November 25, 2021 / 06:30 PM / by Afrinvest Research / Header Image
Credit: Afrinvest Research
Global Macroeconomic Review & Outlook
Recovery Weakens amid Resurging COVID-19 Cases
The International Monetary Fund (IMF) in its January 2020 World Economic Outlook (WEO) predicted that the global economic growth would strengthen to 3.3% in 2020 from 2.9% in 2019. However, the unprecedented outbreak of the novel coronavirus, COVID-19, devastated the global economy resulting in a tragically large number of human lives lost. Consequently, countries implemented necessary quarantines and social distance measures to contain the pandemic, putting the world in a "Great Lockdown". The magnitude and speed of collapse in activity that followed was unlike anything experienced and with that, the global economy contracted 3.1% in 2020, a downgrade of 6.0ppts from 2019.
With the development and approvals of vaccines and fiscal and monetary policies to support the recovery of economic activities, 2021 kicked off to a good start. The IMF in its January 2021 WEO projected global economy would grow by 5.5% and 4.2% in 2021 and 2022 respectively. Nonetheless, global prospects remained highly uncertain given renewed waves and new variants of the virus. Furthermore, economic recoveries were diverging across countries and sectors, reflecting variation in pandemic-induced disruptions and the extent of policy support.
The IMF, in its October report downgraded global growth projection to 5.9% for 2021 (down from 6.0% projected in the July 2021 WEO) while the forecast for 2022 was maintained at 4.9%. This was driven by a downgrade to Advanced Economies (AEs) and low-income developing countries, largely due to worsening pandemic dynamics. Across regions, some economies are expected to report downgrades relative to July forecast. AEs are estimated to grow by 5.2%, down 0.4ppts. The US economy is expected to grow by 6.0%, down 1.0ppts due to large inventory drawdowns in Q2, supply disruptions and softening consumption in Q3. In Germany, the expected growth is 3.1%, down 0.5ppts on account of shortages of key inputs weighing on manufacturing output while Japan was downgraded by 0.4ppts, following the effect of the fourth State of Emergency from July to September as infections hit a record level. Nonetheless, the Euro Area is expected to grow by 5.0%, up 0.4ppts. Emerging Markets and Developing Economies (EMDEs) is estimated to grow 6.4%, reflecting a 0.1ppts markup from July forecast. The slight improvement reflects improved assessments for some commodity exporters outweighing drags from pandemic developments, coupled with slow rollout of vaccines (Latin America and the Caribbean, Middle East and Central Asia, sub-Saharan Africa).
Arguably, the outlook for the global economy shows that there is light at the end of the tunnel as it is projected to dust-off the effect of COVID-19 to grow modestly by 4.9% in 2022. This will, however, be driven by more equitable access to vaccines by countries to curtail the potential for mutation and resurgence of a new variant, significant slowdown in the infection rate of COVID-19, additional fiscal support to boost economic fundamentals, sustained accommodative monetary stance, and quicker reopening of economies.
Global Trade Recovery amid Price Pressures
Recently, the global trade front has been muddled with the ongoing COVID-19 pandemic which began in 2020. The economic and social disruptions brought by the pandemic on global trade was severe during the first half of 2020, as the volume of world merchandise trade declined 15.0% y/y in Q2:2020 following the imposed lockdowns and travel restrictions. Thereafter, lockdown measures eased as infection rates reduced, leading to a recovery in Q3 & Q4:2020. The recovery in H2:2020 was supported by major government policy interventions which boosted income levels and drove spending levels globally. Due to effective management of the pandemic, global demand was propped up preventing a larger trade decline in 2020. Accordingly, world merchandise trade dipped 5.3% y/y as stated by the World Trade Organisation (WTO).
The positive trends recorded in H2:2020 grew stronger in early 2021. According to United Nations Conference on Trade and Development (UNCTAD), the value of global trade in goods and services rose c.4.0% q/q and c.10.0% y/y in Q1:2021. More importantly, global trade in Q1:2021 was higher than pre-crisis levels, however, trade in services remained subdued. This rebound was majorly driven by strong export performance of East Asian economies, especially China. Moving forward, data from WTO revealed that demand for traded goods will be driven mostly by North America (11.4%), supported by large fiscal injections in the US which should stimulate other economies through the trade channel. Similarly, we expect Europe and South America to record import growth of 8.4% and 8.1% respectively. On the export front, we expect East Asian economies to meet much of global import demand especially Middle East and Asia whose exports are estimated at 12.4% and 8.4% respectively. Meanwhile, export in Europe and North America is estimated to increase by 8.3% and 7.7% respectively. In Africa and the Middle East, exports would grow by 8.1% and 12.4% respectively but would be dependent on travel expenditures picking up over the course of the year, which would strengthen demand for oil.
The significant shrinkage recorded in the volume of global trade in 2020 (-8.3% IMF, - 5.3% WTO) is projected to reverse with a rebound of 9.7% (IMF)/8.0% (WTO) in 2021. This is expected to be driven by rise in consumer demand particularly in economies that have recorded significant progress in vaccination, despite the possibility of sustained supply-chain disruptions and cross-border travel constraints. Nonetheless, inflation rate is expected to remain elevated globally due to rise in food prices stemming from supply shortages, increasing prices of commodities, supply-chain disruptions, and the impact of currency depreciation pressures on imports.
Accommodative Monetary Policy Still in Play
Thus far, the monetary policy direction has largely been accommodative since the COVID-19 pandemic started in 2020, providing cheap capital to support economic growth. Although the global economy is staged for a post-recession recovery following significant progress in vaccine administration, the rebound is expected to be uneven with AEs outpacing EMDEs. This reflects the former's early access to vaccinations and better room to accommodate supportive macroeconomic policies.
In AEs, the US retained all policy parameters after cutting its benchmark rate by 150bps to a range of 0-0.25% in 2020. Previously, the US Fed envisioned the possibility of a rate hike in 2023 but following the pace of economic growth and soaring inflation, there is at least one expected hike in 2022 and the possibility of tapering its asset purchases in November 2021. In a similar fashion, the European Central Bank left its policy rate unchanged at 0.0% while conducting net asset purchases under the Pandemic Emergency Purchase Programme (PEPP) with a total envelope of â‚¬1.9billion until at least the end of March 2022. Going forward, the ECB indicated that decisions on policy rates would be guided by inflation outlook. Likewise, the Bank of England (BoE) retained interest rate at 0.1%, although, its current inflation rate stands at 2.5%, higher than its target of 2.0%.
