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Coronanomics (1) - Understanding the Realities of an Impending Recession

Proshare Confidential	4238 VIEWS
Proshare Confidential
4238 VIEWS

Saturday, June 06, 2020 / 08:00 AM / by Proshare Content/ Header Image Credit: EcoGraphics

Executive Summary

The connectedness of industries is positive in good times and a problem when times are difficult. - Professor Hamid Beladi

This report represents a deep dive into the emerging realities of a new world economic order that strips away pretence about the growingly outdated concept of globalization. The COVID-19 pandemic has shown that an integrated and tightly knit world could create lasting and catastrophic problems and that nations may increasingly need to secure domestic supply chains by strong backward domestic integration. The potent 'Asianisation' of global supply chains has started to unravel as North America and Europe revisit their production links to China, the s second-largest economy. Emerging markets such as Nigeria have also had to take a step back to see how they can protect their economies from imported contagion of both a health and an economic variety.

The report makes a case for a new approach to fiscal and monetary policy management that it calls 'Fiscmon' which represents an integrated approach that sees monetary and fiscal management tied into a forward plan of action to achieve clearly stated objectives within a specified time frame. The report observes that this approach is becoming a global 'normal' as central banks become more assertive in intervening in the push towards domestic economic growth and employment.

Nigeria's resource mindset has stayed trapped in a past that is fast becoming a burden. Within the dynamics of the new COVID-19 inspired economy, fiscal policy is reduced to the task of bean-counting while monetary policy increasingly ascends to the status of the country's premier macroeconomic policy driver. The recent ascendency of monetary authorities has become a global event as new economic management frameworks adopted by nations blur the once solid line between fiscal and monetary policy. As supply chains get disrupted, and consumer spending power tails off, the trilemma of balancing growth, jobs and low inflation has become a Gordian knot.

The Central Bank of Nigeria (CBN) has since 2015 (four years before the COVID-19 pandemic), taken on an increasingly aggressive role towards determining the trajectory of economic growth by implementing a series of intervention strategies designed to spur the growth of the real sector.

Monetary strategies have ranged from concessionary agricultural loan schemes and insurance cover to aviation sector loans and special credit programmes for manufacturers. The outcomes of the various interventions have been stretched from being good to being weak. The most successful intervention of the CBN appears to be its agricultural sector interventions but the aviation and manufacturing initiatives have proved to be more difficult to resolve.

The report looks at the traditional methods of handling macroeconomic disruptions and demonstrates why the old ways of doing things no longer suffice. The new reality of economic management takes off from a set of revised frameworks that underly the ways new economies work. The Investment/Savings and Money supply/Money demand curves or the IS and LM curves of old that have served so well for so long are currently being called to question.

The Hard Knocks of A Trilemma

Going forward, Nigeria will be smack in the middle of a trilemma. The primary problems Nigerian fiscal and monetary policymakers will face in 2020/2021 are the following:

Negative gross domestic product (GDP) growth (Q1 2020 growth was +1.87%)
Higher levels of domestic inflation rate (April 2020 inflation rate was +12.34%)
Foreign exchange instability (N/US$ was N360/US$ in April 2020)

The monetary authority (CBN) is caught between inflation dampening and economic growth. Keeping the Monetary Policy Rate (MPR) at 13.5% and Cash Reserve Ratio (CRR) at 27.5% the central bank has indicated its desire to keep the inflation rate in check but by imposing a loan to deposit ratio (LDR) of 65% in Q3 2020, the Bank showed a preference for economic expansion through credit growth. The requirement of a high MPR and a high LDR appear inherently contradictory. To expand credit the CBN would need to grow money supply and reduce interest rates as well as bank's cash reserve ratios, but in the last twelve quarters, the problem has appeared more persistent. Beyond the obvious difficulty of balancing growth goals with the desire to contain inflation another part of the policy puzzle has been maintaining external balance by keeping the naira strong in foreign exchange markets.

