Pace of growth slows in Nigeria with drop in oil prices

As Africa’s most populous nation, and with the biggest oil and gas reserves in the region, Nigeria has long been one of the continent’s sought-after markets, but also one of its most complex and challenging. A GDP rebasing in 2014 modernised the country’s statistical measurements, expanding GDP to N94.14trn ($155.1bn at the time of printing) in 2015 according to the National Bureau of Statistics (NBS). This made Nigeria the continent’s largest economy, a title held through most of 2016, when due to currency fluctuations it became arguably the second-largest, depending on the exact exchange rate used.

The Future Of Oil

Nigeria has Africa’s largest proven hydrocarbons reserves, and oil has dominated the economy for the last half-century. Despite ongoing efforts at diversification, petroleum and its by-products will likely dominate the economy for many years to come. While crude oil and natural gas production accounts for less than 10% of GDP, hydrocarbon exports are the source of up to 70% of government revenues and 90% of its foreign exchange receipts. According to the NBS, as a proportion of total exports, crude oil has fallen from around 95% in 2003 to just over 70% in 2015, but much work still needs to be done.

The addition of US oil to a tight market and decreased demand from Europe and China contributed to a 33% drop in the benchmark Brent Crude oil price from $55.27 a barrel at the end of 2014 to $36.61 at the close of 2015. Meanwhile, increased supply from Iraq and Iran amid tepid global economic growth in 2016 is expected to put additional pressure on prices in the near-term.

Furthermore, the International Energy Agency (IEA) estimates that importer countries took advantage of low prices to build their stock of oil while major oil producing countries were simultaneously adding to their supplies, which will contribute to the global glut of oil in the near term. As a result, short-term oil prices are expected to remain low, with the IEA predicting an average price of $43 a barrel for crude oil through 2016.

Growth Recovery 

According to the NBS, real GDP growth slowed in 2015 to 2.8%, down from 6.2% in 2014. Due to falling oil prices, exchange rate uncertainty and other weaknesses in the economy, the IMF has projected that GDP will shrink by 1.8% in 2016, with this recovering somewhat to 1.1% growth for 2016. This is compared to the approximately 6% annual GDP growth the economy enjoyed during the recent boom years. For 2015, agricultural sector GDP grew by 3.7% and the services sector by 4.8%. Industry, on the other hand, contracted by 2.2%. The oil sector fell by 5.5% in 2015, while the non-oil economy grew by 3.8%, according to the NBS.

Demography & Labour

Nigeria has the seventh-largest population in the world. It is growing at an average rate of 2.7% a year and is one of the youngest in the world, with 70% of the population under the age of 30. This presents a complicated picture for the government. Official unemployment, which topped 10% in the first quarter of 2016, will continue to pose a challenge as more young people enter the workforce, although this does not take into account the large informal economy and high estimates of underemployment. Limited labour-intensive activities (see Industry chapter) and an educational curriculum with limited applicability for the job market (see Education chapter) has exacerbated this.

However, with targeted investment, the natural resource-rich country could turn its rapidly increasing population into a net positive. As Gregory Kronsten, head of macroeconomic and fixed-income research at FBN Capital, told OBG, “Assuming the government maintains its policy of value-added production and employing nationals to produce those goods and services, Nigeria would have a comparative advantage in labour-intensive industries, such as commercial agriculture and mining, which is virtually untapped at present.” Taking a page from the South-east Asian growth model of the 1990s, the government’s move to expand export-oriented manufacturing (see Industry chapter) is another way it is attempting to turn its youthful population into an advantage.

The labour force rose by 14.4% between 2011 and 2015, ending the period at 76.95m workers. While incorporating the expanding labour pool will remain a challenge for an economy that has struggled to materially increase the number of jobs, labour productivity in Nigeria increased by 52.5% in the five years ending in December 2015, according to the NBS. In the third quarter of 2015 year-on-year job growth remained strong, with 36% more jobs added, following a 42% rise in 2014. That said, the vast majority (90%) of the 475,000 jobs created in the third quarter of 2015 were in the informal sector, suggesting that the economy struggles to support the high-quality posts necessary for Nigeria to reach its development goals.