In the BRICS region, majority of countries' monetary policy stance was unchanged from levels recorded in 2020. The decision to keep policies easy and interest rates lower is against the backdrop of improving economic growth and relatively contained, albeit rising, price pressures. Accordingly, India, China and South Africa held rates at 4.0%, 3.9% and 3.5% respectively. However, in Brazil and Russia, policy rate increased by 75bps and 50bps respectively to 4.3% and 5.5% in June to tame rising inflation levels. In MINT (Mexico, Indonesia, Nigeria, and Turkey) economies, Turkey's monetary policy actions was the highlight as the monetary authority raised rate by 450bps to 19.0% in five months to tame the high inflation and bring stability to the lira. However, this led to the dismissal of the third central bank's chief in two years by President Tayyip Erdogan.
In Sub-Saharan Africa (SSA), Egypt retained all policy parameters after reducing policy rate four times by 400bps to 8.75% in response to the pandemic. Meanwhile, in Nigeria, the Central Bank of Nigeria (CBN) retained all policy parameters as well, after cutting policy rate twice and expanding liquidity available to non-bank financial institutions. This led to significant lowering of market yield of government securities in 2020. Going forward, we expect fiscal and monetary policies to be sustained, however, monetary authorities in AEs should provide clear guidelines on future scenarios for policy to prevent financial disruption to emerging markets.
Oil Prices in 2020â€¦ OPEC+ to the Rescue
No one envisaged another oil price crash in the horizon since the incidence that happened between 2014 and 2016, yet that was the case of 2020. In 2020, Brent crude oil price averaged $41.96/bbl. and global oil demand fell 8.8mb/d due to the prevalence of COVID-19 which necessitated severe economic lockdowns and restrictions in movements across regions. Nonetheless, the global oil market, battered by COVID-19, opened the new year (2021) with a price rally gathering pace. Brent crude oil rose by an average of $54.77/bbl. in January reflecting a boost in demand in cold regions of Europe & Asia, OPEC+ supply cuts that look set to keep the market in deficit, and resumption of economic activities owing to the vaccine roll-out. The continued uptrend in oil prices was further sustained when oil supply fell 2.0mb/d in February to 91.6mb/d after a cold snap shut in US production and Saudi Arabia made an extra cut of 1.0mb/d. Accordingly, Brent crude oil increased to $65.41/bbl., $73.16/bbl. and $74.03/bbl. in Q1, Q2 and Q3:2021 respectively.
In the last OPEC+ meeting in July 2021, most delegates tentatively agreed to raise output by around 400,000b/d per month from August till April 2022 to support production outages caused by the Hurricane IDA. Nevertheless, in line with forecast by the Energy Information Administration (EIA), we expect Brent crude oil prices to average above $70.00/bbl. in 2021. On the demand side, robust global economic growth, rising vaccination rates and easing social distancing measures would underpin stronger global oil demand for the remainder of the year. Thus, we expect global oil demand to increase by 5.0mb/d in 2021 and 3.6mb/d in 2022, although rising COVID cases remain a downside risk. On the supply side, we expect global oil supply to rise by 2.0mb/d in 2021 and 5.3mb/d in 2022.
Trends in the Global Banking Industry
The advent of blockchain technology led to the unlocking of highly sought-after financial solutions and assets that were not envisaged a decade ago. This has led to the swift adoption and rise to prominence of cryptocurrencies such as Bitcoin and Stable coins. While the volatile nature of crypto assets has attracted much criticism, the decentralised nature of the technology continues to be a source of red flag to financial regulators and governments. As individual investors and entities continue to exploit the decentralised network, monetary regulators have struggled to supervise its usage with most restricting access to financial services for entities dealing in cryptocurrencies. Despite this, the use cases of blockchain continue to increase, driving the rising trend of digital currencies adoption within Central Banks globally.
Unlike the popular cryptocurrencies, the Central Bank Digital Currency (CBDC) is expected to run on a centralised network which guarantees regulatory oversight and evaluation of transactions to ensure the stability of the financial system. According to data obtained from Atlantic Council, about 81 countries, representing over 90.0% of global GDP, are currently exploring CBDC option. Out of which, only five countries have fully launched their CBDCs, while the rest are either in Pilot (14), Development (16), Research (32), Inactive (10), or Other (4) phases. Arguably, central banks around the world are looking to add the CBDC to their currency gallery and the commercial banks are expected to serve as the primary distribution channels. As much as possible, the central banks hope to leverage the commercial banks' large customer base, existing digital infrastructure, and APIs to reach substantial number of customers at launch.
Meanwhile, sustainable finance has attracted prominent interest within the global banking system as developed nations continue to advance broader Environmental, Social & Governance (ESG) plans to secure the world's future. By lending to economic activities that boost sustainable development and rolling out incentive products targeted at addressing ESG opportunities and challenges, banks can take charge of the sustainable development drive. Furthermore, banks have begun to reallocate funding to sectors and companies that are driving good ESG practices. For instance, Goldman Sachs is set to mobilise US$750.0bn across investing, financing, and advisory activities by 2030 focused on sustainable finance subject matter such as climate change and inclusive growth. Regulators around the world are quite focused on the unprecedented impact that risk of climate change may have on financial markets and stability, hence, many have proposed new frameworks with a broader set of expectations.
Domestic Macroeconomic Review
Covid-19 Pandemic: Long Road to Attaining Herd Immunity
More than a year ago since Nigeria recorded her first confirmed case of COVID-19, the country has endured the economic hardship and disruption of livelihood that followed. While the world had little hope in the resilience of the dark continent, Nigeria managed to keep her head above the COVID-19 waters in the face of the first and second waves of the virus. Through this, the increased level of hardship resulted in social disorder and economic agitations which led to the destruction of critical infrastructures (worth over US$800.0m) across the country while the economy plunged into its second recession in 5 years between Q2 & Q3:2020. Although the Nigerian economy has clawed out of the recession (now with 3 successive quarters of growth), the populace remains at risk of the stinging fangs of COVID-19 especially with the discovery of the new Delta variant.
Before the commencement of vaccination, the weekly count of COVID-19 cases in Nigeria peaked at 11,659 cases as of January 18, 2021, during the second wave, surpassing the first wave peak by 152.0%. Thereafter, there was a progressive decline in the weekly count to 96 cases on June 14, 2021, the lowest level recorded in more than a year. This decline is attributed to improved awareness on the preventive measures. However, this was short-lived as compliance with non-pharmaceutical preventive measures was weak. As vaccination rate gained momentum, a new variant of the virus emerged, fueling another round of concerns with the weekly case count on the rise since August 2021.
In terms of vaccine administration, Nigeria (as at the time of compiling this report) has administered about 3.8m doses equivalent to 0.7% of the population fully vaccinated compared to Morocco's 33.3m doses (40.1% of the population) and South Africa's 15.3m doses (14.7% of the population) according to data from Africa CDC. The low level of vaccination can be traced to the inadequate resources to acquire sufficient vaccines, poor vaccine distribution, and sceptic hesitation of the populace. It is expected that the recent acquisition of vaccines from COVAX and the United States would increase national supply to over 9.7m doses, however, this would only cover about 2.3% of the population. Nevertheless, the aftermath of the economic slowdown experienced in 2020 has made it imperative to combat the resurgence of COVID-19. This has brought to the limelight several approaches that can be adopted to mitigate the effect of the virus through herd immunity. Before proceeding further letâ€™s pause to throw clarity on what we mean by "herd immunity".