To keep the naira strong in FX markets, the domestic interest rate needs to be high to give a 'risk premium' that would afford foreign investors the opportunity to gain margins higher than those in more mature economies. The premium would suggest that domestic interest rates would need to stay high at a time the economy also needs to grow. Usually, at this point, the fiscal authorities try to make up for the growth slack by spending more money and creating new jobs. Unfortunately at a time of supply chain disruptions and a health pandemic, the traditional model of growth and non-accelerated inflationary rate of unemployment (NAIRU) breaks down.

The Search for Liquidity

Higher local interest rates would also strengthen the naira but discourage non-oil exports. The COVID-19 new normal of increased economic nationalism and domestic supply chain strengthening could easily be compromised by a stronger naira exchange rate. The fiscal and monetary authorities would need to decide whether an external imbalance in the current account would be a good gambit in the face of rising domestic cost of credit. Some economists, such as Dr. Ayo Teriba see opportunities within and beyond the COVID-19 era to attract international liquidity to grow domestic infrastructure and local production linkages while other economists, such as Dr. Abiodun Adedipe believe that heavy reliance on foreign liquidity could create challenges in the face of unexpected international shocks, thereby importing foreign financial contagion.

Teriba argues that the COVID-19 period could be used for a reset where Nigeria positions itself for growth by unlocking liquidity both domestic and foreign. The economist has argued that liquidity locked in non-core physical assets should be liberated and directed to self-sustaining and self-financing projects. He, for example, argued that prisons built on prime land across the country should be relocated and the underlying value of the real estate should be realized and directed towards projects in which marginal social benefits exceed marginal social costs.

However, a few observers have differed from Teriba, arguing that such a strategy would result in further income inequality with wealthy Nigerians taking over what was previously collective social assets. The point of uneven and worsening wealth distribution in Nigeria is becoming a severe problem that has been made worse by the COVID-19 pandemic. Nevertheless, Teriba's point about reducing the size of the countries domestic and foreign loan books without hurting growth is important and needs to be taken seriously.

In a recent special report on global debt at a time of COVID-19, the London-based, The Economist magazine's Economic Intelligence Unit (EIU) in May 2020 observed that "The coronavirus pandemic is a game-changer for the global economy. The years 2020 and 2021 will be lost years for growth. The Economist Intelligence Unit does not expect global GDP to recover to pre-coronavirus levels until 2022". But more precisely on the matter of debt, the report goes on to note that "For the most reliable sovereigns, the cost of servicing higher levels of public debt will not be an immediate cause for concern. However, governments will eventually have to confront debt pile-ups. To curb fiscal deficits, governments in most developed countries will not be able to pursue spending cuts".

The report goes further to point out that, "Austerity absorbs political capital, and there might not be enough left to pursue such a plan, especially given that the last period of belt-tightening was so recent for many countries".

In sub-Sahara African countries like Nigeria, the report states that "the newest funding (albeit on concessional terms) will be added to the balance sheets of emerging economies. In addition, the debt-assistance package from the G20 is a delay rather than a write-off; debt repayments will remain outstanding and continue to accrue interest as time passes. Many countries will, therefore, emerge from the current virus-driven economic crisis even more indebted and financially stressed than before. This will raise concerns about their ability to repay external debt in the absence of more comprehensive debt-relief plans. Sovereign defaults might not take place this year, but they are likely among poor countries in the medium-term".

The Debt Bogey

In this report, the authors note that Nigeria's total debt stock as of December 2019 stood at N27trn. This included N21.7trn owed by the Federal Government and N5.6trn owed by the sub-national governments.

The Federal Government's debts accounted for 79.59% of the country's total debt, while the states and the federal capital territory (FCT) debt accounted for the remaining 20.41%.
Foreign debt account for 32.93% of the total debt at N9.02trn, with the Federal Government owing N7.53trn and the state governments owing N1.48trn.
Domestic debts accounted for the remaining 67.07%. The Federal Government had a domestic debt portfolio of N14.2trn, accounting for 52.09% of total debt stock, while the states owed N4.1trn, 14.99% of the total debt stock.

