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LAGOS (Capital Markets in Africa) – The novelty has worn off by now. Barring a minor miracle, the Nigerian economy entered a full-year recession in 2016, its first in two decades. Added to this, the simultaneous rise in unemployment (up to 13.9% according to most recent data) and inflation (18.6% in December) tilted the country into stagflation. A slump in oil export earnings on the back of major disruptions in oil production significantly contributed to this economic reversal as current account deficit reached 1.1% of GDP in the nine months through September while the naira shed over a third of its value during the year, in spite of or perhaps as a result of, a hesitant move towards a floating exchange rate system.
To understand the scale and surprise of Nigeria’s current economic woes, one must look at the recent past. Despite its mixed international reputation, Nigeria averaged over 5% annual GDP growth between 2010 and 2014 and inflation moderated significantly in the last few years. Although Nigeria finds itself in a slightly unusual economic position, there is little time to lick our wounds as 2016 already represents a missed opportunity to address both fleeting and chronic economic concerns. On the plus side, the recent rebound in global oil prices following the ratification of the OPEC output curb agreement permits a more favourable global economic environment. The result of this has already started to trickle through – external foreign exchange reserves held by the Central Bank of Nigeria (CBN) rose to $26 billion at the start of 2017. Against this backdrop, the key question is whether recent missteps can be atoned for in 2017 as Nigeria battles its way to economic recovery.
Policy in the Limelight
One thing is clear: Policy will once again play a determining role. As the economy descended into choppy waters in 2016, policy action was slow, conflicting, or ineffective. Specifically, delays in the passage and implementation of the Federal Budget blunted the impact of the largest proposed budget in Nigeria’s history and capital expenditure was the biggest loser with barely half of the pro-rated allocation released as at September 2016. Meanwhile, attempts to deter full-blown crises in both the Niger Delta region and the foreign exchange (FX) market failed to pay off. On the first issue, a potential military counterattack to stop oil production infrastructure vandalism made way for protracted negotiations between the Federal Government (FG) and primary militant groups but not before production shut-ins at key terminals including Forcados and Qua Iboe. Meanwhile, the naira was floated in June to a considerable furore. Subsequently, the CBN imposed a series of soft pegs (N305/$1 as at year-end) as it sought to ration FX in the economy. Finally, a switch to tighter monetary policy failed to halt the surge in inflation as a number of supply-side factors drove national prices to decade-highs.
However, 2017 presents another opportunity to get the policy right. The main challenges remain – fiscal policy is still uncertain, oil production levels are still relatively low, and depreciation pressure remains on the naira. The efficiency of policy response will be the defining feature of 2017. In normal times, policy retains an outsized influence on Nigeria’s economy. This year, it acquires extra importance because the private sector is under serious strain. FX scarcity continues to weigh on manufacturing and services firms while diminishing real incomes and an uncertain outlook will keep consumers and investors cautious through the year. Therefore, policy should shape Nigeria’s economic climate in 2017.
Implementation key to unlocking Budget potential
The 2017 Budget offers reasonable encouragement. Firstly, 31% of proposed budget spending is committed to capital expenditure (CAPEX) with a significant dose for transport and power infrastructure. Secondly, there is a stronger focus on expanding special economic zones (SEZ) and export zones to accelerate industrialisation and stimulate trade. This is typified by a N20 billion Export Expansion Grant (EEG) tax credit scheme. Thirdly, the provision for special intervention schemes is retained from the 2016 Budget as the FG seeks to stimulate aggregate demand and address dire poverty in the country.
Despite all this, the Budget has come under a fair dose of criticism, mainly centred about perceived unrealistic projections for spending – up to 4% in inflation-adjusted terms, and oil revenues – up to a whopping 140%. Allowing for justified criticism over these numbers, the core issue remains implementation. In 2016, ambitious fiscal plans were let down by an average implementation. Even with the fiscal year extended to May 2017 (a year from the passage of the 2016 Budget), it is unlikely that spending and revenue goals will be met.
