Wednesday, November 07, 2018 / 01:25AM / By Vetiva Research
The month in review…
October was a relatively muted month for the Nigerian economy as 2019 election season came into focus.
Purchasing Managers’ Index data from the Central Bank of Nigeria suggested that the economy expanded at a faster pace in October, with manufacturing and non-manufacturing PMI rising from 56.2 and 56.5 in September to 56.8 and 57.0 in October. However, other variables pointed to underlying economic weaknesses. Annual inflation inched up as base effects weakened, and yields climbed in the fixed income market. In addition, external reserves suffered their largest monthly decline ($2 billion) this year as pressure on the naira intensified.
Key stories in the month
Minimum Wage war rumbles on… Nigeria’s minimum wage story continued to evolve in October as talks between the Nigerian government and labour unions stalled. At the end of the month, the Nigerian Governors’ Forum proposed a new minimum wage of ₦22,500, slightly less than the Federal Government offer of ₦24,000 but far away from the demand of ₦66,500 by organized labour. We note that recent government financials point towards underlying fiscal weakness at all levels, making any minimum wage hike a risky fiscal move. Even as we expect the debate to wage on and become increasingly politized as we near the elections, we do not foresee any change in the national minimum wage in the short run.
Nigeria seeks another Eurobond, will find higher rates… The Nigerian Senate approved the fiscal authorities’ request to borrow $2.8 billion (₦854 billion) to help fund the ₦9.1 trillion ($30 billion) 2018 budget. The government is expected to once again tap into the Eurobond market after its last issue of $2.5 billion in early 2018. Nigeria’s Eurobond holdings have ballooned from $1.5 billion at the end of 2016 to $8 billion at the end of 2018, pushing external debt to 30% of total national debt. Meanwhile, the country can expect tougher pricing on its next issue amid rising global interest rates and negative investor sentiment towards emerging markets, and Nigeria in particular due to the imminent elections.
DMO sells bonds at higher rates yet again… The Debt Management Office (DMO) conducted its usual monthly bond auction in October, offering ₦115 billion (the highest this year) across the 5-, 7-, and 10-year bonds. The apex bank eventually sold ₦13 billion, ₦20 billion, and ₦55 billion on the respective bills at stop rates of 15.0%, 15.2%, and 15.3%. Notably, the stop rate on the 10-year bond was 10bps higher than at the September auction. We note that bond rates have steadily increased, with the rate on the 10-year bond rising from 13.5% at the January auction to 15.3% at the October auction. This is in line with the wider trend of rising interest rates in Nigeria (and other emerging markets) following sharp sell-offs by foreign investors concerned about imminent elections and global trade developments.
Nigerian fails to improve ease of doing business score… Nigeria dropped a place to 146th in the 2019 World Bank Doing Business Report which ranks countries according to the ease of doing business. This is a sharp contrast to the 2018 iteration when Nigeria climbed 24 places, helped by a raft of reforms initiated by the Presidential Enabling Business Environment Council (PEBEC). Led by the Vice President of Nigeria, Yemi Osinbajo, PEBEC ran through three national action plans aimed at areas such as the ease of registering a business, obtaining construction permits, trading within borders, and getting credit.
The council helped push through the National Collateral Registry Act and the Credit Reporting Act which pushed Nigeria up to 3rd Getting Credit criteria of the 2018 rankings (down to 12th in the 2019 version) and in his capacity as Acting President, Osinbajo enacted executive orders to tackle inefficiency and opacity in the public sector. The release of the 2019 report suggests either slower momentum and focus on similar reforms in recent times, or that PEBEC exhausted the low-hanging fruits that drove 2018 performance.
Despite this setback, efforts to improve the ease of doing business remain of paramount importance as it only just trails infrastructure and corruption as the largest impediment to SME growth in Nigeria. For now, Nigeria remains some way off the PEBEC target of ranking within the World Bank’s top 100 by 2020 and top 50 in ten years.
Summary of Q3’18 earnings season… October marked the start of earnings season for 9M’18 results and a flurry of earnings kept the Nigerian equity market quite active. Results were relatively positive, with the Tier 1 banks in particular posting steady increases in profits whilst notable names such as DANGCEM, NESTLE and SEPLAT also posted healthy numbers. However, earnings remained weak across some of the smaller banks, Nigeria’s top brewers and food manufacturers. With this, the market posted a slightly better performance, only shedding 84bps for the month (after a 212bps dip on the final trading day).
Inflationary pressures show sign of easing… Nigeria’s headline annual inflation rose by 0.1 percentage points to 11.3% y/y in September but came in well below expectations (11.5% y/y) on the back of a slower month on month pace (August: 1.0%, September: 0.8%). Core inflation slowed to 9.8% y/y and 0.6% m/m, but the biggest change was in food prices. Although food inflation still rose to 13.3% y/y (August: 13.2% y/y), this was due to a weaker base from the prior year as food prices rose just 1.0% m/m, the slowest in five months.
This was a pleasant surprise given our worries over intense food price pressure due to bad weather and the herdsmen crisis in the Middle Belt region. It is slightly premature, but this may indicate a positive effect of the harvest season, and if so, should persist till near the end of the year. We note that whilst the weakening inflationary pressure ought to give the Central Bank breathing room, they are unlikely to ease up current tight monetary stance amid pressure on the exchange rate.
Issue in focus: Review of 2019-2021 MTEF
The Budget Office released the 2019-2021 Medium Term Expenditure Framework (MTEF), the government’s medium-term fiscal strategy paper. The disclosed forecasts and plans paint a gloomier picture of the economy compared to the 2017-2020 Economic Recovery & Growth Plan (ERGP) released 18 months ago. The Federal Government now expects the Nigerian economy to grow by 3.0% y/y and 3.6% y/y in 2019 and 2020, compared to 4.5% and 7.0% in the ERGP. This reflects tepid economic growth in recent times as the Nigerian economy grew by just 1.5% y/y in Q2’18, a long way from the 2018 Budget forecast of 3.5% y/y.
