Nigeria: Weakening Economic Outlook Driven by Low Oil Prices

Introduction
The recent sharp drop in oil prices is taking a heavy toll on Nigeria, the sixth largest net exporter of oil in the world. In 2015, economic activity is projected to slow and the fiscal and current accounts are expected to deteriorate. Although Nigeria has some room to live with higher fiscal and current account deficits in the short term, the economy has limited fiscal and external buffers (low levels of the Excess Crude account savings and FX reserves).

Within the business environment, despite huge opportunities (both in the extractive and non-extractive industries), Nigeria’s competitiveness is undermined by increased insecurity in the North, poor quality infrastructure, and weak institutional capacity. In this context, pressing ahead with the reform agenda is more urgent than ever in order to reduce vulnerabilities, support growth prospects and address remaining development challenges.

Adverse impact of low oil prices on the economy
Economic activity in 2015 is expected to slow by around 1 percentage point to around 5.2% due to the indirect effect of low oil prices and despite the positive effects of power sector reforms and higher agriculture production. Low oil prices will undermine oil sector investment and therefore growth, and will sharply reduce fiscal revenues and limit fiscal spending. In addition, oil sector growth will slow due to years of underinvestment partly caused by years of legislative paralysis related to the Petroleum Industry Bill. However, the impact of the oil price shock on non-oil GDP will be relatively small due to limited direct channels from the oil sector. Overall, the non-oil growth is likely to remain robust at around 6%, driven largely by strong demand for services and higher agriculture production.

Inflation is likely to increase to around 11% in 2015, due to high election-related spending (now delayed to the end of March), strong domestic demand and protracted NGN depreciation. Indeed, the depreciation of the exchange rate will drive up prices of imported items (excluding refined petroleum products), on which the country is highly dependent. However, inflationary pressures will be tempered by lower food prices due to increased local production of staple food crops, lower pump prices and reduced imported inflation from refined petroleum products.

The NGN has come under increasing pressure since early 2014, due to (i) the fall in oil prices, which has reduced export revenues and FX reserves build-up (from mid-2014 onwards); (ii) insufficient USD supply at the Retail Dutch Auction System (RDAS); and (iii) strong import demand. In addition, rising concerns over the government’s ability to deal with falling oil revenues has weakened market confidence. In order to stabilise the naira, the authorities intervened in the interbank FX market earlier this year. However, due to limited success in stabilising the naira, on 28 February 2015, the Central Bank of Nigeria (CBN) decided to suspend the RDAS and announced that all FX demand would now be met via the interbank market, unifying the RDAS rate with the interbank foreign exchange market rate. This latest move will significantly add downward pressure on the NGN in the short term, given string USD demand. Nonetheless, the CBN has advised that it will continue to intervene in the interbank FX market, selling USD when it considers it necessary. Therefore, expectations that the NGN could weaken sharply appear overblown.

The fiscal deficit is likely to widen to 3% of GDP in 2015 due to lower oil revenues (which account for around 75% of total revenues) and high election-related spending (assuming no major fall in oil production). For 2015, the fiscal authorities have tabled a tighter budget, revising the 2015−17 Medium Term Expenditure Framework (MTEF) to better reflect the low oil price environment. In late February 2015, the Senate approved a benchmark oil price of USD52/barrel, compared to USD65 in the first draft of the budget. The lower house of the National Assembly is expected to soon ratify the draft budget based on its slightly higher oil price assumption of USD54/b. In order to preserve fiscal consolidation, the authorities are already cutting spending on government travel and equipment, raising taxes on luxury goods, and considering cutting/removing the remaining fuel subsidy. Capital expenditure will also be cut to prevent the deficit widening beyond 3% of GDP.

The current account is expected to move into a deficit of around 2% of GDP in 2015 (from a surplus of 2.4% in 2014) due to strong import demand for capital, equipment for infrastructure development and consumer goods, along with lower export earnings in a context of low oil prices. The deterioration of the current account will result in a lower rate of foreign exchange (FX) reserves accumulation. At the end of February 2015, FX reserves stood at USD31.4bn down around USD10bn compared to one year ago. T

The outlook is largely subject to downside risks. On the domestic front: (i) ongoing security problems in the north could disrupt agriculture and trade; (ii) there is risk of social unrest around the end-March election that would undermine investor confidence; and (iii) weaker confidence in Nigeria’s policy stance could add further pressure to the exchange rate and adversely affect macroeconomic and financial stability. On the external front: (i) slow growth in advanced and emerging economies could undermine demand for Nigeria’s main export (oil); (ii) the tightening of global financing conditions (with US interest rates rising from mid-2015) could lead to further capital outflows; and (iii) persistently lower oil prices would increase pressure on already strained fiscal and external accounts.

