Research Report. An Overview of the Nigerian Economy. Seedwell Hove

Transcription

1 Research Report An Overview of the Nigerian Economy Seedwell Hove January 2017

2 An overview of the Nigerian Economy Seedwell Hove January 2017 Executive Summary The structure of Nigeria s economy has changed considerably over time, as the economy continues to diversify from oil. Today the economy is reasonably well diversified, with the oil sector accounting for about 10% of GDP, from over 30% of GDP in the 1980s. Fiscal revenues and exports however continue to depend on the oil sector, which accounts for about 75% of total revenues and 90% of total exports. The Nigerian economy expanded at robust paces in the last decade, supported by rising oil prices, but the momentum has slowed since the oil price shock of 2014, which saw GDP contracting by 1.7 percent in The economic performance has also been driven by the non oil sector (especially agriculture, and services), as well as domestic private consumption on the demand side. Nigeria s Vision 2020 development strategy aims to develop the economy to become one of the top twenty economies in the world by Fiscal policy has been generally expansionary and geared towards promoting employment, growth and development, although it has remained procyclical to oil prices. The balances of payments have presented surpluses in the past decade, benefiting from high oil prices, but have remained vulnerable to external shocks, with the recent oil price shock turning the current account surplus into deficit. The monetary policy framework has remained consistent with controlling inflation, exchange rate stabilization and fostering financial stability, while allowing gradual expansion of credit to the private sector to support economic activity. The exchange rate, domestic demand and domestic structural factors have been the main drivers of inflation, which is currently above 18%. The Nigerian Naira depreciated markedly since its floating in June The banking sector has been relatively stable, with improving financial innovations, but weakened recently following the economic slowdown. The outlook for Nigerian economy looks positive, and the economy is expected to exit recession with 1 percent growth in 2017, edging up to 2.5 percent in While some downside risks will weigh down on the prospects, Nigeria continue to present ample opportunities for investments in sectors such as infrastructure, agriculture, manufacturing, real estate, telecommunications, banking and other consumer services. 1

3 Table of Contents 1 Introduction Economic Performance Fiscal sector External sector Monetary and financial sector Medium term prospects and risks to the outlook Opportunities in the Nigerian economy Conclusion References

4 1 Introduction Nigeria s economy has transcended through various economic cycles over the years, largely shaped by movements in oil prices. This report reviews and analyses the Nigerian economy, based on recent macroeconomic developments, and discusses medium term prospects, risks and opportunities. The analysis helps to provide insights on the Nigerian economy, and highlights challenges as well as opportunities which the economy offers for investment and economic development. The Nigerian economy has been driven by the developments in the oil sector, following discovery of oil in the 1950s. Nigeria is the biggest oil producer in Sub Saharan Africa, and a member of the Organization of Petroleum Exporting Countries (OPEC). It boasts of proven oil reserves estimated at 37 billion barrels as at 2014 (OPEC, 2015). The structure of the economy has changed considerably over time, with the share of the oil sector in GDP declined significantly, while the oil revenue shares in total fiscal revenue and oil exports in total exports remains high. Today, oil accounts for about 10 percent of GDP, close to 90 percent of exports and roughly 75 percent of the country s fiscal revenues. The Nigerian GDP was rebased in 2014, to reflect the rapidly growing contributors to its GDP, such as telecommunications, banking, entertainment, hotel and tourism and informal sectors. This resulted in more than 80 percent increase in the estimated size of the economy, overtaking South Africa as the biggest economy in Sub-Saharan Africa (SSA) with GDP estimated US$415 billion in Nigeria is also the most populous country in Africa, with about 183 million people. GDP growth accelerated in the last decade, averaging 8.3% between , with the economy remaining resilient to the global financial crisis. The oil price shock of 2014 slowed the economy markedly, pushing the economy into recession in 2016, reflecting dependence on the oil sector. Growth has been driven by non-oil sectors (especially agriculture and services) in recent years, sometimes offsetting the slowdown in the oil sector to keep growth modest. Agriculture, (especially crop production) and service sectors such as financial services, telecommunications and hotel and tourism have been key drivers of growth. On the demand side, growth has been largely driven by private domestic consumption, largely boosted by a growing population especially the middle class, rising incomes and rapid credit growth. Fiscal policy has been expansionary and largely focusing on promoting employment, growth and development, but revenues and expenditures have remained procyclical to oil prices. The balances of payments have presented surpluses in the past decade, benefiting from high oil prices, but has remained vulnerable to external shocks. The recent oil price shock of 2014 has pushed the current account into deficit. The monetary policy has remained consistent with controlling inflation, exchange rate stabilization and fostering financial stability, while allowing for gradual expansion of credit to the private sector to support economic activity. Movement of exchange rate, demand as well as domestic structural factors have been the main drivers of inflation, which is currently about 18.5% (as at November 2016). Despite the economic recession in 2016, medium terms prospects for Nigeria looks positive, with the economy expected to exit recession in 2017, with 1 percent growth and expand 3