According to WHO, herd immunity is the indirect protection from an infectious disease that happens when a population is immune either through vaccination or immunity developed through previous infections. The foregoing highlighted the two common methods to achieve herd immunity - through vaccination or recovery from previous infections. The latter involves allowing the infection rate to surge with the hope that a significant proportion of the population would respond positively to treatment and ultimately recover. Those that recovered are expected to have generated antibodies that can thrash the virus as such, protecting them and those around them from further infections. With this method, a country risks having an infection rate that spiralled out of control thereby overwhelming the available health infrastructure. In contrast, the vaccination method protects vaccinated individuals and those around them without the risk of an uncontrollable infection rate.
In Nigeria's context, going the vaccination route to herd immunity is preferable given the inadequate health infrastructure and shortage of trained medical professionals. To achieve this, a significant proportion of the population must have been vaccinated such that their immunity against the virus reduces its rate of infection. Although the government has continued to ramp up vaccination capacity, the nation remains on a long road to attaining herd immunity as only 0.7% of its population has been fully vaccinated at the time of writing this report.
Economic Recovery: Still Below Inherent
Potential For over six years, Nigeria's economic managers have remained puzzled on the appropriate policy mix that would deliver strong and all-inclusive growth. Since 2014, Africa's biggest economy has continued to grapple with weak growth, sandwiched with recession in 2016 (GDP: -1.6%) and 2020 (GDP: -1.9%). Although the latest recession was short-lived (lasted for only 2 quarters relative to the 2016 episode of 5 quarters), the devastating impact was broad-based. Major economic parameters - the GDP, inflation rate, unemployment rate, and foreign exchange (FX) rate witnessed sharp deteriorations, as the pandemic-induced disruption further exposed Nigeria's years of economic mismanagement and weak capacity to absorb shock. By the end of 2020, Nigeria's GDP contracted in real term by 1.9% (highest since 1993 at -2.0%), while unemployment and poverty rates rose to historic high of 33.3% and 40.1% respectively.
Notwithstanding, the timely roll-out of fiscal and monetary stimulus packages in 2020 proved to be the differentiating factor compared to the lengthy 2016 recession. By Q4:2020, Nigeria clawed out of its second recession in 5 years with real GDP growth of 0.1%. However, the stimulus size was significantly low at c.3.0% of GDP (Fiscal: 0.3%, Monetary: 2.5% CACOVID: 0.1%) compared to emerging market peers of South Africa (c.10.0% of GDP), Brazil (c.12.0% of GDP), Indonesia (c.3.8% of GDP), and Turkey (2020: 3.8%, 2021:2.2% of GDP) due to weak fiscal buffer.
In Q1:2021, real GDP growth improved mildly to 0.5% (vs 0.1% in Q4:2020), supported largely by the non-oil sector with real growth of 0.8%. However, the oil sector contracted 2.2% in Q1:2021 (vs -19.8% in Q1:2020), extending the sector's recession spell to 4 consecutive quarters. In Q2:2021, the National Bureau of Statistics (NBS) reported that the economy grew 5.0% y/y in real term, supported mainly by the nonoil sector (up 6.7%). While this on the surface appears a much stronger growth relative to the prior two quarters, the size was not compelling enough to fully offset the effect of the sharp 6.1% contraction recorded in Q2:2020. Besides, the growth momentum was short of inherent potential, estimated at 8.1% by the US Economic Intelligence Unit (EIU). Besides, a q/q analysis of the Q2:2021 real GDP number even revealed a 0.8% tapering to N16.69tn, from N16.83tn in Q1:2021.
Despite the GDP growth dynamics witnessed in H1:2021, we maintained our growth projection of 2.5% for 2021. In H2:2021, we expect mixed performance across the component segment of the non-oil GDP (Agriculture, Services, and Industries) due to the weak capacity of the fiscal and monetary authorities to stimulate the economy, and the protracted impact of structural bottlenecks. For the oil sector GDP, we expect the gradual increase in Nigeria's oil production towards the new cap of 1.83mbpd (from 1.45mbpd) by the OPEC+ to boost the sector performance in H2:2021. Nonetheless, potential downside risk to this expectation includes overweighing impact of the Delta variant on global demand, reduced demand from Nigeria's major buyers - India and China - due to shift to cleaner energy sources, and resurgence of militant activities in the Niger-Delta.
Price Level: Structural Risks Pressure Inflation Higher
The quest to rein in inflation have remained an uphill task for Nigerian policy makers in recent years. Since February 2016, when the headline inflation rate hit a double digit of 11.4% for the first time since 2012, price level has remained elevated, taking immense toll on both individual purchasing power and business capacity to flourish. This in turn have continued to impact on the economic performance, as business confidence index thread low (Dec. 2020: -15.2 index points) due to elevated inflationary risk among others.
Before the emergence of the pandemic in 2020, structural bottlenecks such as weak infrastructure, conflict in agrarian communities, weak manufacturing capacity, exchange rate volatility, and multiple taxation were the main drivers of the elevated price levels. These factors were reinforced in 2019 by FG's closure of all land borders for 16 months (Sept. 2019 - Dec. 2020), with food prices mostly impacted due to lack of domestic capacity to plug the gap. As the pandemic struck and crippled the already weak value-chain, the pressure on the general price level intensified, racing to a three year high of 18.2% in March 2021. Interestingly, the CBN has for many years, now set an inflation target of 6.0% - 9.0% as one of the benchmarks to achieving its first objective - Monetary and Price stability. Sadly, this goal has remained elusive in the last six years due to conflicting and counterproductive policy measures.
Although inflation rate eased in all the five months to August 2021 (to print at 17.0%) due to high base-year support, we believe the CBN's inflationary target will remain elusive in the near term, as structural bottlenecks remain in place. In the near term, we expect a reversal of the moderation in inflation due to the pass-through effect of the recent pressure on the exchange rate, the knock-on effect of the rising cost of energy items (gas, diesel, and electricity) and the planned complete removal of subsidy on PMS (by 2022). Consequently, we revised our 2021 average inflation rate projection from 14.1% to 15.8%.
