance codes. Policy makers should also ensure the passage of non-intrusive regulations for offshore funds operating locally. Additionally, policies that enhance the development of substantive on-shore management activities in Nigeria should be drafted. This could make Nigeria a good destination for funds domiciliation. With respect to having a more efficient and properly structured capital market, the SEC and the Nigerian Stock Exchange (NSE) can facilitate the listing of companies and enhance trading in unlisted companies. 

Secondly, it is important for companies to ensure that they have a solid and effective financial reporting structure that truly represents the economic activities in their businesses. There are many profit-able and growing companies in Nigeria with a lamentable financial reporting structure. Such a situation reduces investor confidence as potential PE investors tend to question the veracity of the com-pany’s financial accounts. In cases where investors decide to invest despite a weak financial reporting system, increased transactional costs are incurred as the potential investee company needs audits and extensive due diligence conducted. Nonetheless, with Nigerian entrepreneurs and businesses increasingly appreciating PE’s potential to boost their expansion goals, many are improving their audit-ing and financial reporting frameworks. Also, more accounting professionals are becoming adept at the International Financial Reporting Standards (IFRS). This affords businesses, that do not have re-sources to hire expensive professional services firms, the opportunity to secure services of independent professional consultants to help in proper bookkeeping. 

Thirdly, it is important for Nigeria to have a strong economic founda-tion if it seeks PE investors. PE supports firms with high growth po-tential and a capacity to expand and deliver projected returns. Con-sequently, a stable and dynamic environment is a requirement for increased PE investments. The decision to float the naira is a positive step that is beginning to mitigate the economic uncertainty that en-gulfed the Nigerian economy in recent times. However, in addition to changes in the exchange rate, the government has to be more con-vincing of its desire to turn Nigeria from its current economic dol-drums. A decline in Q1’2016 growth does not portray Nigeria as an attractive investment destination. The frequent tinkering of the country’s exchange rate policy does not portray Nigeria as a country with a clear economic direction resulting in the unresponsiveness of investors to the new foreign exchange (forex) policy. 

Sectors that could attract PE investments include agriculture, financial services, telecommunications, energy, manufacturing, logistics, consumer goods, construction and utility. Financial services, tele-communications and consumer goods are the sectors that have received the most PE allocations in many African countries, including Nigeria. They are also positioned to benefit further from more PE in-vestments. The financial services industry is expected to grow fur-ther and take advantage of PE investments due to improved infra-structure in the sector and higher financial inclusion. Telecommunications is expected to grow as there is increasing teledensity and improving broadband usage. Companies in the consumer goods industry are gaining interests from PE investors because of strong demographics, a burgeoning middleclass and emerging consumer trends in Nigeria. The agricultural sector is an area that could pro-vide immense business opportunities given the attention that the administration is paying to it. The newly introduced Green Alternative Policy, aimed at restoring inclusive growth and repositioning agriculture in the economy, underscores the government’s commitment. The Fund for Agricultural Financing in Nigeria (FAFIN), developed to secure significant minority equity stakes in medium-sized enterprises, could be a model of how to utilize PE in agriculture. 

A key determinant in the level of PE investment across various sectors will be the level of infrastructure development. The private and public sectors have come up with programs that aim to develop Nigeria’s infrastructural base. Furthermore, the $25 billion infrastructure fund, which was launched in 2015, should catalyze development in the transport and energy sectors. The recently launched Nigerian Infrastructure Fund SP, with a target of $2 bil-lion, plans to invest in the power, transport and telecommunications sectors. 

Just as the economy can benefit from private equity, private eq-uity needs an enabling economic environment to achieve its prospects.  

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