Thursday, April 06, 2017/3:26 PM/IMF
This chapter examines the degree to which economic fundamentals at the time of the recent oil price decline explain the intensity of its impact on the Nigerian economy.
A cross-country regression finds that countries with a stronger fiscal position, higher international reserves, a more diversified export base, a history of price stability, and a flexible exchange rate regime weathered the shock better.
These factors explain about half of the outsized impact of the shock on Nigeria. In addition, the slowdown in Nigeria was larger than can be explained by fundamentals alone, suggesting that country-specific factors also played a role.
1. The Nigerian economy was hit hard by the decline in oil prices that began in 2014.
Before the shock, projections were for continued robust economic growth of about 7 percent per year, in line with the average growth rate experienced over the previous two decades.
However, in the wake of the oil shock, growth slowed sharply in 2015 and the economy experienced an outright contraction in 2016.
The unexpected decline in oil production in 2016 explains only part of this downward surprise. Non-oil sectors, which account for almost 90 percent of the total economy, also slowed sharply (Figure 1).
2. The impact on Nigeria was relatively large compared to other oil exporters.
To place the impact of the shock in a cross-country perspective, while keeping the focus on countries where oil prices likely played a meaningful role, real GDP growth was compared to pre-shock forecasts for 26 countries with substantial oil exports.
The impact of the shock was calculated as real GDP in 1 By Andrew Swiston, based on a forthcoming IMF Working Paper with Francesco Grigoli and Alexander Herman, with research assistance from Adrian Robles.
This includes countries in which oil exports in 2013 exceeded 8 percent of GDP, but excludes South Sudan and Yemen due to the armed conflict in these countries over this period, Iran and Iraq as their GDP growth performance was strongly affected by increases in oil production not projected as of 2014, and Libya and Syria due to data gaps.
Real GDP was used as the variable of interest as there are a number of transmission channels from oil prices to economic activity in oil exporters, and real GDP forecasts are widely available.
2016 minus the projection from the Fall 2014 World Economic Outlook (WEO), the last vintage of the WEO before prices fell sharply.3 Economic activity in most oil exporters was typically below Fall 2014 forecasts, with the shortfall in Nigeria the third largest of the 26 countries (Figure 2).
The impact on Nigeria was also relatively strong when measured as the slowdown in real GDP rates in 2015–16 compared to the 2011–14 period of high prices (Figure 3).
3. The impact appears to exceed what could be explained based solely on the basis of the importance of oil in the economy.
Nigeria experienced a substantial decline in oil exports in the wake of the shock, as did most oil exporters (Figure 4).
While a number of other countries have oil exports exceeding Nigeria’s 2013 level of 17.6 percent of GDP, Nigeria is heavily dependent on oil for export receipts and fiscal revenue.
However, there is no correlation across countries between the importance of oil in either exports or fiscal revenue and the impact of the shock on real GDP, and the impact on Nigeria was larger than could have been foreseen based on any of these metrics (Figure 5).
4. A wide range of factors was examined in order to explain the cross-country variation in the severity of this impact.
Given the low correlation between the importance of oil for each economy and the growth impact of the shock, other economic characteristics were assessed in order to evaluate their role in mediating the impact of the shock.
A key issue is to distinguish between an economy’s fundamentals entering the shock, as distinct from increased vulnerabilities due to the impact of the shock.
For this reason, each country’s fundamentals at the time of the shock—in this case, 2013 values—were used in regressions to explain the magnitude of the impact of the oil shock on real GDP.
A number of indicators were tested as proxies for the following factors:
Macroeconomic policy space: Several indicators were used to gauge whether an economy enjoyed space for countercyclical fiscal, monetary, or exchange rate policies to buffer the impact of the shock.
Among the fiscal indicators were the overall balance, primary balance, non-oil balance, gap between the primary balance and its debt-stabilizing level, and ratios of net debt to GDP, overall revenue, and non-oil revenue (the latter two as proxies of debt repayment capacity).
Indicators of monetary and exchange rate policy space include the output gap as a measure of spare capacity entering the shock, the inflation rate and the historical volatility of inflation (as measures of monetary policy credibility), the flexibility of the exchange rate regime, and the level of reserves (relative to the IMF-standard reserve adequacy metric.
External factors: Revisions to partner country growth and the non-oil terms of trade were controlled for. Other indicators were used as proxies for potential risks of a sudden stop in capital flows.
These include the non-oil current account balance, the level of external liabilities, and the level of external assets.
Oil dependence and economic diversification: An economy more dependent on oil for foreign exchange or fiscal revenue, or with a higher share of the oil industry in the overall economy, would be expected to suffer a stronger direct impact.