External Sector: Worsens due to low Earning from Crude Oil
In 2020, Nigeria booked a Current Account (CA) deficit of US$17.0bn, same as in 2019. This translates to 4.2% of the 2020 nominal GDP of N154.0bn. By disaggregating the CA into component parts - Goods Trade, Services, Income, and Transfers Account - three recorded deficits, led by the Goods Trade account with a deficit of US$16.4bn (2019: US$2.2bn). The sharp jump in the Goods Trade account deficit was driven by a 44.1% y/y decline in earnings from crude oil exports to US$26.8bn (2019: US$47.9bn), while refined oil imports remained disproportionately high at US$52.3bn, despite moderating 15.7% y/y. However, the deficit on the Services Trade and Income accounts moderated to US$15.8bn and US$5.8bn respectively, relative to US$33.8bn and US$12.5bn in 2019. We linked the decline in Services Trade account deficit to the restriction on trans-border travels in most part of 2020, while the tapering of Income accounts deficit was driven by the aggressive management of FX by the CBN. On the other hand, the Current Transfers account emerged as the lone account with a surplus, albeit it recorded a 20.3% y/y moderation to US$21.0bn (2019: US$26.4bn).
In H1:2021, Nigeria's Goods Trade account deficit plunged to N5.8tn (H1:2020: N2.3tn) mainly driven by a record high N3.9tn trade deficit in Q1:2021 (Q2:2021 deficit: N1.9tn). The Q1:2021 deficit was fueled by the impact of the 23.9% devaluation of the naira on imports bills (to N379.00/US$1.00 vs Q1:2020 - N306.00/US$1.00) and weak domestic capacity to plug the demand gap. On the export leg, aggregate inflows (H1:2021) improved by 26.1% y/y to N8.0tn, aided mainly by the 75.2% recovery in crude oil export earnings to N6.0tn as global demand and prices recovered to near pre-pandemic levels. However, this was not sufficient to offset the impact of the high import bills which printed at N13.8tn over the period. Although the stabilisation of crude oil prices above US$60.00/bbl. may support improved earnings from exports in Q3 & Q4:2021, yet we see the huge importation bill (estimated at US$5.6bn/month) and weak portfolio flows to sustain the deficit gap in 2021. Hence, we project a CA deficit of US$9.1bn in 2021.
Foreign Capital Flows... Investor Apathy Deepens on FX Illiquidity
In over half a decade to 2020, foreign capital flows through Direct Investments (FDI), Portfolio Investments (FPI), and Other Investment grades (mainly loans & claims) emerged as the third-largest source of FX flows into Nigeria behind oil & gas (+US$206bn) and diaspora remittances (+US$124bn). According to the NBS, Nigeria attracted a total sum of US$98.2bn between 2014 and 2020 from foreign capital flows, with the highest inflow (US$23.9bn) in 2019. However, foreign capital flows contracted sharply by 59.2% y/y in 2020 to US$9.7bn. This was driven largely by a 68.6% y/y decline in FPI to US$5.1bn, which over the observed period, accounted for 68.0% of the total foreign capital inflows on average. The trend in 2020 was a "flight-to-safety" by foreign investors as the spill-over effect from the pandemic weakened Nigeria's macro-fundamentals including the interest and exchange rates. Besides, the inability of portfolio investors to repatriate over US$2.0bn in Q2:2020 due to FX liquidity management by the CBN played a part in the contraction, as investors developed apathy for the Nigerian market.
Foreign investors' apathy towards Nigeria continued in H1:2021. Total foreign capital flows stood at US$2.8bn, which translates to a 61.1% y/y decline compared to H1:2020 (US$7.1bn). Across the three investment flow channels - FDI, FPI, and Other Investments, we noticed synchronized moderation of 35.9%, 67.5%, and 51.1% y/y respectively to US$232.7m, US$1.5bn, and US$1.0bn. Although recent improvements in economic fundamentals and the yield environment have boosted growth outlook, yet we believe foreign investors may remain on the side-line in the near term, given the lack of clarity on exchange rate policy.
Fiscal Policy: 2021/22 Budget Review & Analysis
Revenue Jinx Resurfaced Again
The need to stimulate aggregate demand for improved recovery underlines the material increase in the 2021 expenditure plan of the FG, themed "Budget of Economic Recovery & Resilience." At first, a total sum of N13.8tn was signed into law for appropriation by the Executive, representing an increase of 36.6% over the actual budget for 2020 (N10.1tn). However, the National Assembly (NASS) in July 2021 approved a supplementary budget of N982.7bn to boost military operations and facilitate the procurement of COVID-19 vaccine. With this, the total expenditure plan for the year jumped to N14.8tn, which translates to an increase of 46.5% over the actual budget for 2020. On the revenue leg, the FG projected N8.0tn (including revenue from Government-Owned Enterprises - GOEs) to fund the N14.8tn expenditure plan. This created a deficit gap of N6.8tn (old: N5.8tn), to be plugged by domestic and external borrowings. Based on our analysis of the H1:2021 budget implementation report by the MFBNP, the actual budget performance was underwhelming. Pro-rata revenue projection of N3.3tn (excluding GOEs) suffered a shortfall of 30.4% (actual:N2.3tn), dragged by the 44.4% gap in oil & gas revenue (actual: N618.2bn) and ultimately, a 61.7% shortfall in revenues from unsustainable sources including Signatory bonus/Renewals and Grants & Donor funding (actual: N356.9bn). Notwithstanding, non-oil revenue outperformed the pro-rated amount at 104.5% (actual: N778.2bn), aided by improved performance of the CIT and VAT which returned 116.5% (N379.0bn) and 108.2% (N129.0bn) respectively. On the other hand, actual expenditure for the period (excluding GOEs) printed at N5.8tn, marginally surpassing the pro-rated amount by 0.7%. Nevertheless, the expenditure size was 51.2% higher than actual revenue - translating to an actual deficit of N3.5tn (budgeted: N2.4tn), which was plugged by debt issuance estimated at N1.3tn and CBN's Ways & Means credit of N2.4tn. For 2022, a sum N16.4tn have been proposed by the executive for passage by the NASS. This translates to a 12.6% increase over the 2021 budget of N14.6tn. Likewise, budgeted revenue is estimated to increase 24.8% to N10.1tn (2021e: N8.0tn), comprising of revenue from oil & gas: N3.5tn (34.8%), non-oil: N2.1tn (21.0%), and independent & others sources: N4.5tn (44.1%). This is anchored on key macroeconomic assumptions including average daily crude oil production of 1.88mbpd, oil price benchmark of US$57.0/bbl., exchange rate of N410.50/US$1.00, Inflation rate of 13.0%, and GDP growth of 4.2%. Based on our analysis of the macroeconomic assumptions and the major drivers of the projected revenue, we posit that the actual deficit for 2022 may top N10.0tn (budgeted: N6.2tn), due to some overly optimistic assumptions and the lack of clear fundamental to drive the realisation of the 44.1% (N4.5tn) share of the revenue from independent & other sources.
Prominent Legislation & Socio-Economic Update
Petroleum Industry Act 2021: Passed, but with Many Scars
On August 16, 2021, the long-awaited Petroleum Industry Bill (PIB) was finally signed into law by President Muhammadu Buhari (now Petroleum Industry Act - PIA), to end nearly two decades of political gymnastics on the bill. For context, the PIB is omnibus legislation, aimed at repositioning the Nigerian oil & gas industry through far-reaching reforms in four (4) key areas of Governance, Administration, Host Communities Welfare, and Fiscal Provision.
