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Nigeria’s Economic Growth to Pick but Three Scenarios are put into consideration

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By Q2’17, the Nigerian economy exited its recession, recording a positive growth rate of 0.5% y/y. The recovery was in part due to a sharp recovery in the oil sector, driven by an improvement in oil prices and production volumes.

In addition, the non-oil sector recorded a positive growth for the second consecutive quarter, spurred by ongoing recovery in the manufacturing sector due to improved foreign exchange (FX) liquidity. Asides the improvement in real GDP, the performance across several other macro-indicators suggest that the economy is on track for a broad-based recovery.

The International Monetary Fund (IMF) has projected that the Nigerian economy will expand by 1.9 per cent in 2018, but would remain subdued due to population growth, cautioning that the country’s projected growth was still lower than its population growth rate of 2.7 per cent.

The IMF also pointed out that concerns about policy implementation and market segmentation in the foreign exchange market would be a challenge in the medium-term.

I n driving Nigeria’s economic growth, three scenarios have been examined such as the implementation of structural reforms, impact of political shocks, and economic diversification on key economic indicators in Nigeria.

In the analysis, it is assumed that oil will continue to be the main driver of fiscal and export revenues over the forecast period. As such, the extent to which the Nigerian economy moves towards its nearterm development aspirations is dependent upon the success of its import substitution policies.

Scenario 1: Implementation of structural reforms and Policies

Oil price increases from an estimated average of US$55/bbl in 2017 to US$60/bbl in 2018 and remains at this level to 2022. Between 2018 and 2019, the supply of oil moderates due to the OPEC production cut agreements while the demand for oil increases mildly in line with the global growth recovery.

On the other hand, between 2020 and 2022, the demand for oil weakens as advanced economies gradually move to greener sources of energy, and investment in oil production slows. Towards the end of the forecast period and beyond, the global oil market rebalances.

Domestic oil production rises to 2.0 mbpd in 2018, and increases further to 2.2 mbpd by 2019, remaining at this level through to 2022. This is expected to be driven by minimal production disruptions in the Niger Delta region, as the mediation efforts of the government pays off. The government is committed to the implementation of structural reforms, with policies aimed at improving the business environment.

Economic growth increases steadily from 0.7% in 2017, maintaining an average of 4.4% between 2018 and 2019, before rising to trend at 7% in 2022. There is stability in oil exports and an improvement in non-oil revenues as a result of the government’s tax reforms.

The fiscal deficit narrows and the pace of borrowing slows, providing head room for significant rate cuts. The economy records a consistent and growing current account surplus, driven by a significant reduction in imports between 2019 and 2020 as the government’s import substitution policies yield results.

However, between 2021 and 2022, imports pick up as a result of strong economic growth and increasing per capita income. Final consumption expenditure of households grows steadily, as employment growth strengthens and real incomes increase, owing to price stability.

Inflation declines from 16.5% y/y in 2017 to 6.2% y/y in 2022, due to exchange rate stability and increased food production arising from the success of government’s import substitution policies. Nominal GDP per capita rises to a peak of US$3,301.9 in 2022, which continues to spur consumer spending.

Investor confidence supports high investment

The share of investment to GDP increases from 16% in 2017 to 26% in 2022, in line with the estimates of the investment level required to drive growth to trend. Foreign investments return to pre-recession highs as lower constraints in the business environment and a more predictable operating landscape results in an improvement in Nigeria’s economic freedom score and ease of doing business ranking.

In addition, there is improved macroeconomic stability and consistency in policy making which improves investor confidence. Increased credit to the private sector provides a boost to investments, riding on lower macro risks, higher government capital expenditure implementation, and implementation of the Economic Recovery and Growth Plan (ERGP).

Scenario 2: Weak policy implementation

Oil price remains stable at an average of US$60/bbl through the forecast period and domestic oil production remains firm at 2.2 mbpd from 2018, through to 2022. The implementation of structural reforms to improve the business environment, the drive for non-oil revenues and import substitution progress at a sluggish pace.