How do we avoid a similar fate this year? The imperative starting point would be a speedy passage of the budget which is still being reviewed by Nigerian lawmakers. Following this, regular payments to contractors will be key to keeping vital projects on track whilst efficient rollout of special intervention schemes and SEZ projects would enhance the value of the fiscal multiplier. Given the recent experience, and considering Nigeria’s history, these will be a challenging task to achieve. On the revenue front, a quick resolution to the Niger Delta impasse and a return to at least 2.2 million barrels per day output are required to achieve the revenue targets, even in light of expected oil prices during the year. Meanwhile, external funding efforts – necessary to plug a projected budget deficit of N2.4 trillion – must be accelerated to avoid a recurrence of the 2016 experience where just under N200 billion was raised through an AfDB loan, with another N300 billion expected through a Eurobond sale in Q1’17.
Monetary policy at its limit?
For monetary policy, there are two issues that must be resolved. The first – and perhaps most important – is the FX market. Attempts to defend the value of the currency by rationing FX have led to severe market illiquidity. This FX scarcity has had a real impact on the economy, especially on manufacturing firms reliant on imported raw materials and capital equipment. The chosen FX management methods during the year drove the black market premium up to 60% as well as a slump in capital inflows to $1.8 billion in Q3’16, down 34% year-on-year.
Capital markets suffered as a result, with a turnover in the Nigerian Stock Exchange down 41% at the end of November 2016, driven mainly by reduced foreign participation – 51% less than in 2015. The importance of the FX market cannot be over-stressed. The monetary authorities have three broad options – hold, devalue, or float (again). Holding would mean maintaining the status quo of a relatively strong currency (officially) and lower inflationary pressures but persistent FX scarcity would almost certainly strangle the economy. Devaluing would ease some pressure on the naira without solving the underlying issues of price discovery and illiquidity in the market. A free float – the least likely option at present – would induce higher inflation in the event of a sharp depreciation but it would also gradually restore confidence – and FX inflows – into the market. None of these options is particularly appealing but that is a consequence of the effective breakdown of the official FX market.
The other relevant issue is the direction of monetary policy during the year. With the current recession, it is hoped that the hawkish trend of 2016 is reversed to spur investment and reduce borrowing costs. This view is complicated by expected double-digit inflation (not including sharp currency depreciation) which would precipitate tight monetary policy. Perhaps more significantly, the efficacy of monetary policy in tackling inflation or stimulating growth is doubtful. Current inflation is driven by rising business costs and a weaker currency and traditional monetary tools are limited in addressing these (even through the currency as the FX policy is a stronger determinant).
Meanwhile, monetary policy transmission to lending and growth remains weak in Nigeria. This is a sentiment echoed by Suleiman Barau, a member of the CBN Monetary Policy Committee who said, “In view of the oligopolistic structure of the country’s banking system, pricing of credit is more of supply than demand driven, and as a consequence, a reduction in the policy rate may not necessarily translate into reduction in lending rate.” In a way, these doubts reinforce the importance of FX policy as part of monetary policy in 2017.
Firm grip needed to steer the ship in 2017
The policy decisions to be made this year vary in nature and complexity. Though the political aspect of fiscal policy remains frustrating, the economics is straightforward. In this regard, decisive action is needed. Similarly, oil production is a vital parameter for the country so efforts to assuage the militant uprising must bear fruit. The most complex issue of all – FX policy – could be the most decisive. All these issues are likely to play off each other. For example, higher oil production could provide the dollar earnings needed to support the currency and finance government expenditure whilst FX scarcity is likely to squeeze aggregate supply and discourage private sector investment. 2016 was an extremely tough year for Nigerians but despite this, this year, they remain hopeful as and observe another roll of the policy dice.
By Michael Famoroti, Research Analyst & Economist, Vetiva Capital Management Limited, Nigeria
This article features in the February 2017 edition of INTO AFRICA Magazine, insights on Africa’s economic prospects for 2017.