Will Oil Production Cut Rebalance the Nigerian Economy?


Thursday, October 13, 2016/ 6.18pm /FSDH Research

The major highlights of the Monthly Economic and Financial Market Outlook report are:

The Organization of Petroleum Exporting Countries (OPEC) have agreed with some non-OPEC countries to boost oil prices through a production cut

This action may help to lift global crude oil prices in the short-term, but it may not be enough to turn the fortune in favour of the Nigerian economy
The Nigerian government needs to communicate a coherent and consistent set of policies to address the current economic challenges in Nigeria

According to the International Monetary Fund (IMF), global growth is projected to slow to 3.1% in 2016 before recovering to 3.4% in 2017
The IMF added that the GDP in Nigeria is expected to contract in 2016 by 1.7% because of the disruption in oil production, with a forecast growth of 0.6% in 2017

The current favourable external environment, including low interest rates and the global search for investment opportunities, presents an opportunity for firms and countries to restructure their balance sheets

We expect the inflation rate to increase to 18.14% in September 2016, from 17.61% in August 2016

We believe that a clearer direction of government incentives to drive investment may attract Foreign Direct Investment into the external reserves

We recommend investments in Treasury Bills in order to maximize the current high yield. There should also be some investments in FGN Bonds to minimize reinvestment risk from current high yields level

The equity market still awaits appropriate policy direction and is expected to react based on communication concerning any socioeconomic policies.

Global Developments
In the countries we monitored, the prices of government bonds appreciated in more countries in Septemeber 2016 than they depreciated. The 12.705% June 2022 Kenya Government Bond and the 7.75% February 2023 South Africa Bond both recorded the highest month-on-month price increase of 5.08% and 2.05% to 98.92 and 97.22, respectively.

The 3.52% February 2023 China Government Bond recorded a month-on-month price decrease of 0.65% to 104.38. The Nigeria Bond closed the month at negative real yield. Other bonds we monitored closed the month at positive real yields. The Kenya Government Bond offers the most attractive real yield amongst the selected bonds in July 2016.

According to the United States (U.S.) Bureau of Economic Analysis (BEA), the United States (U.S.) economy grew by 1.4% (quarter-on-quarter) in Q2 2016, better than a second estimate of 1.1% released earlier by the BEA. It is the strongest growth rate in three quarters.

Consumer spending continued to boost growth in the U.S. although it expanded less than expected. Exports rose at a faster pace and business investment posted the first gain in three quarters. Similarly, the U.S. unemployment rate increased to 5% in September 2016, compared to 4.9% in the previous month. It was the highest jobless rate since April 2016.

The Global Growth  The International Monetary Fund (IMF) asserts that the current global economic outlook is shaped by a complex confluence of ongoing realignments, long-term trends, and new shocks. This is contained in the IMF World Economic Outlook (WEO), October 2016 edition. According to the IMF, global growth is projected to slow to 3.1% in 2016 before recovering to 3.4% in 2017.

This represents a 0.1% downward revision for 2016 and 2017 relative to the WEO Update, April 2016 edition. The IMF expects a more subdued outlook for advanced economies following the U.K. Brexit vote and weaker growth in the United States. These developments have put further downward pressure on global interest rates, as monetary policy is now expected to remain accommodative for longer time.

The report indicated that financial market sentiment toward emerging market economies has improved. However, prospects differ sharply across countries and regions, with emerging Asia in general and India in particular showing robust growth and sub-Saharan Africa experiencing a sharp slowdown.  

Several emerging market and developing economies still face daunting policy challenges in adjusting to weaker commodity prices. The IMF added that the GDP in Nigeria is expected to contract in 2016 by 1.7% because of the disruption in oil production. Other factors are foreign currency shortages; from lower oil receipts, lower power generation, and weak investors’ confidence. It added that Nigeria will record a growth of 0.6% in 2017.

Global Financial Stability
The short-term risks to global financial stability have abated since the April 2016 Global

Financial Stability Report (GFSR) of the IMF. This is contained in the IMF Global Financial Stability Report, October 2016 edition. Commodity prices have risen from their lows earlier in 2016, and ongoing adjustments in emerging markets have supported a recovery in capital flows. Immediate concerns over a slowdown in China have eased on the back of policy measures to shore up growth. In advanced economies, weaker growth was mitigated by the prospect of further monetary accommodation.