Nigeria's mounting debt profile has become of concern to a growing number of economic analysts as the financial debt overhang threatens to raise domestic interest rates and cut GDP growth in both 2020 and 2021. The unfolding debt threat is despite the country having about $900bn worth of idle assets in properties and agricultural land. Nigeria's total debt has risen steadily but labour and capital productivity growth have declined. The implication may be that the Federal Government borrowings have not been used for productive purposes. The nation's debt service, after a while, may become a surging burden on the government and its fiscal balance unless liquidity is found from the sale of non-essential public assets and the attraction of foreign direct investment (FDI) and foreign portfolio investment (FPI).

The New Nigerian 'Normal'

The post-COVID-19 'new normal' will mean different things to different people and organizations as humans cope with the reality of COVID-19, business and individual resets will be inevitable as companies and employees make decisions to ensure sustainability. However, new normal will differ across countries and continents. The pre-existing realities of each country and the fiscal headrooms of each government will determine what the new shape of economic and personal management would look like in months to come. While in Noth America, Europe and Asia, citizens would vote for greater digital interaction in Nigeria this would be difficult given the challenges of acquiring computer hardware, the cost of internet access and the intensely communal nature of Nigerian lifestyles.

The report notes that the cost of acquisition of laptop computers, desktop computers, internet modems and other communication facilitators such as a generator to power the business and personal hardware would make remote work and business interaction difficult in a society where 85% of businesses are located in the informal sector of the economy.

Another problem with the concept of the new normal as applies to Nigeria is that there are deep-rooted cultural mores that place a premium on interacting on a person-to-person basis; the village square is more than just a place to congregate, it is a place for dispute resolution, communal planning and an incubator for folklores and the passing of ancient knowledge and wisdom across generations. No digital programme or contraption could substitute for the folksy mystic of the village. Social distancing is a notion simply alien to the realities of rural Nigeria.

Furthermore, social distancing in environments that are heavily dependent on daily -subsistence earnings is impossible. The hustle and bustle of commercial trading cycles from Lagos to Kano and from Portharcourt to Abuja make urban cities the hotbeds of social interaction as they fasten deep commercial and financial bonds that tie everybody together. The large retail markets of Lagos, Kano, Portharcourt, Aba, Onitsha, Kaduna and Jos repel efforts at keeping safe distances. The reality of the market, like a cyclone, overwhelms the expediency of health rules no matter how well-intentioned.

For the Nigerian government to take full benefit of the digital age it must gradually reduce the size of the informal sector and increase the breadth of the formal sector as it ramps up electricity generation and distribution, improves transport infrastructure and supports a significant reduction in the cost of access to the internet. Internet data costs need to fall as micro, small and medium-sized businesses (MSMEs) become more active in the emerging formal sector which will experience consumer spending shifts.

Of Banks and Sandboxes

Nigerian businesses will reinvent themselves but not rapidly. Banks, for example, will trim down staff strength and scale-up technology applications as they reduce brick-and-mortar engagement with customers and move a lot more of their services to digital online platforms. The tearaway success of unstructured supplementary service data (USSD) or "Quick Codes" applications for most tier1 banks in the country indicates the possibility of technology taking away several previous back-office and front-office clerical jobs.

Artificial Intelligence (AI) would likely throw a further layer of a redesign of user experience (UX/UI) into the service delivery mix as banks like Access Bank Plc take advantage of their tech foundries and sandboxes. Access Bank's five-year corporate strategic plan that started in 2017 and is scheduled to end in 2022, was clear about the strategic imperatives of increased technology application and cost-trimming that would come from a slimming-down of staff strength and driving of product delivery efficiency by expanding digital channels. UBA Plc also indicated this strategic push when it 'right-sized' its business at the beginning of the year in January 2020.

The new financial sector 'normal' would possibly lead to the recruitment of a younger generation of employees with tech-savvy and the slow replacement of an older generation of staff with increasingly jaded skill sets. Admittedly, experience in credit appraisal (CAMs) and credit administration would likely attract new job slots but even here, banks would prefer individuals who have upgraded their skills in the use of big data applications (Python, R, Oracle Database, and MS BI) and informatics. Also, bank marketing functions will be more about problem-solving than pretty faces and English prose. For rural transactions, agency banking will begin to gain ascendancy as banks shy away from impressive branch buildings in communities where the likelihood of meeting breakeven margins, in the short or medium-term, is either remote or non-existent. The era of 'competing showmanship' will likely give way to one of 'scaling bottom lines'.