5 further by 2.5 percent in Prospects are subject to some downside risks emanating from possible continued disruption of oil production facilities in the Niger Delta region, slower than expected global economic growth, slowdown in China and policy uncertainities in the US under Trump leadership. However, economic growth drivers which appear to be more on the upside will bolster economic activity to see the economy regaining its momentum in the near term. The Nigerian economy continues to present many investments opportunities in sectors such as infrastructure, agriculture, manufacturing, real estate, telecommunications and banking. 2 Economic Performance The Nigerian economic performance has varied markedly over the years, with booms and busts, which reflected the dynamics of the oil sector, changing structure of the economy, and various economic policies. Nigeria experienced an impressive growth performance over the past decade with GDP peaking 14.6% in 2002 and averaging 8.3% over , and exceeding the Sub Saharan region s average growth of 6% over the same period, largely bolstered by the rising oil prices during the super cycle commodity price boom and increased oil production (well above the historical average of 2 million barrels per day). Nigeria was less affected by the global financial crisis, and its growth averaged 7.6 percent over , a few percentage points below the pre-crisis average growth of 8.6%, as the strong non-oil sector growth helped to keep growth strong. Growth of the oil sector has been more volatile, reflecting fluctuations of international oil prices. Oil sector GDP slumped by an average -3.6% over , as oil prices plunged by over 60 percent at the height of the crisis in Despite the decline in the oil sector, overall GDP remained strong, boosted by the non-oil sector which managed to offset the effects of the slowdown in the relatively smaller oil (17 % of GDP over ). Figure 1: GDP Growth Rates: Overall Real GDP, Oil Sector and Non-Oil Sector Real GDP Growth Oil GDP Growth Non Oil GDP Growth Sources: National Bureau of Statistics Nigeria, IMF Estimates 4

6 Real GDP growth accelerated to 11.3% in 2010, exceeding the Sub- Saharan region s average of 7%. This growth acceleration was boosted by strong recovery of both oil and non-oil sectors, thanks to resurgence in oil prices. A modest growth of 5.2 percent over was largely supported by the non-oil sector, especially strong growth in agriculture and services. The oil price shock in June 2014 significantly affected the oil sector GDP which contracted by 3.6% and weighing down overall GDP growth to 2.7% in Table 1: Selected Macroeconomic Indicators for Nigeria GDP Growth (%) GDP Per Capita ($) 1,959 2,365 2,583 2,798 3,042 3,268 2,763 2,260 2,193 GDP Nominal (Billion US$) GDP Nominal (Billion Naira) 44,287 55,469 63,713 72,600 81,010 90,137 95, , ,090 Oil Production (mb/d) Inflation (%) Unemployment (% of total labour force) Fiscal balance (% of GDP) Current Account Balance (% of GDP) Government Debt (%of GDP) Exchange Rate (N/US$) Forex Reserves (months of imports) Broad Money Supply Growth (%) Net FDI (% of GDP) Sources: IMF, World Bank, National Bureau of Statistics Nigeria and EIA Recent data shows that real GDP has contracted in the first 3 quarters in 2016, with the latest contraction of 2.24% in Q3, 2016 (NBS, 2016). The GDP contractions were largely driven by the oil sector, which declined by -22 percent, on the back of low oil prices. The positive nonoil sector expanded by 0.03%, largely driven by agriculture (4.5%) in Q3, 2016, much smaller to offset the large negative drag from the oil sector. The economy contracted by an estimated -1.7% in 2016, closing the year in recession for the first time in 25 years, as oil prices remain subdued (averaging about 43% in 2016) (Figure 1). The slump in the oil sector has spilled over to the non-oil sectors. The low oil prices and less supportive external environment interacted with some domestic forces, such as disruption of oil activity in the Delta oil region, foreign exchange imbalances and power shortages to drift the economy into recession and see nominal GDP declining to an estimated US$415 billion in 2016 (Table 1). Although the economy has been vulnerable to oil price shocks over the years, it has been diversifying from oil to other sectors such as agriculture, manufacturing and services (especially financial services, information and telecommunications, entertainment and hotel and tourism). The rebasing of the economy in 2014 revealed a more diversified economy than previously considered. The oil sector (which constitutes almost the entire mining sector s 5