Nevertheless, we picked three major flaws in the PIA which may have far-reaching consequences on the economy, going forward. First, the PIA provided that 30.0% of NNPC's profit, in addition to 10.0% from rents on petroleum prospecting licenses and mining leases, be committed to exploration in frontier basins. While we are not opposed to capacity expansion, we believe the focus of the Act should be to attract private investors to the frontier basins, given the government's thin resources. Besides, we believe the share of profit committed to this venture is material and will result in a significant reduction in the flows to the federation account in the immediate term. Secondly, the PIA did not reveal any plans of the government to leverage existing hydrocarbon resources to build a future of cleaner energy that could generate steady cash flow. Given the rapid shift of global attention to cleaner energy sources, we think the PIA has a major vacuum that may become manifest over the next decade as major economies cut back on fossil fuels for cleaner sources. Lastly, the provision of the PIA does not restrict the President from doubling as the petroleum minister (just as we currently have). Hence, we are of the view that political interest may continue to play out in the operation of both the Upstream commission and the Midstream & Downstream authority, given that both managements report to the petroleum minister, who also doubles as the President.
NPRGS - Recipe for Lifting 100m off Poverty... Another White Elephant Project in the Making?
Since Nigeria toppled India to become the "World's Poverty Capital" in 2018 (according to Brookings Institute), forward-looking macroeconomic indicators in the country continue to point to further deterioration in the poverty level. As of 2019 when the NBS last published the Nigerian Living Standards Survey (NLSS) report, an estimated 40.1% (or over 80.0m) of the population were said to be poor, living below the National Poverty Line (NPL) of N137,430 salary per annum. We believe this number would have worsened by at least 1.5% in 2020, given the general economic downturn that accompanied the pandemic, and the attendant GDP contraction of -1.9%. Against this backdrop, the Presidential Economic Advisory Council (PEAC) set up in 2019 presented a National Poverty Reduction with Growth Strategy (NPRGS) plan to the Federal Executive Council (FEC) in March 2021, to serve as the road map for the president's poverty reduction agenda.
Practically, we believe this strategic goal and the proposed funding structure are feasible, given the success story of India and Ethiopia both of which deployed similar models recently. However, we are not convinced about the political will of the present administration to drive this lofty objective, given its slow approach to critical matters. In addition, another area of concern is Nigeria's frequent policy somersault and lack of continuity of governance. This is evident with the untimely ending of similar national strategies such as the National Poverty Eradication Programme (NAPEP) in 2001; National Economic Empowerment & Development Strategy (NEEDS) in 2004; Subsidy Re-investment Programme (SURE-P) from 2012 - 2015, and the Vision 20:2020, to highlight a few.
Monetary Policy Review & Outlook
Monetary Policy Direction in Post-2020 Lockdown... Still in Search of the Right Mix?
Since the CBN Governor, Godwin Emefiele, assumed office in 2014, the dynamics of monetary policy tools have been steadily anchored on an unorthodox policy model. Before the pandemic in 2020, the domestic monetary policy environment was utterly focused on exchange rate stability, while perspicuous rhetoric was on price stability and growth stimulation.
Meanwhile in 2021, major global central banks continued the accommodative monetary policy measures put in place to mitigate the devastating effect of the pandemic and propel their economies out of distress. Same way, the CBN sustained its stimulus measures whilst keeping MPR steady at 11.5% despite the high inflation rate. In addition, other policy parameters - the asymmetric corridor at +100/-700 basis points, CRR at 27.5%, and LR at 30.0% were retained. This policy direction was expected to sustain the gradual recovery of the economy, as policy tightening (to rein in inflation) will increase the cost of capital, and by extension weigh on the recovery drive. Amidst this dilemma, high inflation pressure shaped the CBN's position on the yield environment. Consequently, the average T-bill's rate rose from a record low of 3bps in December 2020 to 2.0% in January 2021, then rallied to 9.2% by the end of H1:2021. Similarly, the 10-year government bond yield rose from 6.2% in December 2020 to 12.6% by the end of H1:2021. Despite this, real return remained in the negative territory amidst the high inflation rate.
Meanwhile, the 60.7% y/y surge in import bills to N13.8tn recorded in H1:2021 driven by the devaluation of the Naira and weak capacity to fill the demand gap mounted pressure on the FX reserve as demand for FX increased. On the other hand, supply remains subdued because of low export earnings and dwindling reserves, following the impact of COVID-19. As the demand for imports accelerated, speculation on the Naira increased, with the CBN depleting the reserves to meet demand through the official channels. The FX reserves which opened the year at US$35.4bn declined by 5.9% to US$33.3bn by the end of H1:2021. Accordingly, the CBN removed the official spot rate of N379.00/USUS$1.00 from its website in May 2021 replacing it with the NAFEX rate of N410.50/USUS$1.00, effectively devaluing the currency.
While this move temporarily brought the exchange rate unification closer by reducing the spread between the parallel market and official rates to N91.25/US$1 in June 2021 (from N116.00/USUS$1.00), we maintained our position that this was not sufficient to calm the pressure. Accordingly, the spread has continued to widen - increasing to N94.00/US$1 by the end of July 2021, despite the recovery in crude oil prices above the US$70.00bbl threshold. This increased divergence was further worsened by the CBN's stoppage of FX supply to Bureau De Change (BDC) operators, as the spread crossed N130.00/US$1.00 on September 10, 2021, and with no sign of a near-term improvement at sight.
A Resurgence of the Exchange Rate Conundrumâ€¦ Some Historical Perspectives
No doubt, the exchange rate crisis in Nigeria pre-dates the tenure of Mr. Godwin Emefiele as the governor of the CBN. Although the CBN remains the only institution saddled with the primary responsibility of ensuring monetary and price stability, the failure of the fiscal authorities to implement complementary policies has over the years contributed to Nigeria's exchange rate problems. Prior to 1958 when the CBN was established, Nigeria operates the Shillings & Pence as a legal tender under the ruling of the British government (1880 - 1912). This was replaced by banknotes and coins issued by the West African Currency Board (WACB) between 1912 and 1959. By 1959 when the CBN issued Nigeria's first banknotes, the Naira value was pegged to the highest between the US dollar and the British pounds at a rate of N0.71 to US$1.00/Â£1.00. This exchange rate regime was supported by Nigeria's position as a net exporter of primary commodities to the rest of the world and this trend subsisted over the next two decades.
