Nigerian Economy and Financial Market: After Elections… What Next?

After Elections  …What Next?
Nigeria’s macroeconomic scene in recent times has been laden with issues surrounding the domestic polity in anticipation of the upcoming elections in March and April. Election campaigns are getting more intense with no one actually sure of which of the two major political parties will carry the day.
Falling oil prices still continues to pressure the fiscal stability of government whilst Naira stability is continually tensed on the back of falling external reserves and weak market sentiments. Yields in the fixed income market remain upward trending while investor sentiments for equities remain passive as investors demand high premium for investment. In our view, there are critical questions that beg for definite answers; “After elections …what next? “

Post-Election Governance and Polity: Wheels Falling Off or a Renaissance?
As campaigns gradually wind-up, the general consensus is that this would be the most keenly contested election in the history of the country, with little to separate the two leading parties — PDP and APC. A close run — as it is being expected – will mark a departure from the past when Presidential elections were won landslide by the ruling party. This perhaps suggests that political structures and institutions are now more robust as the electorates are becoming more enlightened and demanding. Such development could potentially deepen the polity and improve democratic governance at the Federal level as political parties holding sway at the center will be encouraged to deliver on electoral promises in order to retain power in future elections.
However, our near term prognosis of post-election polity dynamics remains pessimistic, as a “catch-22” may envelop the socio-political scene, as adjudged by the subtle threats of hardliners along the socio-political divide heating up the polity. Militants in the Niger Delta have threatened to resume insurgency in the event of a Buhari presidency, and an uneasy calm presently pervades Northern Nigeria, which may give way to rioting if President Jonathan emerges winner. While this may be interpreted as mere threats associated with elections, recent trends and developments offer ominous signals.
Nevertheless, we think the political elites with vested economic and political interests will eventually settle for a middle ground as always. In the end, the truest test of character of whoever wins will be on delivering electoral promises and developing a pathway towards economic renaissance.

Revenue Base to Remain Weak on Lower Crude Oil Prices
A critical issue to confront either party Post- May 29 hand over is the reality of a lower government revenue base given lower oil price (which accounts for 74.4% of export earnings and approximately 75.0% of government revenue). The above is worsened by sustained bearish market outlook for crude oil on continued supply glut in the market. Our bear base scenario sees oil price trading below US$60.00 in the near to medium term.

Expenditure Will Expand Either Way
Juxtaposing the outlook on government revenue as noted above against planned expenditure outline of both parties suggests an expansionary fiscal stance compared to a weak revenue position. In the face of weaker macro-economic fundamentals, we imagine that execution of these spending plans based on both party manifestoes will be a tall order as expenditure will be largely constrained by lean revenue base should oil prices remain below US$60.00. Although in an attempt to address these concerns, both parties will have to come up with ingenious means.
However, we see a constrained fiscal environment on the other side of the road, most especially in light of the current macro-economic realities. Needless to mention is the likely escalation of socio-political unrest after May 29^th on the back of possible hike in taxes as diversification of the economy remained a long-term effort. Based on the foregoing, we highlight the likely challenges to confront the post-handover budget implementation to include the following:

1. Constrained execution of recurrent expenditure may affect public salary payment.
2. Capital expenditure will suffer in the face of meeting more pressing recurrent spending.
3. Higher taxes and tax enforcement is likely to shore up revenue base of government.
4. The need to finance government spending may shoot debt profile up significantly.
5. And labour unrest may likely escalate.

Monetary Policy: CBN May Unleash the String on Public Deposits
The Nigerian monetary policy environment is expected to remain tight post 2015 elections as the Monetary Policy Committee (MPC) is faced with the dilemma to either preserve foreign portfolio investments or ease the monetary environment to encourage lending. As a result of the huge participation of the foreign portfolio investors in the Nigerian capital market, the need to attract capital inflow as well as save the depleting external reserves (YTD decline as at 13/03/2015 – 12.0% at N30.3tn), may compel the CBN to keep the Monetary Policy Rate (MPR) at 13.0% (or +1.0%) till the end of 2015.
In addition, the persistent decline in crude oil prices which exposes the weak revenue structure of the Nigerian economy has increased the country’s risk premium, hence require higher return on investment. In a bid to reduce the challenge of increased lending, we expect the Government via the CBN to come up with additional stabilization funds (in addition to the recently launched Real Sector Support Facility – RSSF) to select sectors that would foster diversification of Nigeria’s revenue base.
In light of the Single Treasury Account (STA) policy, we expect the CBN to unleash the strings on public sector deposits from the current 75.0% as we anticipate less public funds will be available to the banks. However, the threshold on private sector deposits (currently 20.0%) may be tweaked +/- 5.0% before the end of 2015, premised on the stability in exchange rate. Furthermore, we expect the CBN to revert the Net Open Position (NOP) to 1.0% before the end of 2015 from 0.5% to improve available liquidity of the green back and allay the fears of FPIs.

