December 18, 2020 / 5:03 PM / By Cordros Research / Header Image Credit: Cordros Research
The ravaging impact of the twin shocks (the pandemic and downturn in oil prices) may have dissipated following the re-opening of economies. Still, the clog in the wheels of economic activities will linger in 2021. Although we expect the economy to recover from the deep contraction in 2020, we believe policymakers will be faced with the more difficult task of lifting output growth above population growth. Consequently, the recovery will remain mostly insufficient in boosting per capita income, stimulating employment opportunities, and addressing the growing disparity in income levels.
We are cautiously optimistic that the land borders, which were re-opened on 15th December, will ease pressures in food basket given weak domestic capacity. Nonetheless, we expect the gradual increase in electricity tariffs and higher distribution costs linked to higher PMS prices (especially if oil prices gain momentum) to offset the gains.
Despite the FX management strategies put in place by the CBN to reduce FX demand for importation, we expect the current account to be pressured by a faster increase in imports compared to exports. The pressure will be amplified by a wider deficit in the services account, based on our expectations on improvement in the scale of international airline operations and medical-related tourism. Taking into consideration the fragility of macroeconomic conditions coupled with the lingering liquidity constraints in the I & E window, we expect FPI inflows to remain tepid. This view, alongside our expectation of a marginal increase in export earnings, implies accretion to the FX reserves will be limited, thus, hindering the ability of the CBN to defend the local currency.
On monetary policy, we believe the MPC will be at a crossroads. They will be faced with the difficult choice of keeping interest rates low to support economic recovery while easing government financing pressures or tightening to attract FPIs to mitigate currency pressures and restore stability in the external sector. We expect the MPR to remain unchanged in Q1-21 but envisage tightening from Q2 onwards, due to our expectations on inflation and the need to stem currency pressures.
On fiscal policy, we expect budget performance to be characterised by the recurring themes of underperformance in revenue targets, sub-optimal CAPEX spending relative to recurrent expenditure, and weak revenue from State-Owned Enterprises (SOEs). Ultimately, we believe the government will be faced with the difficult task of balancing borrowings to support economic recovery and avoiding a further buildup of debt that will further weaken debt sustainability metrics.