Executive Summary
Against expectations of stronger growth in 2016, the performance of the global economy and financial markets was driven by the resonating effects of increased uncertainties which persisted throughout the year.
In the domestic economy, weak fiscal response, oil production volume shocks and an incoherent monetary policy stance – which resulted in a currency market crisis – pushed the economy into a recession and damaged investor sentiment. In line with the forgoing, we review the performance of the Nigerian economy and financial markets in 2016 vis-à-vis developments in the global space as well as our outlook for 2017.
Global Macroeconomic Highlights
Uncertainties in the global space were amplified by the unexpected outcome of the UK Brexit referendum in June 2016 as well as the US presidential elections in November. Commodity prices however witnessed an uptrend after touching record lows at the beginning of the year.
Thus, Emerging Markets saw increased fund inflows while monetary policy tools were deployed by central banks in the Advanced Economies (US Fed, the BoE, the ECB and the BoJ) to ensure financial system stability as well as buoy output growth.
Accordingly, the IMF estimated global growth at 3.1% in 2016, 0.1% lower than 3.2% in 2015. In 2017, global growth is forecast to improve to 3.4% on account of the uptick in commodity prices which started in H2:2016 and is expected to boost output growth in Emerging and Developing Economies. Nevertheless, downside risks to stronger global growth is centred on uncertainties surrounding the Trump led administration in the US, the potential global consequences of a US-China trade war as well as geopolitical tensions which could worsen in 2017.
Domestic Macroeconomic Highlights
In the domestic economy, the downtrend which began in 2015 persisted all through the year as macroeconomic indicators worsened. Afrinvest Research had a short term bearish outlook on the Nigerian economy due to lower commodity prices with a potential to trigger a balance of payment crisis amid weak policy responses. Unexpectedly, oil production volumes came under pressure due to disruptions in the Niger Delta, further dragging down government revenues.
Accordingly, the economy slid into recession as GDP contracted for three straight quarters (Q1, Q2 and Q3:2016). Also, inflation galloped to double digits from 9.6% as at Dec-2015 to 18.6% in Dec-2016 as the pass through effect from a weaker exchange rate, increase in fuel prices due to price modulation and a hike in electricity tariffs pressured domestic price levels.
The Apex Bank resorted to monetary tightening as against its initial dovish stance in Dec-2015, driving average yields in the fixed income market northwards to compensate investors for higher inflation, attract foreign capital and support liquidity in the FX market. Our outlook on price levels suggests that inflation will remain in the double-digit region due to potential new shocks from an increase in energy prices (fuel and electricity) and currency devaluation.
Nevertheless, we forecast a moderation of inflation to an average of 15.5% for the year on account of the high base effect. Despite our inflation projection, we believe the CBN will maintain its tight monetary policy stance in 2017 with the benchmark interest rate left unchanged at 14.0% in order to continue to attract foreign capital flows which have remained sub-optimal.
On the fiscal side, the strong (but fast diminishing) anti-corruption goodwill of the administration was leveraged on to successfully implement some reforms in the downstream sector after a hike in petrol prices in May 2016.
However, the delay and drama that preceded the passage of the rather optimistic 2016 budget did little to prevent the economy from slipping into recession.
The socio-political environment also remained fragile due to insecurity as sporadic killings within the North-Central region, Fulani herdsmen clashes with farming communities across the country and the increased spate of attacks on crude oil production facilities by the Niger Delta Avengers in the South-South continued to counter the military gains against the Boko Haram insurgency in the North-East.
Against this backdrop, we believe that activities in the Nigerian economy in 2017 will be broadly dependent on FGN’s resolve to implement tough but necessary structural reforms in order to recalibrate the economy towards a path of recovery and rebuild confidence in monetary policy.
We note that oil prices which had hitherto overwhelmingly driven Nigeria’s business cycle will play a reduced role in the medium term. Despite the recent OPEC/Non-OPEC deal to cut production volumes, the balance of oil resources (between conventional low cost-drillers in OPEC countries and increasingly resilient and efficient shale producers) as well as diversification into clean energy in advanced countries suggests that structurally, the era of >US$80.00/b oil is over.
Thus, the short to medium term outlook would be highly dependent on the ability of policy makers to deliver incremental oil output in 2017 while also reviewing the current structure of the currency market. The 2017 budget, which is broadly optimistic given current macroeconomic realities, will require the focused commitment of both the Executive and Legislative arms of government in order to get passed into law so that timely implementation can begin .order to achieve the objective of stimulating economic recovery through increased infrastructure spending.
Nigerian Financial Market Highlights
The domestic equities market declined for the third consecutive year as the NSE ASI slid 6.2% Y-o-Y and continued into 2017 with YTD losses of 2.4% (20/01/2017).
Sentiment for equities was dragged by weaker macro-economic indicators which stifled corporate earnings and increased appetite for debt securities. In the fixed income market, aggressive OMO (Open Market Operation) mop-ups by the CBN and the need to rollover maturing T-bills to fund FGN’s widening fiscal deficit through the domestic debt market supported the supply of sovereign debt securities in 2016.