Exchange Rate: Likely Post-Election Crisis to Mount Pressure
In a bid to stabilize the Naira and preserve the external reserves, the Apex bank devalued the Naira in Nov-2014 (by 8.4%). However, with sustained pressure on FX rate, the CBN shut down official window in February 2015 (implying another tacit devaluation of the Naira). This move led to a relative stability in the currency market as CBN intervenes to meet excess demand through special intervention.
Given continued effort of the CBN to support the Naira in the face of lower oil prices and accretion to the reserves, the country’s external reserves has tumbled 12.3%, docking at US$30.3bn as at 17/03/2015. At current levels, the reserves can only cover less than 6-months of import- a threshold that may pose a major threat to Nigeria’s balance of payment transactions.
Although we forecast FX rate to average N200.00/US$1.00 for the 2015. We imagine that the pressure on FX rate may persist post-elections on the back of lower crude oil prices. More so that an emergence of post-election violence may trigger further exit of foreign investors.

Inflationary Pressures: Post-Election Violence May Spur Hike in Price
Recent direct and tacit devaluation of the Naira is currently taking its toll on the general price levels. As against 8.0% inflation rate in December 2014, general price level inched higher by 0.2% each in January and February to settle at 8.4% in February 2015. We attribute this hike in general prices to increase in price of imported goods resulting from pressure on FX rate.
An increase is expected in the electricity tariff due to the introduction of the MYTO (Multi Year Tariff Order) that divides the electricity consumers into different tariff categories. Ultimately, we suspect that pressure on price level will mount regardless of the election outcomes. We retain our 9.5% average inflation for 2015.

Equities Market: Increase in FPI will lift the Index
Even as the decline in oil prices remains the most potent threat to domestic macroeconomic stability in the medium to long term, the socio-political uncertainties associated with politicking ahead of the general elections have increased the risk profile of the Nigerian Economy, leading to the volatility in the Equity Market as foreign investors stay on the sideline. Foreign Portfolio Investors (FPIs) account for significant liquidity in the Nigerian Equity Market – 47.8% in January 2015 – hence a major determining factor of market performance.
The performance of the Nigerian Equity Market significantly pales, relative to other oil exporting countries and frontier markets – reflecting the higher risk perception of the Nigerian market traceable to skepticism of fiscal managers’ ability to handle the pressure on revenue and more significantly, political uncertainty in the economy.
However, we would expect the foreign investors’ appetite for Nigerian financial assets to improve post-transition in May. The eventual devaluation of the currency which has reduced uncertainties regarding exchange rate policy and increased the Naira purchasing power of foreign investors will further buoy foreign investor participation in the equity market and lift market performance, once certainty returns to the political scene.

Fixed Income: Yields Environment is likely to Moderate
The higher risk premium associated with the political uncertainty and fiscal imbalance has led to a downward pressure on Nigeria’s fixed income instruments; hence, driving yields higher. This has widened the yield premium between Nigerian bonds and those of other Sub-Sahara African countries even as Nigerian fixed income instruments continue to trade at a significant discount to par. We expect bargain hunting in the Nigeria’s high yielding fixed income assets post-transition in May-2015 as investors re-price Nigerian assets discounting for the erstwhile political factors that would have waned significantly. We expect average yield to moderate to 13.5% (closer to the June 2014 levels) from the present 15.4%.

Real Estate: Boost in Private Sector Investment in Prime Real Estate
The anticipated inflationary impact of the recent depreciation of the Naira in the foreign exchange market and two rounds of currency devaluation implies increased opportunity cost of holding depreciating assets like cash and investment securities, improving investors’ appetite for the real assets such as investment properties.
With the moderated political risk post-transition in May, we expect a boost in private sector investments in prime real estate. Nevertheless, a key drag to the growth of real estate sector remains the anticipated lower discretionary spending by the government and lower economic growth (Afrinvest forecast 5.0%) in 2015, which will weaken consumer spending on investment properties.

Conclusion
In our view, whichever party emerges will be required to brace up for the challenges ahead. That said, deliberate strategies are needed by the government to steady the ship of the Nigerian economy in this turbulent period.

By Afrinvest (West Africa) Limited Research Team.