Between 1973 and 1986, Nigeria's exchange rate policy changed four times, driven by the joint impact of political and policy instability, widespread corruption, overbloated governance structure, and the neglect of labour-elastic sectors such as agriculture and manufacturing sector for "oil money". At this point, Nigeria had become a net importer from the rest of the world, notably, manufacturing and services products. By the end of 1986, the Naira had devalued by more than 100.0% to N2.02/US$1.00. This trend became worse from 1987 when Nigeria began implementing the recommendations of the Structural Adjustment Programme (SAP) of the IMF and the World Bank as preconditions for assessing fresh borrowing. Aside from the inherent currency devaluation mechanism of the SAP on the beneficial countries, the gross impunity and high-handedness that prevailed during the military administration from 1990 to 1999 further compounded the exchange rate crises, as the domestic supply of primary and secondary products hit new lows. By 1999 when Nigeria returned to a democratic system of governance, the exchange rate had fallen to N108.00/US$1.00, while external borrowings under the SAP (which ended abruptly in 1993) and other facilities added US$6.9bn to external debt stock increasing it to US$29.1bn.
Despite the external debt relief arrangement (worth US$30.0bn) in 2006, which was followed by a strong accretion of the FX reserves in the seven years to 2013 (averaging US$42.3bn), the exchange rate further moderately ebbed to N157.42/US$1.00 by the end of 2013 from N108.00/US$1.00 in 1999. This was aided by pockets of oil price shock in 2003/4 and the global financial crises cum oil price shock of 2008/9. Notwithstanding, the strategic management of both crises by the Soludo (2003-2009) and Sanusi (2009-2014) led administrations at the CBN through timely rate adjustment and the attraction of FPI's with market-friendly policies prevented the crises from escalating.
2015/17 Exchange Rate Crises... A Case of a Wrong Approach to Good Intention?
The 2015 - 2017 episode of the exchange rate crisis will go down in history as one of the worst faced by Nigeria. Although the CBN could be absolved of the root cause of the crises (like the case of previous episodes), its management approach to the crises led to a more devastating experience.
For context, Nigeria faced a severe FX illiquidity situation at the beginning of 2015 following the crash in global crude oil prices to below US$50.00/bbl. in Q4:2014 from US$114.6/bbl. as of H1:2014. The illiquidity situation worsened as offshore investors began to pull out from the Nigerian market, following CBN's reluctance to devalue the exchange rate. Resultantly, the CBN's resolved to capital control measures, blacklisting 41 import items from accessing the official FX market. With the spillover of the demand from the ban hitting the parallel market, the crisis aggravated.
As the scarcity worsened, demand for FX ramped up in the parallel market, leading to the wide margin between the official and parallel market rates of N61.30 by December 2015 (from N4.22 in June 2014). In a surprise reaction to this development, the CBN in January 2016 announced a ban on the sale of FX to BDCs over allegations of FX racketeering - a development that further worsened the FX crises until mid-2017 when the CBN set up the Investors & Exporters (I&E) window and also reached a truce with the BDC operators.
Reincarnation of the FX Crises in 2021... Same Ailment but Wrong Treatment
In our 2020 BSR, we emphasized that "the Nigerian economy may be heading for another currency crisis, just three years after it began recovery from the last episode. While the reverberating effect of the crash in global crude oil prices has been the dominant trigger of many of the recent currency crises, we highlighted that the CBNâ€™s management strategy during the last episode was inadequate. We posited that the current management of the CBN takes a cue from measures that were adopted by the prior CBN governors (timely devaluation and other proactive responses) to manage the 2003/4 and 2008/9 FX crises."
Based on the reality that played out since FX illiquidity resurfaced in 2020, the CBN has resolved to adopt most of its 2015/17 strategies. As the pandemic struck globally, sending crude oil prices to the lowest level in four decades (US$17/bbl. in April 2020), the CBN yet again was swift to implement capital control measures but was reluctant to fully devalue the Naira to reflect the forces of demand and supply. Also, the dual pressure of reduced inflows from crude oil receipt and the unsustainable support provided to the Naira (by the CBN) eroded US$2.3bn from the foreign reserves in H1:2021, thereby raising concerns over FX sustainability.
As the margin between the official and parallel market rate widened to N86.74 by the end of Q2:2020 (from N52.10 pre-pandemic), offshore investors moved to repatriate their investment to avoid imminent exchange rate loss. However, this attempt was foiled by the CBN capital control measure as an estimated sum of US$2.0bn offshore holdings and c.US$5.0bn FX swap obligation was trapped due to FX illiquidity. We believe the credibility of the CBN has taken a big hit with this development and it will take a much clearer exchange rate policy and attractive yield environment for Nigeria to attract sizeable foreign capital flow last seen in 2019 (US$23.7bn).
Ban on FX Sales to BDCs: The Case of a Sacrificial Goat?
In a similar fashion to the January 2016 episode, the CBN governor at the end of the July 2021 MPC meeting placed a ban on FX sales to BDC operators and suspended the issuance of new BDC licenses over allegations of FX racketeering. This was followed by a directive to DMBs to set up an FX teller desk in all branches to cater to approved FX transactions.
Although this development could help boost the FX and commission income of DMBs (due to increased transactions), we are less optimistic on how it would restore complete sanity in the FX market given the huge FX needs that are met outside the official delineation. Besides, the import-substitution objective of the FG cum CBN which led to the blacklisting of 41 items from accessing FX at the official window in 2016 has not yielded any significant fruit that could help reduce the demand for FX in the parallel market.
Recall that, currency crisis worsened in the aftermath of the 2016 ban of FX sales to BDCs, despite the instruction to commercial banks to fill the void. This on one hand was driven by the insufficient FX supply to banks by the CBN, and on the other hand, customers' apathy to banks' cumbersome processes. Consequently, demand for FX at the parallel market remained elevated, aided by the large market already created by the CBN's ban on FX sales to importers of the blacklisted 41 import items. By extension, these fueled a steep rise in the inflation rate (Jan'16: 9.6% to Dec'16: 18.6%) and the deterioration of offshore investors' confidence which resulted in large capital flow reversal of 67.2% y/y to US$1.8bn in 2016.
Interestingly, the CBN had in the last 20 months expanded its list of banned items to 45 items (Maize, Fertilizer, Milk, and Sugar being the new additions), while foreign capital inflow declined 61.1% y/y in H1:2021 to N2.9tn. This is reminiscent of the 2016 trend, especially as the import-substitution objective of the FG has not yielded desired results.
Banking Sector Performance In 2020 And H1:2021
Industry Stays Strong in a Pandemic-induced Environment
Amidst the tough macro and tight regulatory environment, banks remained resilient. This is evident in banks delivering a 15.6% and 6.8% y/y growth in total assets and profit respectively in H1:2021 despite elevated CRR debits and compulsory LDR levels. With the pandemic, the Nigerian Banking sector vulnerability heightened which required swift policy responses from the CBN. Consequently, the CBN rolled out stimulus packages to critical sectors with significant loan exposure, reduced interest rate on intervention facilities (from 9.0% to 5.0%) and granted banks the forbearance to restructure loan exposure. As a result, real GDP growth in the financial institutions sector grew by 13.3% y/y.
