- Commodity market turbulence to take its toll on Africa’s economic giant
The bible says in Genesis 41:29-30 that, seven fat years in Egypt will be followed by seven lean years in the time of Joseph. It was to warn the profligate children of Egypt to reduce their ostenta-tious and extravagant ways. They were advised to save some wheat or grain in preparation for the tough times ahead.
Even in biblical times, the cyclicality of economics was acknowl-edged. Therefore, it is surprising that various Nigerian admin-istrations in the last 20 years failed to heed this basic principle of putting something aside for the rainy day.
I am saying this today to illustrate the Macro-economic Cul-de-sac which Africans largest economy and country by population is fac-ing. The country is confronted by its steepest decline in oil reve-nue by 57.25% to $4.12bn, leaving a significant shortfall to fund the budget for 2016. The funding gap which translates into an amount of N2.2trn is 1.93% of GDP.
The countercyclical budget is meant to stimulate the economy into the path of recovery. There is also the more profound issue of the external sector im-balance resulting from the acute shortage of foreign currency par-ticularly US dollars from oil.
This external shortfall in dollars resulting more from the sharp fall in the yield (spread) for a barrel of oil which has fallen by 91.57% from $95pb to $8pb. This is more than the 65% fall in the nomi-nal price of oil in the market. In the good old days, the quarterly dollar inflow was in excess of $18bn per year. This is now down to a paltry $8.48bn. The effect of this picture is that the Nigerian economy is now tottering on the edge of an extended period of slow GDP growth.
This is happening at a time of a crisis of false expectations. The people had been conned into believing that the economy was in good shape by an outgoing administration that tried to paint an optimistic picture to a miserable electorate.
This paper is to situ-ate the current Nigerian situation in the context of the global com-modity crisis and seek to project the likely outcome in 2016, in what can be best described as a year of economic turbulence.
In layman’s language, we can say that most Nigerians should fas-ten their seat belts in anticipation of the rough tide ahead. The first question that needs to be addressed is what is the current commodity crisis and is it different from previous ones?
The present commodity crisis has its origin in the unexpected slow down in China. The Chinese economy had been growing in double digits for a decade.
Therefore a decline to 7% in the last 2 years had major repercussions to global commodity producers. The $10.36tn economy, which is the second largest in the world, had to cut back on its demand for many primary and secondary prod-ucts. This also coincided with flat-lining in the Eurozone, which is also the 3rd largest market in the world.
The EIU expects the four year slide in agricultural commodity pric-es to come to a halt in 2016 – 2017. The EIU FFB index fell by 18.2% in 2015, extending average annual declines of 5.4% in 2012 -2014, but it will recover some ground in the coming two years, rising by 3.4% in 2016 and 4.9% in 2017. Tightening mar-kets will be the prime drivers of this increase. Global demand for food and beverages will continue to grow steadily, underpinned by demographic and income trends.
This is the global picture of agricultural commodities. On the oth-er hand, we see the outlook for the oil market has deteriorated sharper than we originally anticipated. However, the consensus is that in spite of geographical tension and the distortions created by the Saudi attitude towards forcing oil prices down, that we should see some recovery in oil prices during the year.
The EIU says al-so that ―although the oil supply – demand balance will tighten, putting upward pressure on prices, we do not expect crude oil price to come back to pre–2014 level in 2016/2017‖. Despite a dip in U. S. production, global crude supply will expand further in 2016 on the back of continued output growth from OPEC and to a lesser extent Russia.
Therefore, the revenue and foreign exchange earnings picture for Nigeria in 2016 will remain bleak to challenging. For example, the price of oil has been below 50pb for over 15 weeks. This has blown a huge hole in the budget of the FGN but more for the states.
The Nigeria budget of 2016 is based on a benchmark price of $38pb which is very conservative in real terms, but will be test-ed in a market that is now trading at $33pb. What does this mean to the two main economic constituencies?
The FGN has accepted that the party is over. In other words, a reality check. Luckily, the Nigerian electorate endorsed the APC government be-cause of its lack of trust and confidence for the PDP. The APC have not shown a proper understanding of economics and are still trying to figure out what the problem is.
It has run out of time, because the honeymoon is over. Now the government has to re-ignite the economy to life and simultaneously convert economic wealth into economic well-being for the people.
Therefore, the key decisions that will put the economy into a path of general dynamic equilibrium requires for the reduction or possi-ble elimination of subsidies. This will reduce distortions, increase government revenue whilst empowering the government to fund the social safety net for the poor and underprivileged.
The Federal government is embarking on an ambitious fiscal programme increasing its spending by 25% at a time when revenues are sharply lower. It is to make three critical decisions
The removal of subsidies, which will reduce expenditure by N1trn or 25% of the previous budget. It will automatically increase available revenue for sharing by the same amount for the states of the federation. This singular and important decision will not on- ly change the economic destiny of Nigeria but also reduce its im-port bill by over 20% and allow the Naira some breathing space.
What is happening is that Government has refused to accept that market economics works in African countries. That economic re-form is not incompatible with patriotism. The fundamental mis-conception that a strong currency is synonymous with a strong economy is defining the national economic narrative.