7 contribution to GDP) contributes about 10% of GDP as at The contribution to GDP has been declining over the years, from of about 30% of GDP to over to 16 percent over and 10% of GDP in The contribution of agriculture to GDP has averaged about 24 % between 2006 and 2014 (Figure 2), with crop production accounting for over 90% of the total agriculture production and the remaining livestock production forest and fishing taking the balance. The contribution of manufacturing has been low, but steadily increasing from 8% of GDP in 2008 to 10% of GDP in 2015 as efforts to diversify the economy continues. The Services sector is the biggest contributor to the economy, with contributions increasing steadily in recent years, to the estimated 54% of GDP in The Nigerian economy is reasonably broad based compared with other Sub-Saharan countries. Agriculture is by far the largest contributor to employment, absorbing over 60% of the working population (AEO, 2016). Figure 2. GDP by Sectors (% shares) Source: Central Bank of Nigeria Agriculture Mining Manufacturing Other Industry (Electricity,Water and Construction) Services Sectoral growth rates reveal a variegated picture of the growth rates of the sectors. The agriculture sector experienced steady growth, averaging 4.4% between 2010 and Agriculture growth peaked in 2012, with growth of 6.7% supported by a favourable rain season. Manufacturing has been expanding at robust paces, with average growth above 11% between 2010 and 2015 driven by strong growth in cement, chemicals and pharmaceuticals and textile and footwear sub-sectors. The services sectors including the ICT, hotel and tourism, entertainment have posted solid growth rates, reflecting rising incomes in the working age populations especially the middle class. Public administration was rather slugish possibly reflecting increasing bureacratic hurdles and governance challenges in government. 6

8 Table 2: Sectoral Growth Rates Average Agriculture Oil and gas Manufacturing Construction Trade Transport Information and Telecommunication Electricity and Water Accomodation and Food Services Finance & Insurance Real Estate Professional and technical services Public Administration Education Health and Social Services Arts, Entertainment and Recreation Other Services Overall GDP growth Source: Central Bank of Nigeria On the demand side, GDP is largely driven by private consumption, which accounts for about 63 %, reflecting the large size of the population and rising incomes. The contribution of government expenditure has been small, and continued to decrease steadily from 9% in 2010 to 6 % in 2015, while investment has been relatively stable, averaging 16% of GDP between 2010 and The contribution of net exports has doubled in the last 5 years, to 16% of GDP, reflecting reduced domestic absorption and increasing savings over investment, which propelled the current account balance into surplus. 7

9 Figure 3: GDP by Expenditure (% share %) Household Consumption Government Consumption Investment Net Exports of Goods and Services Source: Central Bank of Nigeria Nigeria s population grew at an average rate of 3 % between 2000 and 2016, from 122 million people to an estimated 183 million in The population is projected to reach 310 million people by 2035 (UN Population, 2016). Real GDP has grown by an average rate of 6.3% between 2008 and 2015, which saw the size of the economy more than doubling in this period. Real GDP per capita has grown at 3.6 % between 2008 and 2015 to average $2627, well below the SSA region of $ The many years of oil driven growth has also not significantly reduced poverty, which has remained elevated, with 46% of the population still lives on less than US$2 per day (World Bank, 2016a) Oil production has been increasing steadily in the last decade, with production above historical averages of 2 mb/d. Oil production, which peaked 2.5 mb/d in December 2005, declined to 2.1 mb/d in Q1, 2016 and further to 1.6 mb/d by October 2016 due to disruption of oil production infrastructure by the Niger Delta Avengers and other militant groups. Nigeria produces only about 2.6% of the world's oil supply in comparison with Saudi Arabia, with (13%), Russia with (12.4%) and United States with 13 % (BP, 2016). The Nigeria economy has benefited from several episodes of commodity/oil price booms. The super cycle commodity boom from saw oil prices rising by more than 400% to peak at $133 per barrel in July 2008 (Figure 4). The Nigerian government took advantage of the oil price boom to increase oil production to levels above 2mb/d. The oil price shock of 2014 saw oil prices plunging from $110 in June 2014 to $31 in January 2016, which slowed down the Nigerian economy to 2.7% in The confluence of persistent low oil prices, disruption of oil production, low government spending (due to lower oil receipts), foreign exchange shortages and restrictions and tighter 8