Currency 

One of the defining trends in the economy over the past year has been downward pressure on the naira, with the Central Bank of Nigeria (CBN) maintaining an official peg to the US dollar until June 2016. In February 2015, prior to the election of President Muhammadu Buhari, the CBN instituted a de facto devaluation of the currency, at a rate of 198 naira to the dollar, in response to falling oil prices and declining foreign reserves. The CBN had been expending up to $100m daily to maintain the previous trading band of N160-176:$1. Despite the devaluation, the official band of N197-199:$1, which lasted from February 2015 to June 2016, was still drastically out of step with the informal market, which at points valued the currency as low as N400:$1.

With the backing of Buhari, the CBN resisted further devaluation of the naira, citing the possibility of disruption and instability in key areas of the economy. As a result, businesses across the board suffered from a shortage of foreign currency due to the controls instituted by the CBN to limit dollar transactions. As a consequence, importers had trouble making payments, with shipping volumes slowing as a result and foreign firms struggling to conduct transactions or repatriate profits. Iberia and United Airlines, for example, both announced that they would temporarily suspend flights or reduce capacity due to foreign exchange restrictions (see Transport chapter).

According to the CBN, foreign reserves fell 16% to $29.1bn in December 2015 from $34.2bn in December 2014. Much of this drop stems from the sale of reserves in defence of the naira, with low oil prices also a factor. Oil exports are still Nigeria’s primary source of foreign exchange. As oil prices fall so do export receipts, depriving the CBN of its primary means of replenishing its coffers.

Policy 

The Monetary Policy Committee, the CBN’s policy-setting body, recognised the need for increased access to foreign exchange in the economy in its January 2016 report, but it was not until June 2016 that the CBN moved the naira to a nominally free float. The currency fell by 40% on the first day of the new framework, but remained impressively stable for the next month: there was little movement as the CBN continued to sell $35m-60m a day, according to JP Morgan. However, in late July the currency began to slide again, falling an additional 9.2% against the dollar, reaching an all-time low of N309:$1.

Inflation 

Inflation, which grew to 9.6% in 2015 from to 7.98% in 2014, has accelerated further in 2016. The CBN announced in March that year-onyear headline inflation in February had risen to 11.4%, surpassing the average 2015 estimate of 10.2%. By June the rate had jumped to 16.5%, well above the target of 6-9%. Citing inflationary pressures stemming from exchange rate pass through to import prices, the scarcity of refined petroleum and higher electricity tariffs, the CBN surprised markets by raising its monetary policy interest rate from 11% to 12%. The NBS has estimated that in 2017 inflation will fall to 9.49%, but investors are keeping an eye out for any upward revisions to that estimate as 2016 unfolds.

Part of the Buhari administration’s reluctance to devalue the currency was rooted in its desire to stave off inflation, although the capital controls instituted to maintain the currency peg indirectly exacerbated the situation. Nigeria imports a large amount of food and the economy is dependent on imports for basic materials to fuel its growing non-petroleum sectors, such as construction. Insufficient access to dollars limited the ability to import food and building materials quickly and efficiently, and the higher costs and delays associated with obtaining funds through parallel or unofficial channels were passed on to consumers.

Accessing Loans 

While the CBN has taken initial steps to increase access to credit outside of the petroleum industry, many firms are still not able to secure the loans necessary to grow and expand their operations. Attempts by the CBN to inject additional liquidity into the banking system – which, as is the case in many African frontier and emerging markets, suffers from low intermediation and high commercial lending rates (see Banking chapter) – have not resulted in expanded lending in targeted areas of the economy. In fact, prime lending rates increased to 16.96% as of December 2015, relative to 15.88% a year earlier. While CBN data shows that both broad money supply (M2) and net domestic credit grew following CBN liquidity actions, the primary beneficiary was the federal government, which saw its credit outstanding grow by 151% by the end of 2015. This was a result of banks buying up larger volumes of government debt – a safer bet for returns given the opacity of the broader lending environment.