Growth advances moderately

Economic growth increases marginally to about 2% in 2018, and further to an average of 4.4% between 2019 and 2022. Oil export earnings increase, supported by higher oil production and prices. However, initiatives to boost non-oil revenue records only marginal success. As the size of the budget continues to increase, the fiscal deficit remains large, negatively impacting capital expenditure.

With slow progress in the substitution of food imports, Nigeria’s current account surplus narrows. Final consumption expenditure of households grows at an average of 3.7% between 2017 and 2022. This is due to a modest recovery in purchasing power, owing to improving employment conditions and increased real income.

Investment slightly above recession levels

The share of investment to GDP rises from 15% in 2017 to an average of 16% between 2018 and 2022, below the 26% required for the economy to return to trend. The business environment remains challenging due to the slow pace of reforms, and the lack of a market driven exchange rate policy puts a lid on investment. As a result, capital inflows remain below pre-recession levels.

The combination of these factors, in addition to a narrowing current account surplus, results in uncertainty and volatility in the foreign exchange market. Although monetary policy is accommodative between 2020 and 2022, domestic investment provides no significant reprieve as banks are cautious in lending to the real sector.

Scenario 3: Heightened political risk environment

Oil price remains stable at an average of US$60/bbl through the forecast period.

However, there is a reduction in oil production to an average of 1.7 mbpd by 2019, before a gradual recovery to 2.2 mbpd by 2022, as security challenges in the Niger Delta region disrupt oil production activities. Political tension accelerates in the wake of the general elections in 2019, causing insecurity in the crisis prone region of the North-East, and negatively impacting policy implementation.

Fiscal sustainability comes under threat

Government revenues weaken, as oil exports fall due to lower oil production. The non-oil revenue drive of the government suffers a setback due to the deteriorating conditions in the broader economy which impacts the non-oil sector. Consequently, the government records a significant increase in its fiscal deficit, and ramps up borrowing. However, this comes at a high cost in the domestic and external debt market, due to rising risk premium as credit rating agencies downgrade Nigeria’s sovereign bonds in 2019. Sub-nationals continue to struggle to meet salary obligations, and capital expenditure remains consistently weak. The need to increase Internally Generated Revenue (IGR) continues to gain prominence, with minimal success among states.

Growth deteriorates considerably

Economic growth deteriorates considerably from 1.9% in 2018 to 0% in 2019, largely due to increased risks in the political environment. Political tensions in the Niger Delta negatively impact oil production, while security concerns in the Northern Nigeria affect food output.

However, in the aftermath of the 2019 elections, the government makes quick interventions to pacify the various interest groups. As a result, growth picks up to 2.3% in 2020, before rising steadily to 4% by 2022.

Final consumption expenditure of households’ declines by -1.3% in 2019, before recovering to an average of 4% between 2020 and 2022. This is because inflation increases to 17.8% y/y in 2019, due to supply shocks such as declining food production and a weaker exchange rate. Similarly, Nigeria’s nominal GDP per capita declines 2.8% to US$2,288.3 in 2019 (2018F: US$2,350.9).

Investment falls to recession levels

The share of investment to GDP remains flat at an average of 14% from 2019 through to 2022, due to risks in the political and economic environment. It is assumed that Nigeria’s economic freedom will weaken to 5.2 points in 2019 (2016: 5.9 points), similar to the levels recorded at the beginning of the democratic dispensation between 2000 and 2001.

As a result, capital outflows increase, and foreign direct investment weakens to about $4.4bn, around levels recorded during the 2016 recession.

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Nigeria

President Buhari’s Second Term: A chance to provide peace, prosperity, and security?

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Nigerians re-elected President Buhari for another four years in what many have termed – a chance to make amends. In what could be called his third stint at the helm of affairs in Africa’s most populous country, questions about a coherent economic strategy are already being asked. In the last dispensation, protectionist posturing was worsened by a management style perceived to be distant while crucial decisions were delayed.