10 monetary policy stemming from managing inflationary pressures from the depreciating exchange rate continued to depress economic activity in 2016 (as growth slided to -1.7% in 2016), with significant implications for employment, fiscal revenues, and financial sector stability. These challenges have compounded other preexisting structural bottlenecks in the Nigerian economy: infrastructure deficits, especially electricity, high unemployment and low access to credit to private sector (19.8% of GDP). The new government led by Muhammadu Buhari, which came in May 2015 adopted an expansionary fiscal policy in 2016 anchored on huge infrastructure programme in order to stimulate the economy and address the constraints facing the economy. The low oil prices have led to sharp decline in fiscal revenues and cuts in expenditures as the economy adjusts to what is believed to be a new normal of low prices. The fiscal and external balances turned from surpluses to deficits, while inflation has leaped to double-digit figures (18.5% as at November 2016) and the exchange rate depreciated significantly, especially after it was floated in June Unemployment rate has increased from 6.4 percent in 2014Q4 to 13 percent in Q2, As the economy painfully adjust to the lower oil price environment, growth is likely to remain well below historical trends in the short term. Figure 4 : Brent Oil Prices and Oil production in Nigeria Brent Oil price Oil production (mb/d) Sources: EIA; CBN Private sector-led economic growth continue to be affected by the high cost of doing business, including power shortages and other infrastructure deficits in transports and social services. Infrastructure deficits especially power, road, rail and social services remains constraints to economic activity, being characterized by low access and high costs, and affecting the country s competitiveness. Nigeria s electricity production is well below other peer countries at 26 billion KWh, compared with for example Algeria with 45 billion KWh. Power outages in firms is elevated at 33 per month compared with SSA average of 8 per month. Shortages of power sector is forcing households and businesses to resort to diesel and petrol generators to meet their power needs. This underscores the need to make concerted efforts in investing in power infrastructure to enhance competitiveness. Nigeria benefits from the proximity to the 9

11 sea and have 3 main ports that is Lagos, Harcourt and Port Calabar. The quality of port infrastructure is modestly comparable to other peer African countries, at 3 out of 7 compared with Mauritius and South Africa at 4 out of 7. Mobile cellular subscription trails behind peer economies, at 677 per 1000 people, while it is 1306 per 1000 people in South Africa and 1131 per 1000 in Mauritius. The road network is comparable to the SSA region, but lacks timely maintenance, which reduces efficient connectivity. African Development Bank data shows that about 72% of roads are paved in Nigeria, compared with 98 % in Mauritius. The country is in the process of implementing reforms, which are opening doors to private investors to help in addressing infrastructure deficits, especially power and transport. To date, over 10 generation and distribution companies were successfully privatized in 2014, while the transmission company was placed under a management contract to improve efficiency (World Bank, 2016b). These includes reforms in the transport seaports, energy sector. The energy sector is undergoing a major restructuring that is paving the way for performance improvements, including a move towards electricity tariffs that recover a larger share of operating costs in the sector. In the ports sector, the government is exploring pragmatic reforms and transitioning to landlord models and terminal concessions to attract private investment into the sector. Nigeria s recent growth performance has benefited from peaceful political transitions since the 1990s. The most recent elections in March 2015 in which Muhammadu Buhari won saw a peaceful transition. The new government pledged a number of reforms to boost the economy, focusing on economic diversification, infrastructure development, job creation, security and anti-corruption. The country s development path is well defined in the Vision The vision focuses on transforming the Nigerian economy and growing it become one of the top twenty world economies by This is expected to be achieved by maintaining macroeconomic stability, fostering economic diversification, stimulating the manufacturing sector and strengthen its linkages, improving competitiveness and deepening the financial sector and increase investment in infrastructure and human capital development and deploying relevant mix of macroeconomic policies. 3 Fiscal sector Fiscal policy thrust has been generally expansionary, geared towards promoting employment, growth and development. Over the years, fiscal revenue performance has been largely determined by movements in oil prices, since over 70% of revenues comes from oil (Ministry of Finance, Nigeria, 2016). Fiscal revenue fluctuated from 10% of GDP in 2009 to 18% of GDP in 2011, and dropped to an estimated 6% of GDP in 2016, reflecting the decline in oil prices. Fiscal sector continues to be constrained by dominance of oil revenue. Total revenue accounts for 13.2 % of GDP, of which tax revenue accounts for 2.6% of GDP, as much of the revenue from the oil sector is non-tax revenue. Oil revenue is about 9.2% of GDP. Expenditures averaged about 13% of GDP over , remaining well below SSA average of 20% of GDP over Government expenditure is highly skewed towards current expenditures, which constitutes 74% of total expenditure. In 2015, public expenditures constituted about 10