In addition, FX market liquidity crunch as well as inflationary pressure drove yields northwards. In view of the observed weaknesses in the economy, we note three key factors that will determine performance of the local bourse as follows:
- Apex Bank’s resolve to fix the currency market crisis and close the huge gap between official and unofficial market rates once and for all.
- Resolution of the on-going crisis in the Niger Delta region and its impact on oil production volumes as well as revenue;
- Significant structural reforms as part of the implementation of an economic recovery plan to restore growth;
In light of these, we envisage three possible scenarios that could play out in 2017. Our bull case scenario (+15.6% Y-o-Y) sees the NSE ASI at 31,071.25 points, our base case (-1.5% Y-o-Y) at 26,460.91 points and our bearish case (-16.4%) at 22,456.32 points.
In the fixed income market, we expect that yields will fall in 2017 on account of lower inflation rate as well as lingering macroeconomic risks which will possibly drive interest in fixed income securities and increase demand for bonds.
On the expectation that MPR will remain at 14.0% in 2017 as well as macroeconomic uncertainties which could swing performance against equities, we advise investors to underweight equities and overweight fixed income instruments which offer reduced risk. Nevertheless, we do not rule out the prospect of bargain hunting in fundamentally sound stocks currently trading at attractive entry prices.
In an economy with fast rising inflation and poor sentiment for financial securities, investors continue to look for alternative investment opportunities to deliver superior return and diversify portfolios. In view of the above, we believe including alternative assets in a portfolio lowers risk and stabilizes returns as it remains an efficient way to hedge against volatility in traditional asset classes. In this report, we bring new focus on the following alternative asset classes:
- Derivatives;
- Real Estate; and
Reform or Be Relegated
A major revelation from our analysis is that the economic and financial market outlook for Nigeria in 2017 will be hinged on the resolve to implement tough but necessary structural reforms. We note that the Nigerian economy, which is regarded as the largest in Africa as well as one of the most viable investment destinations, has been on a slippery slide downhill following the crash in commodity prices in H2:2014. However, a number of other commodity exporting countries, affected by lower commodity prices, have since taken tough but necessary steps to boost their economies.
The reluctance of Nigeria to impose appropriate policy reforms is perhaps most reflected in the currency market where a severe liquidity crunch has lingered after the CBN imposed capital control measures on FX transactions and fixed FX rate at N199.10/US$1.00 in 2015 before moving the peg to N305.05/US$1.00 in 2016. This was against the much needed reform to adopt a flexible exchange rate policy allowing for appropriate pricing of the domestic currency which the CBN adamantly resisted.
Increased monetary stimulus by a number of Central Banks in the Advanced Economies alongside an uptick in commodity prices drove funds flow into Emerging and Frontier Markets in 2016 and moderated the damaging impact of lower commodity prices in the year.
Nonetheless, Nigeria was an outlier as capital flows dried up due to inappropriate policy responses, especially in relation to FX. Foreign Direct Investment (FDI) into Nigeria tumbled 63.2% in 2016 to US$2.1bn from US$5.7bn in 2015 and US$9.9bn in 2014 while Foreign Portfolio Investment (FPI) into equities in 2016 slid 51.4% (from N973.7bn to N473.5bn), weakening demand for domestic equities significantly. As such, the NSE ASI further depreciated 6.2% in 2016 after plunging 16.9% in 2015 and 16.1% in 2014.
In contrast to events in Nigeria, large Emerging Markets such as Russia and Brazil, which were also negatively affected by the fall in commodity prices with pressures on their respective domestic currencies and prices, maintained a flexible FX policy and implemented market-friendly policies to buoy confidence and adjust to the oil shock.
As such, inflation rates trimmed to 6.1% and 6.3% in Dec-2016 from the highs of 17.5% and 10.8% respectively in 2015. Similarly, their equities markets recovered from the 2015 losses with the Russian RTS and Brazilian IBOVESPA advancing 107.7% and 38.9% respectively in 2016.
Also, the Russian Rubble and the Brazilian Real appreciated 20.1% and 22.0% after depreciating 20.3% and 32.8%, respectively in 2015. Brazil and Russia recorded Capital inflows (FDI and FPI) worth US$261.6bn and US$31.1bn in the first 9 months of 2016 compared to outflows of US$284.3bn and US$39.9bn in 2015 respectively.
In Africa, Egypt implemented a set of reforms ranging from increase in Value Added Tax (VAT) rate, reducing energy subsidy to adopting a flexible exchange rate regime; all in a bid to access IMF’s US$12.0bn loan support programme.
This resulted in a 36.6% depreciation in the value of the Egyptian Pound to the Dollar and bolstered investor sentiment in Egyptian assets as increased capital flows drove the local bourse 76.2% northwards in 2016. To cushion the impact on the vulnerable, targeted welfare spending such as social protection programme – school meals, subsidies for infant milk & children’s medicine and vocational training for young people – and structural reforms to ease business climate were introduced.