Therefore, we see a Central Bank that is attempting to defend a currency at a value which is unsustainable. It therefore appears to send panic and frantic signals into a market that is extremely nervous.
The CBN means well but is confusing economic agents with mixed signals. Therefore the key issues facing the government are the fact that adjustment of the Naira is now imminent, inevitable and imperative. This adjustment will have huge consequences for government finances, investment flows, export values and trade patterns. There will be short term pain, but medium term gain.
Therefore what do we expect? The currency will be allowed to glide into a path of quasi-equilibrium. An initial band of 185-220, will open the floodgates of demand, but will also encourage some investment inflows. Foreign Direct Investment in 2011 was as high as $8.1bn and fell to $1.4bn in 2014. However, FDI had crashed to near zero in the last few months.
Nigeria‘s gross external reserves are now below $29bn and can barely cover 4 months of imports and payment. Therefore any resistance to a currency adjustment and the adoption of a policy framework that allows for appreciation of the Naira when the fundamentals improve and slide when conditions deteriorate will be fool hardy.
Therefore, the Nigerian public has run out of patience and now wants forex availability at a market price instead of rationing that is open to abuse. The Beauty is that the people, the markets and the CBN have the same objective i.e. to ensure macro-economic stability.
Therefore in 2016, we expect an adjustment of approx 10-15% of the Naira even after oil prices recover. We believe that the import bill will fall by approximately 20 -25% because of the fictitious import of refined products.
Investors & Manufacturers
These are the foot soldiers of the economy, especially the small and medium scale industries. They want to see government ex-penditure increase and translate into consumer spending and ac-tivity. They had enjoyed a subsidized exchange rate, rent seeking pricing in government contracts etc.
This group will need to come to terms with a more efficient government, fiscal system, devoid of ghost workers and leakages and where productivity will be the key determinant of reward.
However, the FGN will need to put many things in place for this to happen, not to say the least being the hiring of capable hands and firms to help recalibrate the way government works.
The efficiency unit of the Finance Ministry is already kicking in the correct direction. The availability of forex and the relaxation of controls are critical to empowering these investors and manufac-turers. The lowering of interest rates has not translated into more loans.
This is because loans are a function of risk and liquidity, not of lower interest rates alone. The markets now have come to accept the inevitability of a change in policy. The government is now in the best position to capitalize on the mood of investors and the people to accept the new economic order.
The beneficiaries of economic injustice in the guise of local con-tent and economic added value , will need to be competitive. This is because the FGN is going to provide a level playing field to en-courage new investments. The advantage of investment over debt is that it brings with it cash, technology, employment which are critical to the Buhari agenda.
Therefore, the markets are will-ing and ready for new investments in the magnitude of $5 – 10bn in the next eighteen months. The markets are also expecting that Nigeria will raise $4.5bn of external debt from multiple sources including the Eurobond markets, multilaterals and the Paris Club. The conditions precedent to the borrowing will help instill fiscal discipline and strengthen the hands of Buhari’s strict agenda.
One sector that will be in treacherous waters is the banking sys-tem. This industry in 2016 will be under margin compression pressure. The final removal of COT and the Single Treasury Ac-count will wipe out at least 20% of revenues. This combined with the slash in forex availability means that trade finance activity will nose dive.
Therefore, it is imminent that banks might have to slash their workforce and compensation. This will become even more pressing because of the loan quality problems now plaguing the industry. Attempts to recapitalize will be difficult and futile because of the slump in share prices of banks.
Therefore, this will be a tough year for banks. Yet, we believe that there will be a rejuvenation of the cashless policy which will lead to new efficien-cies in the payment and settlement space.
The outlook therefore is for new investments, more currency and trade flows but at a Naira exchange rate that is adjusted for the sharp fall in oil prices. I will like to end this piece with an objec-tive assessment of the economic outlook.
The good news is that huge resources both from private and pub-lic sources will go into productivity sensitive infrastructure pro-jects especially road, transport, rail and marine, power and hous-ing sectors. This will be at the expense of the consumer goods sector. We will see gross capital formation spike to 15.7% of GDP or $77bn. This will be followed by a gross multiplier effect on GDP leading to a growth recovery to 4 – 5% in 2017
The tough news
The state governments will remain technically insolvent through-out 2016. Some states like Lagos, Rivers, Akwa Ibom will coast along, others might need to fire staff and rationalize their expec-tations and expenditure.
The CBN will develop a more pragmatic exchange rate policy that allows it the flexibility to strengthen the Naira when things get better and adjust when necessary. The removal of subsidies will make the work of the CBN much easier than at present. External Reserve management will be a major thorn in the flesh of the CBN.
It will need to decide, how much of this asset it will use to support the Naira with infrequent interventions. The delicate bal-ance between reducing interest rates to accommodate the fiscal growth objectives of the finance ministry and attracting interna-tional investment flows when the U.S. has increased interest rates is a major challenge.
In summary, therefore we look forward to a year of economic re-covery from a low of 2.34% in 2015 to a high of 3.5 – 4% in 2016. This will be taking place in an improved macro-economic environment that will reduce uncertainty from high to medium and risk level from high to moderate.