12 15.6% of GDP, with 12% absorbed by current expenditures, and 3.6% by capital expenditures (AEO, 2016). To promote more growth, it is necessary to adjust the budget and increase expenditure in capital projects, which is more growth supportive. The fiscal sector posted a budget surplus of 5.7% in 2008, despite the global financial crisis. Rising expenditures over has narrowed the gap between revenues and expenditures, wiping out fiscal surpluses which have been accumulated during periods of oil price booms (Figure 5). Lower oil prices significantly reduced fiscal revenues from 11% of GDP to just 7.2 percent of GDP in 2015, resulting in more than doubling of the general government deficit from 1.2% of GDP to about 3.8% of GDP in The government deficit widened to an estimated 4.6 % of GDP in 2016 (Table 1). In addition to low oil prices, in 2016, fiscal revenues have also been affected by the decrease in oil production due to disruption of oil production facilities. The slump in fiscal revenues resulted in cuts in expenditures both at the federal and state levels, with capital expenditures endured the most of the expenditure cuts. As revenues remain subdued, salary arrears have been accumulating especially at the sub-national levels of government in 2016 while fiscal deficit is increasing (CBN, 2016a). Rising fiscal deficit, projected at 4 percent in 2017, is raising concerns about fiscal sustainability especially in light of the huge infrastructure programme, which was launched in Public debt has been rising from 7% of GDP in 2008 to about 15% of GDP in 2016, reflecting larger-than-historical debt levels (10 % of GDP over ) stemming primarily from the reduction in oil revenues. Nigeria has maintained low debt/gdp ratio since exiting the Paris club in 2006 when close to US$20 billion debt was cancelled. To date the country s public debt has been maintained below the average public debt for SSA (about 40% of GDP), possibly indicating that the economy still has the capacity to borrow to finance its huge infrastructure programme. The government is already tapping external resources, especially multilateral sources. It has secured USD1 billion from the African Development Bank (US$ 600 million for budget funding, with an additional USD 400 million disbursement dependent on the implementation of reforms) (AEO, 2016). It plans to access additional loans from the World Bank, Islamic Development Bank and issue Euro bonds in The debt sustainability analysis by the IMF (2015) project public debt to rise by eight percentage points between 2015 and 2021 (IMF, 2016a). Gross financing will remain higher than the historical average and debt service is projected to represent a higher share of fiscal revenue. Although still low compared to the SSA average and other SSA oil exporting countries, Nigeria s debt dynamics remain vulnerable to macroeconomic shocks, especially to primary balance and interest rate shocks. The level of external debt is low (about 2.2 % of GDP in 2015), but is projected to increase moderately in the next few years due to expected increase in public external borrowing. 11

