COVID-19, Global Oil Price and The Nigerian Economy

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Friday, May 22, 2020 / 2:48 PM / NESG / Header Image Credit: NESG

 

Introduction

The outbreak of COVID-19 in China dampened China's economic outlook for the year 2020. Efforts to contain the spread of the virus has led to widespread movement restrictions and shutdown of industrial activities. The effect is evident in China's Manufacturing Purchasing Managers Index (PMI), which slipped below the sectoral expansion benchmark of 50 points to 35.7 points in February 2020. This implies the Gross Domestic Product (GDP) growth figure that will emanate from China will show a significant contraction. Further, the regimented movement of humans due to the fear of contagion and the inability to secure vaccine, continue to dampen economic activities.


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With the spread of coronavirus to other continents, global output will experience a decline in 2020. The IMF projected global GDP to decline by 3 per cent, with countries such as the United States, Germany, United Kingdom and Italy recording significant output decline of 6.1, 7.0, 6.5 and 9.1 per cent, respectively in 2020. Across these countries, the immediate priority has been to contain the spread of the virus as well as limit its impact on citizens and businesses. This has, therefore, necessitated the implementation of massive fiscal stimulus, tax breaks, monetary policy cuts to boost production and aggregate demand.

 

The manifestation of this pandemic is evident in declining oil price and lower demand for crude. As a result of movement restrictions and lockdown of major economies across the world, the demand for crude oil has plummeted significantly, leading to falling and volatile crude prices. The price of Brent crude fell from US$70 per barrel at the dawn of 2020 to US$20 per barrel as of April 22, 2020. Given the continued spread of the virus to other countries, it has graduated from a Sino-epidemy to a pandemic, as its epicentre has now moved to Europe, America and Africa. Furthermore, as the contagion effect intensifies, the continued global banning, border closure, social distancing and restrictions will suppress growth further globally. Coupled with the unrelenting power tussle between Saudi Arabia and Russia in the global oil market, the worst is still ahead for the oil market.


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Lower bonny light price has continued to take a toll on the reserve thereby limiting Nigeria's creditworthiness and the ability of the monetary authority to defend the country's currency. As a result, the external foreign reserve has shed over 12% from USD 38.54 billion on January 1, 2020, to USD 33.63 billion as of April 23, 2020. However, with the slight upward drift in Nigeria's crude oil price. Also, the exchange rate vis-a-vis the US dollar was adjusted from to N360/$ from N305/$, the exchange rate at the Investors' & Exporters' FX window (I & E) was adjusted to N380/$ from N360/$, whereas at the parallel market, the US dollar trades at over N400 (See figure 3). The commercial bank lending rate has remained stable, but with a wide difference of over 15 per cent between the Maximum Lending Rate (MLR) and the Prime Lending Rate (PLR)

 

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For Nigeria, the fiscal effect of the fall in oil price will be enormous with severe sectoral implications. Nigeria, being a major dependent player in the oil market faces a dual challenge of dwindling windfall from oil and economic constriction as global lockdown continues on the back of COVID–19. While the fragility of the economy persists, the oil market impacts the Nigerian economy through its dominant contributions to export earnings, foreign exchange inflows, movement in external reserves and government revenue. From a fiscal point of view, the 2020 budget of the Federal Government was based on $57 per barrel benchmark, which was later revised to $25 per barrel. Falling crude prices, in addition to weak export demand, would significantly add pressure on Federal and State governments' finances. This means that the revenue projections in the revised 2020 budget will be unmet, thereby constraining government's ability to meet its obligation such as payment of salaries and financing critical social and infrastructure projects in the year. Many States in Nigeria rely solely on allocations from the Federal Account Allocations Committee (FAAC), which are predominantly oil-dependent. Falling oil price means that many States will have difficulty in paying salaries of workers. This will have negative implications on aggregate demand and the performance of key sectors like Construction, Cement and Manufacturing. For non-oil revenue, limited economic activities arising from lockdown of some States and restriction of movement will result in poor performance of non-oil revenue.