Nonetheless, the sector's earnings and profitability slowed in 2020, hurt by the stringent implementation of the CRR policy (27.5%) which effectively sits at north of 50.0% for some banks due to CBN's non-refund policy and the discretionary excess debits. In addition, the low interest rate environment in H2:2020 and H1:2021 drove weak yield on assets for the sector despite the drive to expand asset base. These factors coupled with deposits reduction in both consumer and business segments, exposure to currency risk and increased credit default, affected Nigerian bank's profitability. Consequently, aggregate gross earnings for the banks within Afrinvest's coverage (5 Tier-1 and 8 Tier-2 Banks) marginally grew by 2.8% in 2020 relative to 9.9% in 2019. Meanwhile, earnings weakened as the industry's PBT fell 2.3% from a growth of 13.2% in 2019 while PAT slightly grew by 0.4% y/y compared to 13.1% in 2019.
In terms of asset creation, the banks under our coverage grew loan books by 16.3% y/y to N24.6tn from N21.2tn in 2019, as banks aimed to achieve the CBN's LDR target (65.0%). The growth was supported by a surge in deposits of 28.4% y/y within the same period. Also, aggregate credit to private sector rose 21.7% in the first 12-months of the policy implementation to N30.2tn compared to an 11.1% increase in the preceding 12-months, according to data obtained from the CBN website. Industry nonperforming loan (NPL) ratio in 2020 improved to 4.4% from 5.3% supported by the CBN's regulatory forbearance to boost asset quality. However, Cost of Risk (CoR) weakened to 1.2% in 2020 from 0.9% as impairment charges surged 105.5% to N392.5bn from N191.0bn in 2019 given the increases in stage 3 loan classification. Industry Capital Adequacy Ratio (CAR) improved to 19.4% in 2020 relative to 18.7% in 2019 (ex. Unity Bank), reflecting the banks resilient. This was higher than the prudential regulatory thresholds of 10.0%, 15.0% and 16.0% for national banks, international banks, and Domestic Systemically Important Banks (D-SIBs).
Basel III Adoptionâ€¦ Fostering Sound Financial Stability
The implementation of Basel III started globally since January 2013 and places importance on strong liquidity and capital for financial stability. The Nigerian banking sector after successfully implementing Basel II, is set to commence the adoption of Basel III from November 2021 after a year-long delay due to the pandemic. The phased implementation requires a parallel run of Basel II and III for six months with a possible three-month extension and a transition to full implementation if banks perform satisfactorily. Overall, this adoption would strengthen banks' stressed capital level, improve capital quality (as risk levels are reduced with the exposure restriction) and maintain strong liquidity position. However, this is no good news for banks below par as capital raising to meet up could cause a dilution and affect dividend payout. Also, maintaining the revised liquidity position could hurt NIM as banks have to paydown long-term assets with higher yield.
As highlighted by the CBN, adoption of Basel III requires Nigerian banks to strengthen their current capital adequacy, liquidity, and leverage positions. Accordingly, banks are required to hold a capital conversation buffer of 1.0% in addition to the minimum CAR of 15.0% (international) and 10.0% (national) with an additional 1% of common equity capital for higher loss absorbency for DSIBs, in the form of common equity capital. Notably, additional tier 1 capital which is typically hybrid instrument was introduced in the computation of total Tier 1 capital. Also, ceiling for banks' dividend payment would be based on Common Equity Tier 1 (CET1) capital adequacy, NPL ratio, leverage ratio and composite risk rating (determined by the CBN) as against previously using NPL and CAR ratios.
For liquidity measure, banks are to maintain liquidity coverage ratio (LCR- a stock of high-quality liquid assets (HQLA) that is at least equal to total net cash outflows) of at least 100.0% on an on-going basis. Similarly, liquidity monitoring tools were introduced and includes contractual maturity mismatch, concentration of funding, available unencumbered assets, LCR by significant currency and market-related monitoring tools. To lower excessive on and off-balance sheet leverage by banks, the CBN requires that banks maintain a minimum leverage ratio of 4.0% and 5.0% for DSIBs (computed as tier 1 capital over on and off-balance sheet, derivatives, and securitiesbacked transactions exposures).
From our analysis using 2020 figures, all banks in the tier 1 and 2 categories operating as a national, international and DSIB passed the stress test conducted to determine compliance with new CAR threshold. However, we note that FBNH and FCMB failed this test at current levels (H1:2021- FBNH:15.7%; FCMB:15.9%) thus it is important for the bank to shore-up capital level either through retained earnings or additional tier1 capital issuance as the current environment is not very supportive of common equity raise.
Tier-based Criteriaâ€¦ Upscaled to Reflect Changes in Economic & Business Landscape
In our 2013 BSR, we initiated the concept of "tier-based classification" for banks within our coverage universe. This stratified our coverage banks into two buckets - tier-1 and tier-2, based on performance of selected industry parameters that are scientifically testable in establishing an all-around efficacy. Key parameters considered were the size of total assets, capital adequacy, asset quality (with a focus on NPL), and liquidity. The benchmark adopted for each parameter are - minimum total assets of N1.0tn, a minimum CAR of 15.0% (CBN's benchmark), NPL cap of 5.0% (CBN's benchmark), and LR of 30.0% (CBN's benchmark). Lenders who meet up with all the benchmark conditions for all the parameters are classified as tier-1 banks, while the rest, are classified as tier-2 banks. Based on our evaluation using these criteria, only six of our coverage banks - Access, Guaranty (now GTCo), UBA, FBNH, Zenith, and ETI, met all the criteria for the tier-1 bucket.
Given the significant changes in the macroeconomics environment (especially, with inflation and exchange rates) and the banking industry landscape over the last eight years, we have revised the qualification threshold and also introduced new parameters. Consequently, we raised the minimum threshold for total assets to N5.0tn (to capture the c.108.6% Naira devaluation since 2013) and CAR to 16.0% in line with the D-SIBs benchmark.
Due to the lack of sufficient details on CBN's forbearance provision to some industry players (since 2015), we substitute the asset quality parameter in our previous criteria with management efficiency - defined as 3-years average ROAE greater (tier-1) or less (tier-2) than 3-years average core inflation rate (2018 - 2020) of 10.0%. Owing to CBN's strong enforcement of the 30.0% LR and insufficient data on excess CRR, we have excluded liquidity from the selection criteria. The newly introduced parameters are share of business assets domesticated in Nigeria, CAR consistency, and Deposit size. To qualify for the tier-1 bucket, the share of business assets in Nigeria must be equal to or greater than 50.0%, 3-years average CAR must be equal to or greater than 16.0% while, the last full year deposit base must be equal or greater than N2.5tn. Based on this revised criterion, only five lenders - ACCESS, FBN, GTCo, UBA, and ZENITH met all the criteria for the tier-1 bucket as at end of FY2020.