13 Figure 5: Fiscal indicators (% of GDP) Government Revenue (%of GDP) Fiscal Balance (% of GDP) Government expenditure (% of GDP) Public debt (% of GDP) Source: CBN Fiscal policy in 2016 remained expansionary, with a strong focus on infrastructure spending to address structural bottlenecks, stimulate the economy and enhance competitiveness. The policy also includes reforms expected to boost fiscal revenues and its management, reduce revenue leakages, and enhance the efficiency of public investments, cut non-essential expenditures and enhance security in the country. The key reforms include the rationalization of the public sector, enforcement of the treasury single account (TSA), broadening of the tax base and improve tax and customs administration and provisions of fiscal incentives to encourage the industrial and manufacturing sectors. The government has made significant gains in terms of governance and transparency in the oil sector, for example, in restructuring the Nigerian National Petroleum Company (NNPC), raising operational efficiencies at the refineries. The Petroleum Investment Bill (PIB), which has been stack for a number of years, is expected to be passed by the Senate in 2017 (Moody s, 2016). In October 2016, the Nigerian government proposed a US$30 billion infrastructure programme to develop transport, energy, ICT infrastructure as well as social services infrastructure (health, education and water resources). The programme is expected to be financed from external as well as domestic sources. Over a period of three years, about $11.3 billion would be spent on certain proposed projects and programmes, while $10.7 billion would be spent on special national infrastructure projects and $3.5 billion for federal government budget support. About $4.5 billion is expected to come from Eurobonds per cent of the foreign loans have been earmarked for infrastructure projects, while social programmes in health and education, the federal government's budget support facility and agriculture support will absorb the rest. The infrastructure projects include Mambila hydroelectric power plant ($4.8 billion), railway modernisation coastal project (Calabar-Port Harcourt-Onne Deep Seaport segment) ( $3.5 billion), Abuja mass rail transit project (Phase 2) 12

14 ($1.6 billion), Lagos-Kano railway modernisation project (Lagos-Ibadan segment double track) ($1.3 billion), Lagos-Kano railway modernisation project (Kano-Kaduna segment double track)($1.1 billion) and others - $6 billion (Balma and Ncube, 2016). 4 External sector Nigeria s trade accounted for about 25 % of GDP in About 97 % of Nigeria s exports came from oil and gas in 2000, but have decreased to 92% by The country s external sector remains vulnerable to oil price fluctuations. Exports of goods and services as a share of GDP have been declining from the peak of 50% of GDP in 2000 to about 10% of GDP in Exports averaged 40% of GDP over , largely reflecting the commodity super cycle over much of this period. They declined sharply to 18% of GDP over , well below the SSA average of 30% of GDP, reflecting both oil price dynamics and declining contribution of oil exports in GDP and as GDP base continued to broaden towards other non-traded goods and services. Imports have been following the trend of exports, averaging 25% of GDP over , but declining gradually to 17 % of GDP over the The current account balance recorded higher surpluses during , which shrunk sharply over due to lagged effects of the global financial crises. The oil price shock in 2014 led to a sharper decline in exports, than imports, turning the current account surplus into a deficit (-3.1% of GDP in 2015) (Figure 6). The current account deficit was largely financed by capital inflows, drawing down on international reserves and remittances. In 2014 capital inflows were dominated by portfolio investment that accounted for over 70% of total capital inflows but this declined significantly in 2015 and first half of 2016, as external financial conditions worsened. Net foreign direct investment as a share of GDP has been declining from an average of 2.1 % of GDP over to 1.2 % of GDP over This highlights the need to put in place policies and incentives to attract FDI, and improve conditions for doing business. Figure 6: Exports, Imports and Current Account Balance (% of GDP) Exports of goods and services (% of GDP) Current account balance (% of GDP) Imports of goods and services (% of GDP) Sources: IMF and World Bank 13

15 N/$ US$ billion The main export destinations for Nigerian exports are the European Union, which accounts for 34% of exports, India (17%), Africa (17%), Netherlands (9%), Spain (9%), and Brazil (8%). The main sources of imports (mainly manufactured products, capital goods, refined fuel and food) include China, which accounts for (25%), the EU (22%), USA (7%), Netherlands (6%), India (4.3%) and Africa (4.2%) (IMF DTS, 2016). Nigeria is a key member of the Economic Community of West African States (ECOWAS) and the ECOWAS Common External Tariff (CET) arrangement. Nigeria s exports to the ECOWAS are low at less than 3% of total exports as at 2015, reflecting relatively weak level of integration. Much external reserves were accumulated during periods of BOP surpluses, which peaked at US$53 billion in 2008, and gradually declined as BOP surpluses narrow (Figure 6). Intense external pressures especially on the Naira in 2015/2016 resulted in sharp decline in reserves (-12.4%) to US$24.8 billion between December 2015 and November The susceptibility of Nigeria s external sector to oil price shock suggests that export diversification must remain a policy priority in order to insulate the country from external shocks. The Nigerian naira has been stable since as the central bank tightly managed the exchange rate. The management of the Naira exchange rate however came at a cost of loss of foreign currency reserves. The decline in foreign exchange inflows led to huge imbalances in the foreign exchange market, characterized by foreign exchange shortages, growing overvaluation of the naira, parallel foreign exchange market and diverging official exchange rate and parallel exchange rates. The naira was floated on 20 June 2016, which saw the exchange rate depreciating by about 60% between June and November While floating of the naira helped to reduce macroeconomic imbalances somewhat, foreign currency shortages and the concomitant import restrictions have persisted in the economy. The persistence of large wedges with parallel exchange rates in Nigeria estimated at 25 percent at the end of August 2016, suggests that the foreign exchange market remains in disequilibrium (IMF REO, 2016) Figure 6: Exchange Rate and Foreign Exchange Reserves Exchange Rate (N/$) External Reserves - Stock (US$' billion) - Source: CBN 14