 

One direct effect of COVID-19 on the economy is the movement restrictions and lockdown of some States. The shutdown of production facilities and lockdown of several States across the country will have negative implications on investment, aggregate demand and overall economic growth. While the lockdown and restrictions was relaxed in some States on May 4, 2020, economic activities during the four-week lockdown were severely constrained, and this is expected to reflect on GDP growth figures for the first to second quarters of 2020. In the World Economic Outlook projections released in April 2020, the IMF estimates that the Nigerian economy will contract by 3.4 per cent in 2020. What will be the impact of COVID-19 on the performance of key sectors in Nigeria? To respond to this question, we reviewed the performance of major sectors before the outbreak of COVID-19 then examined the implications of low oil price, disrupted global supply chain, technological shock and restrictions on identified sectors.


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Performance of Major Sectors Pre-COVID-19

Nigeria's economic growth has remained weak and fragile since the exit out of recession in the second quarter of 2017. The economy expanded but at a slow pace in 2018 (1.9 per cent) and 2019 (2.3 per cent). While the non-oil sector was responsible in driving overall GDP expansion in 2018, the oil sector became instrumental in 2019, with significant growth of 5 per cent, higher than non-oil sector growth of 2 per cent in the year. On the aggregate level, the economy expanded in 2019 despite weak growth in consumer demand and slow performance in the output of major economic sectors.

 

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Within the last three years, the major economic sectors in Nigeria have struggled to exert significant expansion in output. Since the exit of the recession in 2017, annual output growth of Agriculture, Services and Industry has remained below 3 per cent, poor performance when compared with pre-recession growth rates (See figure 3). The industrial sector has been the most volatile, largely as a result of the impact of crude oil price and output. The sector was the first to record negative growth of 2 per cent in 2015, and it contracted further by 9 per cent in 2016 following the fall in crude oil price and low production volumes. In all oil price-related shocks, the Nigerian economy has witnessed, the industrial sector is usually the first and major casualty, especially because of its exposure to foreign exchange.

 

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While the Agricultural sector was resilient during the recession in 2016, the sector's annual growth has remained weak at just over 2 per cent since 2017, significantly below 6 and 4 percent recorded in 2012 and 2014. One major factor for the sector's resilience during an economic crisis as experienced in 2016, is the Nigerian government efforts to implement import substitution policies and support local food production to conserve foreign exchange.

 

The Service sector was the fastest-growing sector before 2016. Growth of the sector was driven by ICT, Finance and Trade sub-sectors. In addition to the Industrial sector, the Services sector was severely impacted by the recession in 2016 and has maintained low growth rate since the recession. Although major subsectors such as ICT and Transportation recorded remarkable performance post-2016 recession and were the fastest-growing activity sectors in 2019, Trade and Real Estate sectors recorded 3 consecutive declines in growth since the second quarter of 2019, suggesting that both sectors are already in recession. Lower consumer demand, as well as the impact of the land border closure, were largely responsible for this trend.

 

In essence, our narrative on the 3 main economic sectors shows that from a sectoral point of view, the economy has been fragile even before the outbreak of COVID-19. As pointed out in our Macroeconomic Outlook for 2020, we noted that "Nigeria's slow growth has been associated with two main features which include, heavy concentration of growth in very few sectors and lower investment inflows into major sectors of the economy, exemplified by the poor performance of both local investments and Foreign Direct Investment (FDI)." The report showed from a sectoral perspective that the economic recovery continued to confirm signs of fragility, as 13 out of the 46 sectors contracted in 2019 (up to the third quarter -Q3). While about half of the 46 sectors recorded growth of less than 2% in the same period. Major economic sectors such as Trade and Contraction in Real Estate have continued to weigh down economic growth in the period, however, share in GDP remain significant.

 

Structural challenges continue to limit the sectoral expansion

Across the sectors, the issues of the high cost of doing business, uncertainty surrounding the management of exchange rate and infrastructure deficit were major factors that inhibited growth, productivity and investments. Businesses across all sectors continued to grapple with regulatory setbacks, insufficient power supply and insecurity concerns in some parts of the country. Notwithstanding these challenges, Nigeria made progress in some areas relating to ease of doing business.

 

The 2020 World Bank's Doing Business Report showed that in 2019, Nigeria was among the top 10 improvers and ranked 131st out of 190 countries in the Ease of Doing Business Rankings. This represents a significant improvement from 146th and 169th positions from the 2018 and 2016 rankings, respectively.

 

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