Market and Banking Stocks Performance
In 2020, performance at the domestic equities market was a tale of two halves - a gloomy first half and a booming half. Although 2020 kicked-off on a positive note as investors switched interest to stocks due to unappealing fixed income yield, this mood was dampened by the outbreak of COVID-19. Nevertheless, reopening of economic activities, fiscal and monetary stimulus and better-than-expected corporate earnings drove positive sentiments, leading to a 50.0% gain in the benchmark index.
Reflecting the overall market mood, the banking index returned 10.1% in 2020. The performance was driven by investors' interest following impressive earnings and high dividend yield. FCMB (+80.0%), ZENITH (+33.3%), and FIDELITY (+22.9%) were the best performing stocks in the sector while ACCESS (-15.5%), UBN (10.8%), ETI (- 7.7%), and WEMABANK (-6.8%) lagged.
Comparison of Nigerian Banks with BRICS and SSA Banks
Using CAMEL (Capital adequacy, Asset quality, Operational Efficiency, Profitability and Market Valuation) analysis, we modeled tier-1 Nigerian banks compared to their SSA and BRICS peers. From the analysis, the following can be inferred:
Capital Adequacy: CAR of selected SSA (19.2%) and BRICS (17.2%) banks recorded was above the 8.0% global regulatory minimum under the BASEL III, reflecting effective risk management during the pandemic. However, African peers such as Egypt (21.7%), Ghana (20.2%) and South Africa (19.8%) were better capitalized than the Nigerian banks (19.7%). In the BRICS region, the Nigerian banks fared better than its peers save South Africa.
Asset Quality: The negative impact from COVID-19 on risk assets weighed on SSA and BRICS banks leading to a substantial rise in impairment charges. The average CoR of selected SSA and BRICS bank stood at 2.6% and 2.4% respectively. Kenya banks (3.6%) reported the highest average CoR among the banks in the SSA region, trailed by South Africa (3.5%). Equally, across the BRICS region, the Brazilian banks (3.9%) remained the worst performer reflecting the higher business risk environment. The Nigerian tier-1 banks (1.8%) performed relative better than its peers save Egypt (1.7%), Morocco (1.7%), Russia (1.4%) and China (1.0%).
Operational Efficiency: Across the SSA and BRICS region, the average cost to income (CIR) for most banks is quite high. In the SSA region, the Nigerian banks (58.0%) were the worst performers given the rise in operating expenses and moderation in operation income. Nevertheless, Egypt (35.8%) maintained the top spot, trailed by Ghana (51.5%) and Kenya (52.7%). Across the BRICS region, Chinese banks remained the most efficient with an average CIR of 34.8% while Brazilian banks (77.3%) came in at the bottom.
Profitability: Surprisingly, across both SSA and BRICS regions, Ghanaian banks reported the best ROE and ROA of 23.1% and 3.5% respectively due to better-thanexpected operational efficiency within the period. Despite the heightened macroeconomic vulnerabilities to operate business, Nigerian banks emerged the best among its BRICS peers with an average ROA and ROE of 15.9% and 1.8% respectively.
Market Valuation: The Price-to-Earnings (P/E) and Price-to-book value (P/BV) ratios for the selected Nigerian banks settled at 5.4x and 0.5x respectively relative to SSA (18.6x and 1.5x) and BRICS (11.7x and 1.6x) averages. This implied that Nigerian banks are still relatively undervalued, even as the Nigerian Exchange Limited recorded a strong performance in 2020.
FY:2021 Crystal Ball
Broadly speaking, is safe to conclude that the Nigerian banking sector remained resilient in the face of COVID-19 and several regulatory headwinds. Nevertheless, banks' earnings and asset quality have taken a beating while being under pressure from competition. Also, the pandemic has provided learning points for players in the sector to reshape and reimagine their product/services offerings for longterm growth and sustainability. As the broader economy recovers, regulators are expected to relax the support given to the financial system which might affect some segments of the bank's business. The banking sector faces a continuous period of uncertainty, and the resilience of the sector would depend on players' response to new developments. To this end, we highlight key outlook for FY:2021.
1. Earnings Performance to Remain Fragile: Despite the rising Naira interest rate trend so far in 2021 (against 2020 when it crashed), we do not expect a significant improvement in banks' operating terrain. While the banks have shown historically that they can defend NIMs through different interest rate cycles, we expect the CBN's continued cash sterilisation via CRR debits and punitive measures for 65% LDR non-compliance to tame the prospect for strong growth in the short term.
2. Loan Book Growth Amid Expectation of Asset Quality Deterioration: We expect a 15.0% growth in industry loans and advances as the economic recovery strengthens and banks can drive growth in deposits. Compliance with the CBN's LDR directive will not be a big driver for loan growth in our view as banks place a higher premium on quality risk asset creation over the punitive measure for non-compliance. With the improvement in macroeconomic conditions, we expect a lesser deterioration in asset quality based on the ECL model. We note that the CBN has extended its regulatory forbearance for loan restructuring. However, the viability of most of the restructured loans is still questionable.
3. Increased Digitalization: With the pandemic, the adoption of digital banking channels recorded a significant increase. Even with the relaxed restriction, this trend has continued as observed from our 2021 banking survey. We expect this growth to be sustained in 2021 and beyond as increased internet and mobile penetration would result in higher transaction volumes resulting in higher income from digital channel. This would also drive operational efficiency and lower the cost of operating a branch system. However, to capture the full benefits of digitization, banks have to make continued investments in infrastructure resulting in higher costs of maintenance which we expect would mute the savings from operational expenses. Also, tussle with Fintech players in terms of innovation and volume hinder banks' earnings potential through this medium.
4. BASEL III Implementation to Elevate Capital and Liquidity Levels: The implementation of the BASEL III guidelines in November 2021 is expected to have implications for banks in terms of a tradeoff between having solid capital base and dividend payouts, high liquidity and strong margins and loan growth. It is our view that the guideline would help in controlling liquidity, make banks stronger and more resilient during period of stress given that it addresses issues on minimum liquidity coverage ratio (LCR), capital adequacy and system risk. For banks to comply with the LCR criteria, bank would have to hold higher liquid assets while decreasing proportion of long-term debts. This will hinder banks' ability to create higher margins over the long-term. The implementation of Basel III requires a stronger and higher Tier-1 capital to absorb unanticipated shocks. To this end, we expect banks with weaker Teir-1 capital levels to increase retained earnings as current environment is not very supportive of equity raise combined with the already elevated issued share capital of most banks.
5. Need for Regulatory Collaboration: We have noticed the increasing diversification of banks into new and adjacent financial services segments by leveraging on HoldCo structure. On the back of this, we recommend a more inclusive collaboration on the part of key regulators in the banking, insurance, pension, capital market and government sectors. This is necessary to mitigate regulatory restrictions and enable exposure to a wider spectrum of financial services to further deepen the financial system and improve financial inclusion.