The report added that despite lower short-term risks, medium-term risks are building. The continued slowdown in global growth has prompted financial markets to expect an extended period of low inflation and low interest rates and an even longer delay in normalizing monetary policy. The political climate is unsettled in many countries.

A lack of income growth and a rise in inequality have opened the door for populist, inward-looking policies. These developments make it even harder to tackle legacy problems, further expose economies and markets to shocks, and raise the risk of a gradual slide into economic and financial stagnation.

The IMF added that financial institutions in advanced economies face a number of cyclical and structural challenges. They need to adapt to this new era of low growth and low interest rates, as well as to an evolving market and regulatory environment.

These are significant challenges that affect large parts of the financial system, and if unaddressed could undermine financial soundness. Emerging markets are adapting to an environment of lower global growth, lower commodity prices, and reduced global trade.

The current favourable external environment, including low interest rates and the global search for investment opportunities, presents an opportunity for firms and countries to restructure their balance sheets.

Inflation Rate
The upward pressure on the inflation rate in Nigeria persisted in August 2016. The inflation rate increased further in August 2016 to 17.61%, from 17.13% in July 2016. The inflation rate in August 2016 was driven by the faster growth in all major divisions of the Headline Index.

The major divisions responsible for the increase were: Housing, Water, Electricity, Gas and Other Fuels, Education and Transports services. Year-on-year (y-o-y), the Food Price Index increased by 16.40% in August 2016, from 15.80% in July 2016.

The Core Index increased by 17.20% in August 2016, higher than 16.90% recorded in July 2016. In August, the largest increases in the Core Index were recorded in the Solid Fuels, Vehicle Parts, Books and Stationeries and Clothing and Other Articles of Clothing.

We estimate that the inflation rate would be at 18.14% in September 2016 as shown on table 4 below.

Movement in the External Reserves
    The external reserves continued on a persistent downward movement in the month of September 2016. The demand pressure on the available foreign exchange and the limited inflow were the major reasons for the sharp decline in the external reserves.

   The recent rally in global oil prices hasn’t had positive effect on the external reserves. The proposed plan of the Organization of Petroelum Exporting Countries (OPEC) and some major non-OPEC countries to cut global output has also boosted oil prices. Moreover, the resolution of the production challenges would boost the external reserves.

   The 30-day moving average external reserves declined by 3.50% to US$24.53bn as at end-September 2016, from US$25.42bn at end-August 2016. The major concern of the foreign portfolio investors is how to repatriate their funds if they bring in their foreign exchange. They believe that the foreign exchange market in Nigeria is not liquid enough to guarantee their fund withdrawals if they bring it.

   The Federal Government of Nigeria (FGN) should continue to encourage the private sector (foreign and domestic) to invest in the Nigerian economy. We believe that a clearer direction of government incentives to drive investment may attract Foreign Direct Investment. The government should also engage the multilateral institutions so that it can borrow at concessionary rate from them. This will result into the growth of the external reserves.

Crude Oil Market and Bonny Light Price
   Nigeria produced a total of 53.07 millions barrel (mb) of crude oil and condensate for the month of June 2016, representing an average daily production of 1.77mbd. This is according to the Nigerian National Petroleum Corporation (NNPC) monthly report, July

   2016 edition released recently. This represents an increase of about 1.39%, relative to May 2016.

   The Joint Ventures (JVs) and Production Sharing Contracts (PSC) contributed about

   27.49% and 51.54% respectively to the June 2016 production level,. Other production

   arrangements accounted for 20.97%.    

   The Organization of Petroleum Exporting Countries (OPEC) have reached an agreement with some major Non-OPEC producing countries to cut oil production, aimed to boost global oil prices.

   This action may help to lift the global crude oil prices in the short-term but it may not be enough to turn the fortune of the Nigerian economy. Nigerian economy managers need to communicate coherent and consistent policies to address the current economic challenges. This may also improve investors confidence to enable investment decisions and turn things around.

According to the data from Thomson Reuters, the Bonny Light oil price increased by 2.48% to US$49.62/b as at end-September 2016, from end-August 2016. The average price of Bonny Light was US$48.16/b in September 2016, an increase of 1.05% from the average price of US$47.66/b recorded in August 2016.

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