The economy is set to continue its recovery from the worst recession in its history. Nonetheless, the forecast is for economic growth to remain well below historic averages in the next five years. According to economic survey by Economist Intelligent Unit (EIU), Nigeria’s Gross Domestic Product (GDP) is set to reach $473.5bn in 2019 and rise to $680.9bn by 2022. This prediction will hinge, for the most part, on the current intensity of economic reforms and current rate of investment being sustained.

 

Background of the economy leading to election 2019

The Nigerian economy grew by 1.9% in 2018, an improvement from 0.8% recorded in 2017, with the non-oil sector being the fulcrum for the growth picture. Over the last quarter of 2018, the economy recorded a solid growth of 2.4% – with the expansion in the non-oil space (2.7% YoY) taming the contraction observed in the oil sector (-1.6% YoY). Dissecting the components in the non-oil territory, all subsectors expanded, with the services and Agriculture sector leading the pack. Notably, improvement in the number of active subscribers in ICT subsector coupled with mild support from transport drove the expansion in the services sector (3.8% YoY). Furthermore, while the Agriculture sector improved by 2.5% in Q4 18, it was disappointing compared to its four-year average of 3.8%. On the flipside, the oil sector dived into recessionary waters buoyed by low crude production (-2.6% to 1.91mbpd).

 

Declining Income per Capita

It is important to note that Nigeria has a huge population of over 180million and a population growth rate of 2.6% – higher than the 2018 GDP growth of 1.9%. GDP growth is projected to reach 2.0% and 2.2% in 2019 and 2020 respectively before rising to 3.2% by 2021. This means Nigeria would have had five consecutive years of declining income per capita – from 2016 to 2020. A burgeoning youth population is also unlikely to be matched by job growth, meaning unemployment – at over 40% – is likely to rise even further.

A breakdown of the GDP components show that Nigeria’s gross fixed investment, at $66.5bn, will account for just 14.0% of GDP in 2019. This pales in comparison to that of other notable emerging economies – Brazil (19%), India (27.12%), China (42.86%), and South Africa (18.7%). Majority of countries in the world have gross fixed investment of 18-22%. The EIU goes further to forecast that gross fixed investment in Nigeria will rise by just one basis points to 14.1% ($86.2bn) by 2022.

 

Why does this matter?

The importance of this component of GDP is that it is a clear indicator of the future productive capacity of the economy. The aforementioned basically means that the current and projected rate of investment is simply suboptimal and far below the level required to propel Nigeria to an accelerated growth path. It is incapable of providing Nigeria with the investment impetus that will have the desired multiplier effect on output. Nigeria has also grossly underinvested in its infrastructure. The existing infrastructure gap is estimated at over $300bn and requires 10% of GDP ($37.6bn)/annum over the next 10 years to bridge – an unlikely feat given that  current infrastructure needs are far in excess of current cash flows. Nigeria’s capital budget in 2018 was $7.98bn – 26.6% of total budget and 2.2% of GDP. This compares to 6% of combined GDP of emerging market economies. Nigeria’s share of emerging markets total spend on infrastructure is currently less than 1%.

 

Few options, Tough Choices

Nigeria’s high population growth rate means it must be much more efficient with economic policy. Putting Nigeria on an accelerated path to a free and market driven economy requires making tough game-changing decisions now. It will begin with figuring out how to raise the level of gross fixed investment to levels above and beyond the global average of 18-22%. Investment in the next 3-5 years will depend on policies and incentives.

Galvanizing domestic and international investment will be crucial. This will require a structure that incentivizes private investment considerably more than what is currently obtainable. Achieving this will require significant increases in public investment in infrastructure, in addition to more comprehensive and deep-seated market oriented structural reforms.

 

The Game changing Formula

Raising the level of investment in infrastructure given the government’s current revenue and borrowing constraints requires rethinking ways to attract private sector funding in the form of Public Private Partnerships (PPP). Outright sale and concessions of government assets– airports, seaports, inner city highways and trunk roads– should be a key consideration for policymakers.