The Retail Makeover

The retail sector will likely migrate slowly from a physical consumer interface to more digitally-inspired consumer interaction. Business-to-Business (B2B) and Business-to-Consumer (B2C) transactions will ride on the shoulders of increased internet data penetration and a fall in the cost of data which could arise as a result of a major reduction in the right-of-way (R0W) costs of laying digital cables across states, the Ekiti State government recently reduced the cost from N4,500.00 per metre to N145.00 per metre. If reductions of this magnitude occur across all states, data costs could come down and improve data access by micro and small-scale businesses.

With increased digital penetration and consumer sensitivity, the retail market will likely see faster expansion in spending, greater product and service choices and superior user experience and interaction.

Lower consumer sensitivity, especially in Nigeria's large informal sector, and low or non-existent digital involvement would keep the economy running along the same old rail track and would perhaps bring the country to a point of repeating the same worn responses to future pandemics with little lessons learned and nothing gained in terms of socioeconomic repositioning.

The realities of the COVID-19 pandemic indicates that societies that will grow stronger from the pandemic experience are those that migrate from non-digital existences with low consumer sensitivity to those with higher digital engagements with increased consumer participation in influencing product or service design, quality and delivery.

The medical and pharmaceutical sectors will need to raise their delivery standards as equipment, research and development and personnel training will all have to be ramped up over a very short time. Indeed medical laboratory technicians will have to be vastly improved with more professionals schooled in the science of lab technology as vengeful viruses remain an ever-present potential global threat. Healthcare insurance will, therefore, also have to be leveraged to achieve wider coverage and more efficient pricing. Life insurance would equally need to be made easier to buy and faster to process as more micro and small scale entrepreneurs are brought into a micro-insurance coverage scheme. Medical science and its various supply chain interfaces will need to grow into a state of unending preparedness.

The traditional concept of the market place may take time to transition to a new normal, but Nigeria's young national demography (over 60% of the Nigerian population is between the ages of 1 and 35) with growing digital capabilities will result in a gradual reduction in the importance of physical retail platforms. Digital market places will slowly become the go-to platforms for fast-moving consumer goods (FMCGs) and other more durable purchases. How fast the transition occurs depends on the pace of digital infrastructural growth and development.

So are we talking about drones as 'delivery boys'? The concept may not take quickly but over the next half-decade logistics would be more about technology than brawn as human intervention in the E-commerce distribution (or 'fulfilment') value chain would be more about programming than lifting, driving and counting.

Section 2 of the Coronanomics report takes a birdseye view of global economic responses to the coronavirus (COVID-19) pandemic and does a comparison of different approaches to both healthcare interventions and economic policy. The section looks at the impact of the virus on equities, commodities and global fixed income markets.

Section 3 of the report delves into the impact of COVID-19 on large and small-sized African economies. It takes a look at Africa's trade with the world and its trade amongst member nations. The section addresses issues of protectionism and the currency impact of the COVID-19 pandemic and its potential to disrupt world trade and depress African economic growth.

Section 4 breaks down the Nigerian economy in the face of COVID-19 and looks at how the economy has responded to the pandemic and identifies key opportunities beyond the threats. The section deconstructs the economy and takes a look at the country's sub nationals (states) and the opportunities (as well as challenges) open to the subnational entities across the federation with case studies of two states within each of the six geopolitical zones.

Further analysis is done on the differential impact of COVID-19 on Nigeria's business sectors. The sectoral analysis isolates the so-called 'winners' and 'losers'. Amongst the winners are the Agricultural sector (which begins to flourish as the country attempts to build stronger local agricultural value chains), the Fintech sector (which jumps as Programming, Big Data, Artificial Intelligence(AI), and Informatics become core skills that drive commerce and manufacturing), Healthcare sector (which expands as the country re-scales and retools its health sector to cope with present and future shocks), Digital entertainment (which becomes fashionable as consumers get used to social distancing and prefer to receive entertainment content in the privacy and relative safety of their homes), Digital web-based online content (which increases as consumers/readers spend more time on the web than in the past), E-commerce (which grows as e-shops become staples of consumers searching for bargain buys) and Digital online Education (which would likely grow at the speed of thought, will become a blended framework with physical classes).

