Nigeria: convalescent

The sub-Saharan Africa’s largest economy is having hard time to recover. External rebalancing has showed some progress. But imports remain well below pre-crisis levels. In addition, the rebuilding of FX reserves is being accompanied by increased financial vulnerability, which puts pressure on monetary policy as the authorities give the priority to exchange rate stability. Weak public finances are an additional constraint. In the short term, and despite its strong potential, the economy is expected to grow more slowly than the population. As well as improving macroeconomic stability, the authorities will have to address the deep-seated factors that are holding back the economy as a whole.

Nigeria is a long way from staging a full recovery from the 2014 oil shock. Although economic growth has recovered somewhat, it remains well below pre-crisis levels. Above all, forecasts show no significant improvement. There are various factors holding back the economy, including a tight monetary policy, weak public finances and external accounts, and deteriorating bank balance sheets. The ability of the authorities to addressing the underlying structural problems is also questionable.

Ongoing headwinds

Nigeria’s recovery from recession in 2017 was initially driven by the rebound of oil production after some major acts of sabotage in the Niger Delta in 2016. Excluding the agriculture and hydrocarbon sectors, growth remained negative in 2017 (-0.6%) before recovering slightly in 2018 (+2%) due to firm momentum in the information and communication technologies (ICT) sector.

Powerful headwinds remain. The agricultural sector is suffering from a number of conflicts in central and northern Nigeria, and whole swathes of the economy are continuing to be affected by restrictions imposed on around 40 products. Domestic demand is also depressed.

Finally, growth in bank lending to the private sector remained negative in late April 2019, in both real (inflation-adjusted) and nominal terms (Chart 4). Banks are highly exposed to the oil sector (30% of lending to the economy) and so have seen a sharp deterioration in their loan books (Chart 5). The non-performing loan ratio rose from 3% at the end of 2014 to 15% in mid-2017, before falling back to 11% in 2018 thanks to higher oil prices. According to the IMF, the large proportion of restructured loans could even mask a more deteriorated financing situation, and capitalisation ratio remain 3 points lower than its pre-crisis levels. Besides, high-yielding Treasury bonds are crowding out lending to the economy, and this is likely to continue in the near term.

Monetary environment still tight

Nigeria’s monetary policy raises some questions. After more than two years of very tight monetary policy, the Central Bank of Nigeria (CBN) carried out a homeopathic cut in its policy rate from 14% to 13.5% in late March.

Above all, the CBN is constrained by exchange-rate policy. To cushion the external shock resulting from the decline in oil export revenues, the monetary authorities initially devalued the naira’s official exchange rate by 30%, and then in April 2017 introduced a new window allowing investors and exporters to access foreign currency at rates set by market mechanisms.

Despite the distortions that creates, Nigeria’s president and the governor of the CBN are not in favour of seeing the two rates converge, because they believe this would push up inflation.

Yet, both the current account as well as the structure of external financing remains fragile (see below). In particular, the CBN, by issuing huge amounts of securities to mop up liquidity in the last few years, has made Nigeria more vulnerable to capital flight. At the end of April, non-resident investors held the equivalent of USD 15 bn compared with a stock of FX reserves of USD 45 bn. As a result, Nigeria cannot allow yields on government bonds (including those issued by the CBN) to fall too sharply, since that could affect the stability of its exchange-rate regime. In other words, the scope for monetary easing will remain very limited.

Macroeconomic stability: still fragile

With more than 90% of exports coming from the oil sector, Nigeria has experienced a large macroeconomic shock. External accounts fell into the red in 2015, leading to external liquidity shortages and so to the decision by the authorities to implement import restrictions. Since then, undeniable progress has been made.

External position: increased financial vulnerability

The improvement in Nigeria’s external accounts came to an abrupt halt in 2018. Despite firm oil exports, the current account surplus halved to USD 5 bn due to a surge in imports of services. With Nigeria being an importer of refined petroleum products, the increase in the global oil prices also pushed up goods imports by more than USD 3 bn.

A mega-refinery is under construction, and could be operational within 2-3 years. It should be able to cover the needs of the local market. Until then, oil imports will continue to represent the equivalent of 20% of oil exports.

Moreover, Nigeria was also affected by massive capital outflows from April 2018 (USD 9 bn according to the IMF), the impact of which was partially offset by a new eurobond issue in November 2018 (USD 2.86 bn) following that of February (USD 2.5 bn). As a result, FX reserves shrank by 10% in the last nine months of the year, ending the year virtually flat after doubling October 2016 and end-2017.

The external position relies on an increasingly volatile financing profile. Of the USD 7.6 bn of capital inflows in Q1 2019, USD 7.1 bn consisted of portfolio investments, of which 80% went into short-dated debt securities. This extremely high proportion of short-term capital inflows could be explained by tensions relating to the presidential election held in late February. However, portfolio flows have accounted for half of the surge in capital inflows in the last two years (Chart 11), while foreign direct investment has remained desperately low (0.7% of GDP on average). There is little reason for this to change in the near term, since financial conditions in Nigeria are sufficiently attractive for foreign investors looking for high yields. As a result, the stock “hot money”, already high (130% of FX reserves in Q1 2019, Chart 12), should continue to rise, making the country’s external position increasingly vulnerable to a downturn in investor confidence.