With further influx of foreign capital into the Egyptian economy, the domestic currency is expected to strengthen in 2017. The first US$2.8bn tranche of the loan with a 10 year tenor (and 4.5 year grace period) has been released by the IMF with an interest rate of 1.5 – 1.8%. Despite the short term pains being felt by domestic corporates with foreign currency liabilities and consumers, the Egyptian economy has benefited from a confidence boost with authorities now targeting US$10.0bn of portfolio investment in sovereign debt securities. Additionally, the government is planning to raise US$2.0 – US$2.5bn of Eurobond sales in 2017 which is widely expected to be successful.
Adapting a similar set of reforms would be long-term positive for Nigeria, in trimming the budget deficit and boosting capital flows, but may be short-term painful to consumers. However, such a set of reforms will be a major boost to agriculture and light manufacturing which all fit with the current policy direction of the FGN.
In light of the foregoing, our view is that Nigeria which has often been viewed as an attractive investment destination and a strategically important economy in Africa in the past, may be slowly “losing its shine” if critical reforms are not implemented to change the tide of the current macroeconomic realities which continue to deter foreign capital inflows.
Across the SSA region, Nigeria accounts for about 29.8% of the total GDP which puts her as a major contributor to growth. On a broader scale, the SSA GDP accounts for c.1.9% of the world GDP, implying that Nigeria’s total contribution to global GDP is a mere 0.6%.
Putting this into perspective, it is apparent that Nigeria is really only a giant amongst Lilliputians. The realities of 2016 have clearly signalled that foreign investors will not hesitate to by-pass Nigeria and direct funds flows to other EMs if they do not find a welcoming environment.
As noted earlier, Nigeria’s business cycle would be highly dependent on the ability of policy makers to deliver incremental oil output in 2017, restore macroeconomic stability by rebuilding confidence in monetary policy and the administrative side of the FX market structure as well as showing commitments to structural reforms.
These would be necessary to stabilize external account, rebuild external reserves, improve liquidity in the FX market as well as achieve lower inflation and interest rates. Moreover, given the expectation of tighter monetary policy across the Advanced Economies, the pace of funds flow to EMs may slowdown in 2017. Hence, the much needed policy “Reforms” are inevitable as Nigeria stands the risk of being further “Relegated” as already witnessed in 2016.
We highlight below some of the key reforms needed.
- Given that oil revenue contributes a significant chunk to government’s revenue, it is imperative to implement structural reforms that will ensure transparency and efficiency so that the much needed foreign capital flows into the economy can be ultimately attracted. These reforms are majorly centred on passing the Petroleum Industry and Governance Bill (PIB) into law as well as revolutionising the gas sector to enhance the gas-to-power network and resolve the security challenges in the Niger-Delta. We recommend a much more lasting pragmatic solution that incentivize disgruntled Niger-Delta agitators to shield their swords and embrace peace. To this end, we believe that privatisation, across the oil & gas value-chain, should be a key focus so as to entrench efficiency in operations and smoothen the full deregulation of the downstream sector which began in May 2016.
- We believe the current challenges facing the power sector need to be decisively tackled head-on. The whole process from supply of gas to the Generating Companies (Gencos) down to the transmission of electricity to the final consumers as well as the cash collection process from the consumers through to the gas suppliers, needs to be revamped. Also, there is a need for debt and equity restructuring by players in the sector in order to sufficiently capitalise firms as successful implementation of these reforms would make the sector more attractive for potential investors and as such the current liquidity crunch may be addressed.
- There is a bourgeoning opportunity in the Mining sector which is currently on the Federal exclusive list of the Nigerian constitution, implying that exploratory activities in the sector are carried out by the Federal Government. In our view, removing mining from the exclusive list will give the State governments the impetus to explore and develop their respective natural resources and also possibly foster interstate alliances. Likewise, this could possibly provide an avenue for States to boost their Internally Generated Revenue and will in the long run reduce dependence on revenue allocation from the Federal government.
- The aviation sector is another area of reform that will present long term benefits if necessary reforms are carried out. We believe the prospects of privatisation of the Airports around the country should be considered as this will aid in the efficient operation of the airports, unleashing tourism and commercial potentials of the economy. This will also rid the FGN of the burden of maintenance and development of the airports which are currently in a deplorable state. These airports can be viewed as business hubs given the presence of shopping malls, restaurants, office complexes etc.
We are confident that policy makers necessarily need to be bold and assertive in pushing for the much needed reforms as previous efforts made have tended to scratch the issues on the surface while “Kicking the Can down the Road” rather than “Taking the Bull by the Horn”.
A recurring theme critical for reforms therefore is “privatisation”, premised on our understanding that the FGN can set the economy on a sustainable development path by leveraging a private sector led developmental reforms. Consequently, favourable market friendly policies, especially with regards to FX, need to be implemented while also striving to improve ease of doing business.
Successful implementation of these reforms will improve the quality of lives of citizens, provide job opportunities, improve quality of labour and Nigeria’s ranking will improve in line with United Nation’s 2016 Sustainable Development Goals (SDG) towards poverty alleviation.
This will then make State Governments more economically viable than their current unsustainable parasitic structure.
As a result, there is a need to bite the bullet once and “Put Nigeria first” by implementing the necessary reforms.