The losers would likely include Airlines (which would see disrupted cash flows, higher breakeven margins and bumped-up ticket fares leading to lower passenger patronage), Hotels (which could face lower revenues as tourism falls-off and large events move from physical spaces to digital screens), Malls and Restaurants (these places of recreation and high impact social gatherings will wane as the social-distancing culture settles in and people opt for the 'to-go' option for fast food purchases and favour the digital order alternative for groceries and other food items), Cinemas (more people will buy their make-believe entertainment in the form of movies from online platforms rather than go to crowded cinema halls), Sports (sporting events without the gutsy noise of crowds and popcorn may currently appear odd and feel uncomfortable, but the inevitability of smaller attendance at games will cut into revenues and potentially thin down profitability but as people get used to watching matches at home on television sets or computers or even their phones, advertising revenues may begin to pick up well enough to keep games such as football, Tennis, Boxing, Wrestling etc. commercially viable), and Places of worship (religious gatherings will be smaller in numbers as social distancing protocols impose limits on the number of people permitted in confined spaces, nevertheless Tithes, Offerings, Zakat and Sadaqah can be paid electronically just as sermons can be delivered in digital messages) .

The section explains the organizational changes in strategy and planning that would be needed to address the fluidity in consumer experiences and expectations. Corporations will need to evolve business plans that try to map future consumer needs and not their past preferences. The import of this is that companies would be required to construct several scenario models with attendant probabilities to determine the most likely outcomes.

The Investment Bridge Post

The section briefly looks at both the local private equity and fixed income securities market and highlights the gradual growth in private equities despite the general modest growth outlook for the Nigerian economy in the short-term. In its recent Monetary Policy Committee (MPC) Meeting Communique for May 2020, the Central Bank of Nigeria (CBN) acknowledged that it was pleasantly surprised by the Q1 2020 growth rate of +1.87% published by the National Bureau of Statistics (NBS) and was optimistic that the economy would not contract as severely as earlier expected by the International Monetary Fund (IMF) which expected the economy to contract by -3.4% at the end of 2020.

While the economy may see slower growth in Q2 and Q3 2020, analysts are more enthusiastic about a crawling growth of above +1.00% in the two quarters and a full-year growth of between +1.5 and +2.00% for the full year, which would be less than 2019's growth rate of +2.55%. Because several mature economies will witness negative growth in 2020, the slow-motion growth rate of the Nigerian economy may still seem attractive if oil prices hold up at between US$35 per barrel and US$40 per barrel for the better part of 2020. The expectation is that if prices steady at least US$35 per barrel and output averages 1.7mbp the fiscal deficit would still be manageable and debt servicing less punishing than at a lower international oil price.

A bright oil price outlook in 2020/2021 should see larger quantities of capital importation into Nigeria as private equity managers search for bargain opportunities before a full-scale economic rebound. The report equally notes that Nigeria's debt ratings would likely rise as oil markets strengthen and the international cost of sovereign borrowings would possibly fall. Domestic cost of local Treasury Bills and Bonds would equally fall as Bill and Bond prices rise on the back of the government's stronger fiscal position. In other words, as oil price rises the coupon yields on local Nigerian bonds may begin to fall.

Monetary and Fiscal Policy; The New Heterodoxy

Monetary and fiscal policies were in the past Siamese twins, each working to support efforts of the other and managed by separate authorities, but those were the days before the previous global economic crisis in 2008/2009 caused by the collapse of subprime real estate-linked credit in the United States of America. Since the crisis of 2016/2017 fuelled by a rapid decline in international oil prices, global central banks have been more assertive and taken on broader briefs than merely keeping domestic inflation rates in check.

Since the coronavirus pandemic started to affect major (and minor) global supply chains and disrupt consumer and producer demand in Q1 2020, central banks around the world have attempted to prevent economies from slipping into recessions by expanding the money supply, cutting interest rates and providing easy credit targeted at vulnerable industries such as airlines, automobiles, hotels, restaurants and logistics.