Trade 

Following a 10.3% expansion of total trade and a $15.6bn trade surplus in 2014, trade contracted considerably in 2015, falling by 24%, resulting in a trade deficit of $7.7bn. Both imports and exports declined, with exports at $45.37bn, a 45% decrease relative to 2014 and imports falling 21% to $35.1bn over the same period.

The NBS expects trade growth to remain weak in 2016, as low oil prices dampen export growth and currency controls limit imports. Trade is expected to grow by just 2.4% in 2016 but by 31.1% in 2017. Foreign reserves, over 90% of which stem from oil exports according to the CBN, declined in December 2015 to $28.3bn from $34.2bn a year earlier. Despite aggressive controls put in place by the CBN, according to official tallies, reserves fell an additional $470m in the first two months of 2016.

Institutional factors are also dampening trade activity. “An ineffective Customs system creates an atmosphere open to fraudulent activities,” Andrew Hunter, managing director for SGS, told OBG. “Having more efficient measures in place such as a single window platform could both quicken the process for importing and exporting goods, while increasing trade and revenues paid to the government.”

Oil Exports 

The decline in trade is in part a result of one of the tectonic shifts in the global energy industry: the rise of unconventional shale production in the US. With the US reducing its previously strong appetite for energy imports, Nigeria has lost a major export destination for its light, sweet crude (see Energy chapter). According to NBS data, in 2010 the Americas region was the second-largest destination for Nigerian crude, primarily due to the US, which imported more than one-third of total Nigerian crude by value.

During the first three quarters of 2015 only 3.2% of Nigeria’s crude reached the US. Some of that difference, however, was offset by increased exports to India, the Netherlands and Spain, which collectively imported 37.8% of Nigerian crude in the same period. As was the case in 2010, Europe was Nigeria’s largest oil export market in 2015.

Diversified Goods 

Similar to other aspects of Nigeria’s economic story, oil has traditionally been the major player in the export market, but with time, that narrative is slowly beginning to change. The volumes of oil exports have fallen, but total exports have fallen slightly less than oil exports. The overall export tally was buoyed by growth in certain non-oil exports, most notably in the vehicle and vehicle parts sector, which is a particular focus for the current government. According to the NBS, as a proportion of total exports, crude oil has fallen from over 95% in 2003 to just under 70% in 2015 as Nigeria gradually diversifies its economy. Adding to a range of fiscal incentives for exporting industries, in February 2016 the CBN approved a N300bn ($947.1m) export stimulus fund for the Nigerian Export-Import Bank. This will provide loans and guarantees for domestic industries that need support to acquire and fulfil international orders. The fund will be targeted at firms that have the potential to increase exports outside of the petroleum industry.

Imports 

Since 2010 Nigeria has become more dependent on Asia and Europe for imports, relative to other regions. Just as exports to the US have fallen since 2010, imports from the US have also dropped during the same period, from 17.9% of total imports in 2010 to just over 8% in 2015, based on NBS data. Imports have increasingly originated from Europe and China, the latter of which raised its share of Nigeria’s imported products from 16.5% to 22.8% in the five years to 2015.

Offshore Investment 

Foreign direct investment declined considerably in 2015 to $1.5bn, down from $2.3bn in 2014. This drop is attributable in part to uncertainty surrounding the election. Portfolio investment also fell dramatically, from $14.9bn in 2014 to $6bn in 2015. Of the components of portfolio investment – fixed income, equity and money market – fixed income was the hardest hit, falling from $2.4bn in 2014 to $776.3m in 2015. The country was also removed from the J P Morgan Government Bond Index – Emerging Markets fund in October 2015 due to the previous system of capital controls, further reducing inflows.

Corruption & Waste 

Reducing corruption and government waste are major goals of the current administration. Transparency International ranks Nigeria 136th out of 168 countries in its measure of corruption. A March 2015 audit of the national oil company, the Nigerian National Petroleum Corporation (NNPC), found that as much as $16bn of oil revenues had been mishandled. Furthermore, an investigation by the CBN in 2014 suggested the company had withheld as much as $20bn owed to the state. Buhari’s electoral victory in May 2015 was premised in part on an anti-corruption platform – something he had sought to address during his last stint in office in the 1980s.