Worryingly, projected growth barely outstrips estimated population growth of roughly 3% per annum meaning that GDP per capita will remain little changed in the coming years. On a more positive note, the government cut its inflation forecasts for the coming years and now expects Nigeria to hit single digit inflation in 2019, compared to 2020 in the ERGP.
However, we consider this rather optimistic given the weakening base going into 2019, as well as likely changes to national minimum wage or energy prices in the medium term. Similarly, the government is more bullish about oil production, estimating 2.6 mb/d in 2021, above the previous high of 2.5 mb/d in 2005. Finally, the MTEF states an exchange rate of ₦305/$1 through to 2021. As the NAFEX (and other floating rates) is unlikely to appreciate materially in the coming years, we may have multiple exchange rates for years to come.
The MTEF also includes the government’s fiscal plans, some of which we find perplexing. Budget revenues are projected to grow by only 9% between 2018 and 2021, with oil still accounting for a disproportionate share (47% on average) while remaining volatile. Non-oil revenues are also expected to grow but not quickly enough; in 2021, non-oil revenues would only cover 38% of projected spending. Meanwhile, government spending is projected to remain relatively unrestrained.
Including spending on Government Owned Enterprises (GOEs), the 2019 Budget will be ₦10.2 trillion (2018: ₦9.1 trillion), with most of the increase coming from recurrent expenditure as capital spending (capex) will actually decline from ₦3.1 trillion in 2018 to ₦2.8 trillion in 2019. In fact, capex will fall from ₦3.1 trillion in 2018 to ₦2.6 trillion in 2021. In contrast, line items such as MDA personnel costs, pensions & benefits, and debt servicing will all rise during the forecast period.
Worryingly, projected debt servicing in 2021 is equivalent to 80% of what the federal government earned on average each year from 2012 and 2017, which just emphasizes the desperate need to boost revenues in the coming years. Overall, nothing in the MTEF suggests that Nigeria’s fiscal position would record any material improvement in the coming years.
Equity markets in the United States (U.S.) endured a torrid October as investors worried about the medium-term health of the US economy and the pace of monetary tightening even as the U.S.-China trade war rumbled on. The contagion spread to markets in Europe and Asia in particular, making October a month for bears in the global equity space. Released data suggested that fears may be overblown as the U.S. economy grew by 3.5% annualized in Q3’18, ahead of most analysts’ expectation, and the Fed’s favoured gauge has still not broken beyond the 2% threshold that may trigger even tighter monetary policy.
Concern over the European economy is valid, however. Eurozone purchasing managers’ index (PMI) continued its steady decline from 55 in July to 52 in October and this slowing momentum is reflected in downgrades to the International Monetary Fund Eurozone 2018 growth projections—from 2.2% y/y to 2.0% y/y, much lower than 2.4% y/y recorded in 2017. Moreover, large economies like Germany and France are most affected. In Germany, Chancellor Angela Merkel revealed that she would step down as leader of her Christian Democratic Union party in December 2018. Merkel has served as party chief for almost 20 years and German Chancellor for 13 years. Her decision was likely swayed more by social issues like immigration than the state of the German economy. Although Merkel could retain her Chancellor post until elections in 2021, she is unlikely to last much longer once she is replaced as party leader.
Brexit talks broke down at the European Union (EU) summit in October as the two parties failed to agree on what to do with the Irish Border, an issue that has turned out to be the most difficult to resolve in Brexit negotiations. Northern Ireland is in the UK and The Republic of Ireland is in the EU and Brexit implies a hard border being placed between the two countries. However, they share a complicated history of conflict and remain extremely socially and economically intertwined today. As a result, the EU has made it clear that a hard border between the two is off the table as it may severely damage the relationship between the two and trigger a return to sectarian violence. In light of this, the UK has struggled to devise a plan to avoid a hard Irish border without betraying the principle of Brexit. With this issue continuing to drag as we approach the March 2019 Brexit deadline, a “No Deal” Brexit remains a real possibility.
Global oil prices suffered a significantly bearish month in October as price of the benchmark Brent crude grade slumped 8% m/m after peaking in the first week of the month. A global equity rout amid a stronger dollar contributed to the oil price decline, as well as worries over global economic growth. The Chinese economy grew at its slowest pace in 9 years in Q3’18 and the International Monetary Fund cut its long-term growth forecast for the global economy, while also indicating a more bearish outlook for China and other developing economies especially amid the ongoing U.S.-China trade war. Still, supply dynamics were the primary driver of the oil price trend during the month as traders anticipated additional output from the world’s largest suppliers. U.S. field production reached a new high of 11.2 mb/d in October even as crude inventories rose for more than six straight weeks. In addition, Saudi Arabia reportedly added another 150,000 barrels a day of crude in October, pushing combined OPEC output even higher.
The only factor providing price support is the fall in oil exports in Venezuela (down to 1.2 mb/d in September, roughly half of 2015 output) and Iran because of the U.S. sanctions. Another round of sanctions kick-in early November and although the likes of Russia and Turkey would still engage in crude trading with Iran, two major Chinese refiners and Iranian customers have opted against buying Iranian crude. Global oil prices remain above expectations coming into 2018—Brent crude closed at $73/bbl at last week—but are likely to tread water ahead of the OPEC meeting in December which should give firmer indication of whether the group is interested in compensating for falling output in Venezuela and Iran.
What to look out for in November…