Airports concession has the potential to lower the average cost for aviation operators by 50%. The government’s stake in the power distribution companies should be sold to the private sector while the power sector forbearance needs to be dealt with. The rail investment program needs to be accelerated while the road networks to major seaports need to improve.  Another item that is top on the list of reforms is the foreign exchange policy where a movement to currency convertibility with minimal intervention is paramount. Fears of a wild depreciation if the Central Bank of Nigeria lets go of its current policy of a managed float, are greatly exaggerated. The almost insignificant deviation between the parallel and the Investor Exporter Foreign Exchange (IEFX) window – which is closer to market equilibrium than the official rate – supports this fact. There is also the issue of fuel subsidy which has now taken the form of under recovery as the Nigerian National Petroleum Company (NNPC) now fully bears the brunt of the subsidy as the sole importer of Premium Motor Spirit (PMS). Deregulating the downstream sector of the petroleum industry requires the removal of subsidies, which will spur competition, bring about efficiency and increased investment in domestic refining – the lack of which has been a huge drain on Nigeria’s foreign exchange earnings over the years.  Not only is a game changing formula now imperative, it has become inevitable. Nigeria can continue at its current pace of reforms and investment – a recipe for chaos, social and political disintegration; or take drastic measures to raise public and private sector investment to levels that will accelerate productivity and economic growth.

THE ROAD AHEAD

Ending extreme poverty must be a top policy priority for Nigerians and the new government. The country has the capacity to deal effectively with poverty: large endowments of natural resources, especially oil; a young and highly educated population; and many people adept at entrepreneurship and the creation of wealth.

Nevertheless, there are many threats to the creation of wealth. Two of them stand out: widespread corruption and the absence of peace and security in many regions. Corruption, like embezzlement of public funds, has plagued Nigeria since independence. Buhari came to power in 2015 promising to clean up corruption and restore professionalism in the public services. Although he appears to have made significant progress in that fight, his critics say that he only targeted his political opponents and ignored his allies and supporters. Still, many Nigerians give him credit for his efforts and for not illegally amassing wealth for himself. To deal more effectively with corruption, Buhari must now significantly improve openness and transparency in government communication, especially with respect to government procurement programs.

The Buhari government also needs to deal with extremism and other threats to peace and security like Boko Haram and the lawless armed gangs who roam parts of the country kidnapping people and holding them for ransom. This must be done not just through military action but also by providing opportunities for young people, especially in the rural areas, for self-actualization.

Finally, the government must address the issue of lack of basic infrastructure for development: passable roads, adequate and reliable power, water treatment plants (access to clean drinking water is a major problem for most communities), basic health care, affordable housing (especially in urban areas), police protection, and other services that can enhance the ability of citizens to live in peace.

Posterity will judge Buhari and his government by how well they use the opportunity granted to them by Nigerian voters to make peace, security, and prosperity possible for their fellow citizens.

On the economic front, we expect resilience in agriculture sector and a recovery in the oil sector to be the key drivers for growth in non-oil and oil sector accordingly. In the non-oil sector, muted growth in ICT and in turn services as well as weak growth in Manufacturing due to depressed consumer wallet and delay with minimum wage bill, guides to slower growth in the non-oil sector of 1.3% YoY (2018: 2.0% YoY). In the oil space, the additional 200kbpd from the Egina oil field guides the expectation of an expansion in crude production over 2019 (2.06mbpd), albeit capped by OPEC cut. That said, it is expected growth in the oil sector to print at 7.1% (2018: 1.1%). Overall, 2019 growth estimate is forecast to 1.98%, a notch away from 1.93% recorded in 2018. For Q1 19, a slowdown in growth is expected to 1.3% YoY driven by a contraction in the oil sector (-1.1% YoY) and moderation in non-oil sector growth.

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