16 5 Monetary and financial sector Nigeria operates a monetary targeting policy framework, which is focused on price stability, exchange rate stabilization, financial stability, while allowing the expansion of credit to the private sector to stimulate economic growth. The Central Bank of Nigeria continues to align monetary policy with fiscal policy to support diversification of the economy, job creation and broad-based economic growth. Over the years, monetary policy has relied on open market operations, monetary policy rate, and cash reserve requirement ratio and reserve money, supported by prudential provisions to achieve its objectives. Credit to private sector increased from 8% of in 2000 to peak at 36% of GDP in 2008 in line with the expansion in M2 to GDP ratio, reflecting expansionary monetary policy aimed at stimulating the economy, to counter the effects of the global financial crisis in However, credit to private sector has decreased to 19.9% in 2015, as the government absorbed much of the credit. Over period, credit to private sector has averaged 22.5% of GDP, much lower than the SSA average of 29% over the same period (Figure 7). Monetary policy appears to have been less effective in stimulating economic activity in recent years, as much of the credit was absorbed by the public sector. Higher credit to government was necessitated by the continued decline in oil receipts especially in Figure 7: Credit to private sector and M2 (% of GDP) M2/GDP (%) Credit to Private sector (% of GDP) Source: CBN Inflation averaged about 11.6 % between , which reduced to 8% over, , as the exchange rate was successfully managed. As the exchange rate come under pressure in 2015/2016, inflation began to soar, accelerating more after floating of the naira in June to reach 18.5 % in November According to the CBN 2016, and Lariau et al. (2016), inflation is largely driven by exchange rate pass-through following the floating of the currency in June 2016, increases in food prices caused by intermittent fuel scarcity, high cost of energy and rising prices of imports. Figure 7 suggests that money supply growth and exchange rate could 15

17 be important in driving inflation. In July 2016 the central bank increased the monetary policy rate (MPR) to 14% from 12%, while the cash reserve ratio (CRR) and the liquidity ratio were maintained at 22.5% and 30% respectively in an attempt to fight inflation and manage liquidity. These ratios have been maintained until November 2016, despite further increases in inflation, possibly to balance with the need to stimulate growth. Figure 8: Inflation, Money Supply Growth and Exchange Rates Source: CBN Inflation (%) (left axis) Exchange Rate(NGN/US$) (right axis) Broad Money Supply Growth (% change) (left axis) The Nigeria's banking sector has witnessed significant growth over the last few years as new banks entered the market. Total assets of the banking sector to GDP grew from an average 27% of GDP over to 32% of GDP over , but remain below the average for SSA of 54% of GDP over the same period. This suggests that there could still be room for further growth of the sector. The banking sector has been stable in recent years. However, slowdown of the economy since 2014 has weakened the sector somewhat. Capital adequacy ratios (ratio of total capital to risk weighted capital) has been decreasing slowly from 18.3% in December 2012 to 14.7% in June 2016 reflecting the slowdown of the economy. Asset quality has deteriorated, with non-performing loans tripling from 2.9% in December 2014 to 11.7% by June 2016 (Table 3). Liquidity (as measured as the ratio of total specified liquid assets to total current liabilities) has remained higher at 39.6% than the prescribed ratio of 30% in Interest income has remained the dominant source of income for the banking sector, but appear to be trending downwards gradually, as banks diversify their portfolios and launch new products. The banking sector however is in the process of recapitalizing their balance sheets, which presents an investment opportunity in this sector. Nigeria s financial infrastructure has been improving in recent years, thanks to rapid technological advancements, which are helping to boost efficiency in the sector and 1 Capital adequacy ratio is measured as the ratio of total capital to risk weighted capital. Liquidity ratio here is measured as the ratio of total specified liquid assets to total current liabilities. Data from CBN Financial Stability Report, June

