Nigeria Outlook H2-2017: After The Rain


Monday, July 24, 2017 11:50AM / United Capital

Executive Summary

Global Economy: Positive outlook buoyed by strong EM growth

As economic activities gain momentum and commodity prices recover from their troughs in 2016, consensus estimates see scope for an improvement in global economic growth in 2017 [World Bank (2.7%, +125bps y/y) and IMF (3.5%, +129bps y/y)]. Global trade volumes are expected to rise 4.0% in 2017 and 3.8% in 2018 vs. an estimated 2.5% in 2016*. Even as these rates remain below "historical norms", optimism for the global economy resonated across global equity markets during the first half of the year. (MSCI World Index: +10.1%, MSCI Emerging Market Index: 18.2%, MSCI Frontier Market Index: 12.4%).

Broadly, the picture remains bright for Emerging Markets (EMs). Riding on the waves of low US interest rate, a weak dollar, strong global growth and upbeat commodity prices, the region's economic environment is improving. However, compared to the EMs, the picture for advanced economies is constrained by feeble productivity growth and heightened political uncertainty. Emerging and Developing Economies (EMDEs) will continue to account for most of the global growth momentum. According to the World Bank, GDP growth in EMDEs is expected to increase to 4.1% in 2017 and 4.5% in 2018 from 3.5% in 2016, on account of a pickup in economic activity from higher commodity prices and improved global demand. However, EMDEs remain vulnerable to commodity prices and tighter global financing conditions.

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Nigeria: Set for a rebound as macro narratives change

In our Nigeria 2017 outlook - Green Shoots Amid Thorns - we highlighted that the badly needed economic reforms required to reset the Nigerian economy towards a path of sustainable growth hang on policy inertia. We also noted that key among the factors that defined investors' perception of Nigeria as an investment destination in 2016 was the lack of follow-through on market-friendly reforms, a development that dented business confidence. In 2016, uprising in the Niger-Delta region dragged domestic crude oil production to record low amid a lower oil price environment. Government revenue fell sharply, liquidity crisis in the FX market worsened, headline inflation rate galloped to 18.5% and GDP fell -1.5%, plunging the economy into a recession for the first time in a quarter of a century.

But now, the tides are turning for the Nigerian economy. In contrast to lack of decisiveness in policy actions and absence of pro-market reforms observed in the first 18 months of the Buhari-led government, a long list of market-friendly policy decisions has come through. The situation in the Niger-Delta region has improved significantly as domestic crude production gradually recovers to the psychological 2.0mb/d level. After a series of policy summersaults, the CBN appears to have found a way around the FX market crisis. The economy is poised for a comeback. Investor confidence is strengthening and Nigeria seems to be open for business again. That said, the socio-political landscape remains volatile.

Naira Assets: As good as it gets?

In view of the foregoing, we highlight that despite rising optimism, the performance of Naira assets over H2-17 still hinges on a mix of factors. For equities, the sustenance of recent positive momentum means that the improvement in the policy environment must outpace that of Q2-17. To this effect, macroeconomic variables may have to outperform estimates resulting in corporate earnings surprises while shocks in the system stay rather soft. This is our most optimistic view of the market in H2-17 with the potential to push the All Share Index above 38,000 points, the closest to the pre-crisis index level in 2014. If these assumptions hold true, our bull case scenario sees a 41.4% y/y return by FY-17.

Our less optimistic view factors in the fact that valuation may cap further uptrend notwithstanding sustained stability in the policy and macroeconomic environment. Here, we maintain that GDP will rebound but remain sub-optimal and moderation in inflation rate may be weighed by higher food prices even as unsteady oil prices keep investors on the lookout. This, in our view, is the most likely outcome. Thus, our base case market return scenario sees the All Share Index returning a total 29.5% for the year if government policies remain stable and consistent, and if macroeconomic variables further strengthen with Q2-17 & Q3-17 GDP numbers confirming the economy to be out of the trough.

The yield environment stayed relatively flat in the first half of the year, and we expect much of the same over H2. We note that the aggressive pace of OMO issuances by the CBN sustained an attractive yield environment which spurred market appetite, with average subscription rate 2.0 times amount offered.

The body language of the MPC in its last policy meeting shows that the Committee is not looking back on its hawkish stance, at least in the interim, thus we expect the money market rates to remain elevated (in double-digit levels) for the rest of the year.  We do not foresee any swift policy shift in the monetary policy space in the short to medium term given that conditions in the global and domestic market environment which informed a hawkish stance in the first place remain fragile and unstable. Even though key variables in the domestic market are showing signs of improvement, commodity prices in the global market remain unsteady. Also, the propensities for increased trade protectionism in the global economy is getting stronger across regions while policy normalization in the US continues to strengthen the US dollar. These factors will force the MPC to maintain status quo in the interim.


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