By contrast, a more diversified economy would be expected to weather the shock better to the extent that non-oil sectors are less affected by the shock.
The share of oil output in the economy and the ratios of oil exports and oil-related fiscal revenue to GDP were used as indicators of oil dependence.
The share of non-oil output and the ratios of non-oil exports and non-oil fiscal revenue to GDP were used as indicators of diversification.
Structural flexibility: The ability for an economy to redeploy resources across sectors in response to a shock would be expected to contribute to resilience.
Indicators of the business environment and governance were used as proxies. A deeper financial system could also help agents within the economy smooth consumption and investment in response to the shock.
The ratios of private credit and broad money to GDP were used as indicators of financial development.
5. Several variables were found to be significantly related to the severity of the impact of the shock.
The five variables significant in the preferred specification were exchange rate regime flexibility, the ratio of non-oil exports to GDP, reserve adequacy, historical inflation volatility (over the seven years prior to the shock), and the ratio of net government debt to fiscal revenue (Table 1).
Together, these variables explain sixty percent of the cross-country variation in real GDP in response to the oil shock.
The same variables were still significant when the sample was expanded to oil exporters that experienced fluctuations in oil production due to severe armed conflict and other factors, as well as to a range of less oil-dependent countries, though, as expected, they explain a lower fraction of growth developments in those groups of countries (Table 1, columns 2 and 3).
These same variables were also generally significant when the impact of the shock was measured by the average deceleration in real GDP growth in 2015–16 compared to 2011–14, both for overall real GDP and for non-oil real GDP.
Given the difficulty in summarizing the degree of available fiscal space in a single variable, a wide array of specifications was run using a number of variables.
Net debt—whether expressed as a share of total revenue, non-oil revenue, or GDP—was strongly significant across all samples, and several others were significant for the core sample.
6. These results suggest that economic fundamentals entering the oil shock played an important role in mediating its impact.
Economic activity was less affected in countries that entered the shock with a more flexible exchange rate regime, a more diversified export base, more adequate international reserves buffers, a history of price stability, and a stronger fiscal position.
The other external and structural factors discussed above were not found to play an important role.
7. These findings can be applied to explain the relative intensity of the impact of the shock on Nigeria.
For each factor in Table 1, its contribution to explaining the growth impact of the oil shock was calculated for Nigeria and two groups of comparator countries—other Sub-Saharan African oil exporters and economies that operated managed float foreign exchange regimes in 2013.
This latter group of countries has some key similarities to Nigeria in terms of their ratio of oil exports to GDP and the size of their economies.
8. Nigeria’s vulnerabilities entering the oil shock explain about half of the higher impact on economic activity.
The cumulative impact on Nigeria’s real GDP was 15.5 percent, about 8 percentage points more negative than the sample average, of which about 4 points can be explained by its lower-than-average fundamentals (Figure 6).
For other Sub-Saharan African oil exporters, the contribution of pre-shock fundamentals was only minus 2 percentage points.
The main difference was Nigeria’s lower level of non-oil exports, as the contributions of below-average exchange rate regime flexibility, net-debt-to-revenue ratio, and reserve adequacy to the impact on Nigeria were similar to those among other Sub- Saharan African oil exporters.
By contrast, the countries with managed float regimes entered the shock with higher-than-average non-oil exports and reserve coverage, and slightly lower fiscal deficits. Their relatively sound fundamentals diminished the impact of the shock on real GDP by about 4 percentage points.
9. In addition, the impact on Nigeria was more negative than would have been expected solely on the basis of its pre-shock fundamentals.
The regression residual for Nigeria, shown in Figure 6, is negative 4.1 percentage points, while the average residuals of other Sub-Saharan African oil exporters and managed float economies were close to zero, on average.
This suggests that policies in the wake of the shock, such as the delay in implementing the 2016 budget and the imposition of foreign exchange restrictions, as well as other idiosyncratic developments since the shock, such as the increased occurrence of oil infrastructure sabotage in Nigeria, have also contributed negatively.
10. These results underscore several policy priorities for Nigeria.
Fiscal consolidation and building a more substantial reserve cushion would help build buffers to allow the economy to weather the sizable fluctuations typical of oil prices.
Building a track record of price stability would create space for countercyclical monetary policy, and allowing the exchange rate to flexibly adjust to external conditions would reduce the transmission of oil shocks to the non-oil sector.
Finally, structural reforms to improve the business environment would help diversify the economy and boost non-oil exports (see Chapter 4).