Fiscal Policy 

The government’s 2016 budget, which was passed in May, includes new spending in areas that the Buhari administration believes will spur growth and opportunities throughout the economy (see analysis). This includes N1.8trn ($5.7bn) to encourage the further development of a diversified economy and funnel investment into the country’s capital stock and human resources. The beneficiaries of this additional spending include the areas of transport, health, education, and power generation and transmission. Additionally, the government intends to implement a programme that provides an N5000 ($15.79) monthly stipend to up to 25m unemployed Nigerians.

Despite declining government revenues chiefly due to weak oil prices, the government is employing an expansionary fiscal policy designed to stimulate future growth and competitiveness. The government has pointed out that these policies are intended as medium- to long-term investments, and that there is little expectation of return in the short term. This view is in keeping with NBS estimates, which expect GDP to grow by 3.8% in 2016, but to accelerate to 5-6% in subsequent years.

In a recent speech, the minister of finance, Kemi Adeosun, stressed the need to first get Nigeria’s “fiscal house in order,” before tackling other economic concerns. Adeosun believes that the federal government can realise as much as $5bn in savings annually by eliminating waste and freezing public sector wages, but the Federal Ministry of Finance has yet to release details regarding which sectors of the public sector would be targeted.

Restructuring

Among the measures to clean up Nigeria’s fiscal house are restructuring initiatives for some of the key public institutions. The government has maintained the push for privatisation of some of Nigeria’s major publicly dominated sectors, such as the power industry, which underwent a privatisation of the generation and distribution segments under the previous administration in 2013. More recently, on the heels of a N267bn ($842.9m) loss by the NNPC in 2015 amid falling oil prices, the government is committed to reforming and energising the domestic oil industry. Meanwhile, in an effort to increase transparency and spur modernisation, the NNPC is scheduled to open its financial books to wider government and public scrutiny and set out on a path towards listing on the Nigerian Stock Exchange by 2018. For its part, the CBN has increased transparency across government accounts through the institution of the Treasury Single Account. It has also bolstered liquidity in the banking system, and is encouraging banks to translate that increased liquidity into additional lending for small and medium-sized enterprises and other firms in the real economy, especially those outside the oil sector.

Subsidies 

One significant overhaul has been in fuel subsidies, which under the previous administration had begun to decline. While Nigeria is a major producer of crude oil, limited domestic refining capacity requires it to import much of the finished petroleum products that the nation consumes. Reduced global oil prices have slashed the government’s fiscal obligations under its long-standing consumer energy subsidy regime. Capitalising on this, the government has looked to phase out the subsidy programme, reducing future budget obligations once energy prices rebound.

Debt 

To bridge the budget deficit and fund the government’s bold fiscal expansion, Nigeria will need to obtain financing in global markets. The Federal Ministry of Finance intends to first pursue loans from multilateral agencies, such as the IMF and the African Development Bank, to take advantage of the lower interest rates they often offer. Next it intends to tap the eurobond market, something which is expected to occur in 2016. Recent developments, both domestic and international, could make Nigeria’s next financing issuance difficult. With the US Federal Reserve planning to raise interest rates, there is less demand for emerging market debt, while the expected re-entrance of Argentina to the international bond market, with a new debt issuance of up to $12.5bn, would soak up much liquidity. Second, lower oil prices and currency volatility translate into lower government revenues and a challenging trade outlook, which may cause investors to question Nigeria’s creditworthiness, as happened with the country’s removal from the JP Morgan Government Bond Index – Emerging Markets fund in October 2015. However, despite these challenges Nigeria is expected to ultimately enjoy a successful bond offering, thanks in part to its low debt-to-GDP ratio relative to its African peers.

Outlook 

As the current government approaches the end of its second year in power, the outlook for Nigeria’s economy remains unclear. Through an expansionary budget and a war on corruption, President Buhari hopes to usher in an era of long-term, inclusive growth. However, lower oil prices and a still fragile global economy will likely pose significant challenges through 2017. It is incumbent upon the government, private sector and international community to ensure Nigeria is able to overcome these economic headwinds.