Nigeria Outlook - Seeking a Winning Formula


Tuesday, September 20, 2016 3.59pm / Vetiva Research

After a decade long 6% average growth rate, Nigeria slipped into recession in the second quarter of 2016. Reeling from the oil price shock and its subsequent effect on fiscal balances, a steady hand and clear policy direction are needed – both of which the present administration now look to provide after a shaky start.  

Getting back on track, better late than never
Notwithstanding Nigeria’s immediate economic concerns, the Buhari administration has placed some emphasis on long-term planning. This can be seen in the 2016 Budget and more recently, the 2017 – 2019 Medium Term Expenditure Framework (MTEF) policy document which outlines key economic parameters and projections for the specified period. Despite entering a recession this year, the MTEF forecasts a 3% economic expansion in 2017. This compares to Vetiva forecast of 2% and IMF forecast of 1.1%.

Oil revenues remain crucial for Nigeria’s economy. This year, an oil production slump to a low of 1.4 mbpd (compared to 2015 average of 2.15 mbpd) shrunk oil earnings to less than 60% of the corresponding value in 2015. Oil production benchmark has been set at 2.2 mbpd and 2.3 mbpd in 2017 and 2018 respectively, presumably contingent on militancy abating in the Niger Delta region.

Whilst recent moves to revive export terminals, as well as negotiations with the Niger Delta Avengers group, are positive signs, we adopt a cautious stance in light of minimal progress made so far.

The MTEF adopts $42.50/bbl as the benchmark Brent price. We expect supply to continue to dominate the oil market over the next year with consolidation in U.S. shale, projected output recovery in a number of regions, and sluggish demand pickup pressing down on prices. As such, we expect Brent price to average within the $40-$50/bbl range in the coming year. 

Fiscal spending needs to be accelerated
Our skepticism over the expected execution of the budget have played out in reality. Capital expenditure has been fragmented, funding plans delayed, and deficit targets overshot.

The MTEF has similar themes to the 2016 Budget and implementation lessons must be learnt to achieve the full potential of the policy document. The medium term fiscal impact of spending hinges on Government’s ability to deliver on key parameters in transport, power and social welfare going into 2017.

Overall, we anticipate an improved multiplier effect from fiscal activities in the next 6-18 months. Underlying all this is political and security risks. Whilst both appear contained at present, the fallout from a sharp deterioration on either front would have a material economic impact.

In particular, the emerging humanitarian crisis from swelling numbers of Internally Displaced Persons (IDPs) in the North-East poses an acute risk to internal stability and external perception.

Monetary policy at its limits?
Contrary to expectations at the turn of the year, monetary policy has dominated the policy space in 2016. The two key developments were the adoption of a flexible exchange rate policy and tighter monetary policy in the wake of surging inflation.

Despite these, we witnessed capital flight, record low exchange rate and a large parallel market spread. The MTEF sets NGN290/USD as the benchmark exchange rate. We consider this rather optimistic.

Firstly, Nigeria’s foreign exchange earnings are still oil-dependent. Secondly, a significant improvement in capital inflows – an alternative source of foreign exchange – will hinge on tight monetary policy and macroeconomic stability. However, we expect the CBN to move towards looser monetary policy by the turn of the year, in line with expansionary fiscal policy.

Moreover, the uncertain nature of Nigeria’s recovery could delay the return of capital inflows. Therefore, we adopt a year-end exchange rate of NGN325/USD, rising to NGN350/USD at the end of 2017 as USD inflows stall.

Our estimate is for CPI inflation to average 15.5% in 2016 and 14.1% in 2017. We expect a high base, greater import substitution, and consolidation of the downstream petroleum reforms to contribute to the lower inflation figure in 2017.

The markets – contingent upon economic recovery
We expect the equity market’s performance for the rest of 2016 to be dictated by conditions in the economic environment. As we foresee some improvement in oil production and the economy at large, we expect improvement in investor confidence. That said, we anticipate a flat to mild close for 2016 and see stronger returns in 2017 as the economy improves.

Activity in the fixed income market will likely be dictated by government deficit financing. According to the debt management strategy for 2016-2019, the preferred route is to moderate domestic borrowing whilst increasing external financing with a view to rebalancing long term external financing.

As a result, we expect a reduction in bond supply in 2017 compared to 2016 levels. We anticipate a pickup in demand, particularly from foreign investors as we expect to see some improvement in the liquidity of the Inter-bank foreign exchange market which would improve confidence in the markets.

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