Nigeria's CBN in Q1 2020 has been confronted with a double whammy of a large fiscal deficit and a slowing GDP growth rate. The policy choices have been for the CBN to increase the money supply to spur production as interest rates fall (a choice it has felt uncomfortable pursuing) or cut policy rate and allow the money supply to find its level (a choice it has equally seen as undesirable). With conventional monetary tools seen as inadequate and unfit-for-purpose, the CBN has adopted a new heterodoxy, by urging banks to increase their loan-to-deposit ratios (LDRs), keeping monetary policy rates between the lower and middle double digits (between 14% and 13.5% in 2019 and recently 12.5% in May 2020), regularly intervening in the foreign exchange market to keep the N/US$ exchange rate within a narrow band, previously around N307/US$ and more recently N360/US$. The 'dirty float' intervention stance of the CBN in the FX market has earned the regulator some criticisms, especially from local and international economists who believe that the monetary authority should allow for a wider float and an in-built correction stabilizer to the current account (CA) of the country's balance of payment.

Concerned about the wider inflationary consequence of a free float of the domestic currency, the country's monetary authority has refused to be nudged towards higher exchange rates, preferring to adopt the unconventional framework of a managed float with multiple-windows, combined with direct intervention in respect of concessionary lending to select economic sectors. The Bank has supported this with microeconomic interventions in the local credit market by adjusting bank loan-to-deposit ratios (LDRs) first to 60% by September 2019 and then to 65% by December 2019. The banking sector regulator has recently reduced the rates on concessionary intervention fund loans from 9% in 2019 to 5% in Q1 2020 for one year effective March 2020. The Central Bank has tried to propel growth in sectors such as agriculture, aviation, entertainment and manufacturing but so far the intervention efforts have seemingly yet to yield a sustainable outcome to support near-term aspirations of GDP growth rates above the national population growth of +2.7%.

Before the advent of COVID-19, the CBN's heterodoxy appeared to have been working like a charm with the N/US$ exchange rate remaining stable and inflation rate trending downwards as GDP grew at over +2.5% in 2019 (notably +2.3% in Q4 2019 as against +1.8% in Q4 2018). But since the emergence of the pandemic the resilience of the regulator's approach to macroeconomic management is tearing at the seams with pressure on foreign reserves, rising domestic interest rates and a widening gap in the country's fiscal balance.

Orthodoxy may have had its limits but heterodoxy is not without its baggage, or so it seems.

How Fareth The Household?

Households under the COVID-19 new normal have not fared well. The total and partial lockdowns of the economy have taken their toll on families as more companies lay off workers as supply chains become difficult to fix in the short-term. The disruption to production raw material, industrial replacement supplies and the stalling of logistics has meant that many companies have found it difficult to sustain operations with a pre-COVID-19 level of staffing. Even financial institutions such as banks have had to trim down operations as some branches have had to close to abide by the protocols set for social distancing.

Households have also seen costs double and in some cases quadruple making nonsense of the recent 2019 upward adjustment in the national minimum wage from N18,000 per month to N30,000 per month, spiralling retail prices have decimated households real take-home incomes. As bad as this may seem, many households simply do not have take-home pays anymore as company's go under and jobs get lost as lockdowns either persist or are mildly modified.

Section 5 of the report reflects the closing thoughts of the writers concerning how the coronavirus and declining oil prices will affect both the Nigerian and global economy between 2020 and 2021. The various scenarios range from the obscure and dark to the simple and bright. The most likely path seems somewhere in-between.

Section 6 provides a treasure trove of references and additional reading material to build a robust body of knowledge on the impact of COVID-19 and oil price declines in 2020 on global and local economies. The section enables the user of the report to explore related material that adds context to issues that could not be dealt with in detail by the report as a result of the constraint of space and time. The references enable the reader to go to Proshare's market place page and unearth nuggets of actionable business and financial market intelligence data.

Section 7 advises readers on how the report could be used for strategic personal and business decision-making without violating relevant and applicable copyright guidelines.