A challenging business environment but a rewarding investment destination
The sharp fall in oil prices highlights the significant pressures on the economy (which already faces major business constraints such as increased insecurity in the North, weak governance, high corruption and poor infrastructure). If these constraints are not tackled they will continue to undermine Nigeria’s competitiveness, investment environment and growth in the long run. In its most recent report (2014/2015) on global competitiveness, the World Economic Forum (WEF) ranked Nigeria 127 out of 144 countries. Nigeria scored 3.4, where 0 represents the least competitive country and 7 the most competitive; and performed particularly badly in infrastructure, innovation and higher education and training.

Nigeria’s infrastructure is underdeveloped and acts as a major impediment to economic expansion. The key concern is the poor performance of the power sector, with insufficient generation capacity. This situation has led the majority of businesses relying on power generators to carry out their operations, creating high utility costs. Concerning transport infrastructure, road quality is rather unequal but the vast majority of roads are unpaved creating congestion problems (in a context of growing population and urbanisation). Nigeria’s railway network is largely dilapidated leading to deficient performances, erratic service and underutilisation. Port infrastructure has seen major improvements in recent years with the implementation of a comprehensive reform from 2000; however, a number of key challenges remain: poor customs performance, corruption, limited access to ports. Encouragingly the government intends to focus on infrastructure development, but reforms are likely to be slow.

The country continues to register poor performance across all governance indicators. In its 2013 Worldwide Governance Indicators, the World Bank ranked Nigeria in the negative territory for all its indices (that are ranked between -2.5 and 2.5 where the latter indicates good governance). Among those, Nigeria performed particularly badly in political stability and absence of violence/terrorism (-2.08), the control of corruption (- 1.20) and the rule of law (-1.16) . These findings are consistent with Transparency International’s Corruption Perception Index that measures the perceived levels of public sector corruption. In 2014, Nigeria ranked 136 out of 175 countries, scoring 27 where 0 means the country is perceived as highly corrupt and 100 means the country is perceived as very clean. This result, comparable to those of other oil producers, depicts a situation of endemic corruption (notably, in the armed forces and police). Moreover, personal wealth remains highly concentrated and GDP per capita is low. High rates of poverty and income inequality reflects the limited trickle-down effect of revenues to all levels of society, which is largely a result of a weak policy environment, vested interests, and rent seeking.

However, Nigeria remains an interesting investment destination. The country benefits from a large and diverse economy that has achieved a decade of strong growth, averaging 6.8% a year. Following the recalculation of national accounts in Q1 2014, which increased the size of the economy by 75%, the economy appeared more diversified than previously thought: the services sector almost doubled in size accounting for over 50% of GDP in 2013, compared to 13% for the oil sector. This increased diversification creates opportunities both in the extractive and non-extractive industries (such as energy, construction, agro-food industry, banking, retail and telecommunications). Moreover, Nigeria enjoys a large market size, which provides businesses with opportunities to take advantage of economies of scale and scope, and a growing middle class, which in turn support domestic demand for consumer goods and services. Finally, infrastructure deficiencies also create opportunities for foreign investors wishing to bid for government contracts on infrastructure development.

Conclusion
After rebasing GDP in 2014, Nigeria overtook South Africa to become sub-Saharan Africa’s largest economy (and one of the fastest growing economies). Services accounted for a large share of the increase and faster growth (over 50% of GDP in 2013, with the oil sector accounting for only 13%). However, the oil sector remains a critical source for revenue and foreign exchange. With limited fiscal and external buffers (USD2bn in the excess crude account and USD31.4bn in gross international reserves, respectively at the beginning of the year), the sharp decline of oil prices in the second half of 2014 highlights the significant pressures on the economy.

At current low levels of around USD55/b, low oil prices pose a risk to the economy in this election year. Although the budget has been cut to reflect the low oil price environment, major reforms to remove structural barriers are required to place the economy on a firmer footing to face other challenges such as rapid urbanisation, strong population growth, low employment, and diversification from hydrocarbons.

Source: Ecobank’s Middle Africa Insight Series