Public finances: under pressure

The fiscal situation is also difficult. Very low progress in improving tax collection is a particular source of concern. Having fallen to the historically low level of 5.6% of GDP in 2016, general government revenues have recovered since thanks to the upturn in oil prices. However, they only reached 8.7% of GDP in 2018, one of the lowest ratio in sub-Saharan Africa. More worrying still, non oil-related revenues fell to the exceptionally low level of 3.7% of GDP in 2018, down 0.4 points compared with 2015.

This is having various consequences. Firstly, it makes any prospect of a rapid of a rapid consolidation of public finances a distant possibility, even if oil prices remain stable. Budget deficit, which narrowed slightly to 4.9% of GDP in 2018 after peaking at 5.3% in 2017, is set to remain above 4% this year and in 2020 (Chart 13), twice the ratio seen in 2014. Secondly, the government has very little room for manoeuvre. Unsurprisingly, Nigeria’s public spending expressed in % of GDP is also among the lowest in sub-Saharan Africa (Chart 14). In particular, public investment was estimated to be 3.3% of GDP in 2018, 1 point lower on average than others African oil-producing countries, even though they are also subject to major fiscal constraints.

This seems to be a coherent strategy but it’s not without risk as it exposes public finances to exchange rate risk. Public debt denominated in foreign currencies is low, below 6% of GDP, and refinancing risk is moderate because the first large repayments of principal on its eurobonds are not due until 2025. In addition, with a spread of 500 basis points (in line with other African issuers), financing conditions should remain more favourable than in the domestic market.

Medium-term outlook: remove structural constraints

How long will it take for Nigeria to get growth back to its pre-crisis level? The country has undeniable potential. Despite the difficulties of the last few years, Nigeria remains Africa’s largest economy with GDP of USD 435 bn.

Hydrocarbon sector

At first sight, Nigeria’s oil industry is performing fairly well. Production has risen back almost to 2 million barrels per day (bpd) after falling to 1.8 million in 2016 because of sabotage. In addition, production has just started at the huge Egina oilfield, which is expected to add some 200,000 bpd (ie 10% of Nigeria’s total production). However, Nigeria could be doing much better taking into account its huge reserves (a third of Africa’s total) and the maturity of its oil industry, where international oil companies have been operating since 1950.

The reform process is complex and has been going on for more than a decade. It includes notably tax reforms, the restructuring of the national oil company NNPC and the role of the Nigerian state as shareholder. In particular, the state is apparently seeking to reduce its interest in its oil joint ventures with foreign companies to 40% by the end of 2019, as opposed to 55-60% today. However, the current context is not helpful for this kind of initiative. Above all, president Buhari showed little interest in reorganising the oil sector during his first term of office, which does not suggest that major changes lie ahead.

Non hydrocarbon sector

Reforms are not just crucial for the future of the oil industry, but also for the rest of Nigeria’s economy if not more so.

The economy is facing huge challenges. Various business-climate surveys rank Nigeria as one of the world’s most difficult countries to do business. For example, the World Bank’s survey puts Nigeria 146th out of 190 countries. In addition, the overall ranking must be kept into perspective.

Although Nigeria’s position has risen more than 20 places in the last three years, it is only in line with the average for sub-Saharan Africa, which is well below international standards. In addition, Nigeria’s progress has resulted mainly from efforts to simplify regulatory procedures, not an improvement in infrastructure, which remains a real obstacle to the development of the private sector. Power generation is particularly lacking. Nigeria has a total capacity of 12,500 MW for a country of 190 million inhabitants, and needs virtually double that capacity. Most importantly, power generation can fall below 4,000 MW because of limited grid capacity, forcing corporates and individuals to resort to more costly alternative systems. The additional costs arising from the lack of physical (ports and roads) and health infrastructures are also significant. It is therefore not surprising that Nigeria shows entrenched low levels of investment.

The situation has even worsened in the last few years due to rising risk aversion of banks, subdued economic growth and strong pressure on public finances. In 2018, gross investment was below 14% of GDP, down from 16% in 2014 (Chart 19). By comparison, the average for other African oil-producing countries was 23% and 25% for sub-Saharan Africa. Nigeria is also finding it increasingly difficult to attract foreign direct investment (Chart 20). In 2018, it received less FDI than Ghana, despite its GDP being six times larger. FDI into Nigeria is also concentrated mainly on the hydrocarbon sector, with limited knock-on benefits for the rest of the economy.

On positive side, the re-election of president Buhari has removed a major source of uncertainty. His clear victory in the first round of the election and the firm grip of the ruling party, APC, on the National Assembly and the Senate give him the necessary leeway to go ahead with reforms included in the Economic Recovery and Growth Plan (ERPG 2017-2020). The overview of the economic situation that the plan describes is shared by main international organisations. Upgrading Nigeria’s infrastructure, particularly energy infrastructure, developing sectoral policies aimed at speeding up the diversification of the economy, and revitalising the oil industry are among the main priorities.

However, to translate good intentions into action, a greater cohesion between the various levels of the power will be necessary in order to overcome Nigeria’s long-standing challenges amid a weak international climate and a strong financial constraint.