18 permitting greater financial inclusion. The volume of electronic transactions (including mobile banking, internet banking, automated teller machines, point of sales) increased by 14 % to 315 million transactions, while the value increased by 10% to N2,874 billion in the first semester of 2016 compared to the first semester in Table 3: Selected Financial Soundness Indicators, Nigerian Banking Sector Non-Performing Loans to total loans Liquid assets to total assets Capital to Risk weighted assets Interest Margin to gross Income Non Interest expenses to gross income June 2012 Dec 2012 June 2013 Dec 2013 June 2014 Dec 2014 June 2015 Dec 2015 June Source: CBN, Financial Stability Report, June 2016 The Nigerian stock market has been fluctuation in tandem with other emerging market stocks and developments in the global markets. The index declined by 19 percent between 30 December 2015 and January 2016 to points, amid heightened volatility in the global financial markets. The index also shed some points following the Brexit vote in the UK in June 2016, reflecting the strong integration of the Nigerian financial sector to global financial markets. Figure 9: Nigeria Stock Market Index Source: Bloomberg Nigeria s credit rating was downgraded by S& P in September 2016 from B+ to B, but the outlook was upgraded to stable from negative. The main concerns relate to weakening 17

19 economy, amid low prices and decline in oil production and rising debt servicing costs. The credit rating by Moody s and Fitch remain B1 and B+ with stable outlook respectively. Nigeria plans to issue another Eurobond in 2017, following the last issue in 2013, to finance its planned higher infrastructure programme. The decline in foreign exchange liquidity following the oil price shock in 2014, has resulted in Nigeria being excluded from the J.P. Morgan local government bond index in 2015, raising bond yields and borrowing costs. 6 Medium term prospects and risks to the outlook Economic conditions have remained challenging in 2016, with economy closing the year in recession, at -1.7 % growth on the back of persistent low oil prices, compounded by oil production disruptions in the Niger Delta, foreign exchange shortages and electricity shortages. Growth is projected to pick up to the positive territory of 1% in 2017 as oil prices stabilize somewhat in This follows the agreement by OPEC and other oil exporters to cut production by combined 1.8 million barrels per day (mbpd) from January Oil production is expected to normalize with the stoppage of attacks on oil infrastructure attacks in the Niger Delta, following some truce with militant groups and the resumption of payments from the government at the end of A gradual rebound in international oil prices will also support renewed investment in the economy. The fiscal drag is expected to moderate somewhat, while activity in the non-oil sector could also pick up in The outlook is expected to strengthen further with growth edging up to 2.5% in The government s large infrastructure programme and other structural reforms are expected to enhance productivity, boost domestic demand and provide some impetus for growth in the medium term. Improvements in electricity generation because of the public infrastructure investments is expected to support a recovery in non-oil growth. Similarly, reforms in the oil sector will help to improve governance in sector and facilitate an expansion in production with greater clarity in the regulation of the sector. The foreign exchange market is expected to normalize in 2017, with dissipation of distortions, improvement of liquidity and moderation of exchange rate volatility. Expected improvement in global economic conditions in 2017 would also lift external demand for Nigerian exports. We also expect Nigeria's current account to narrow to about -0.4% of GDP in 2017 and possibly balance in 2018, supported by increasing exports as oil production and prices increase and falling imports. We expect foreign exchange reserves to grow modestly in 2017, exports to improve, and the foreign exchange market gradually balances. Improved foreign investor sentiment is expected to further support the rebalancing of the economy, while portfolio capital inflows will improve foreign exchange US dollar liquidity and gradually reduce the exchange rate gap between the official and the parallel market. However, the outlook is subject to a number of risks. The main risk relates to partial recovery of oil prices amid complications in uniting OPEC members and non-members on oil production cuts. Instability in the Niger Delta remain an important risk amid multiple militant groups with different interests, which could overturn agreements to stop disruptions of oil installations. In addition, while insurgency from Boko Haram militants has subsided somewhat, it remains 18

20 a risk to economic activity in the northern regions, which could divert government s attention and resources from more pressing economic issues. Further rise in insurgences will also raise humanitarian challenges, with the number of internally displaced persons now estimated at over 2 million (AEO, 2016). The rebalancing of the Chinese economy is still raising concerns given the recent surge in property market prices, which are starting to cool off amid high credit growth, high local government debt and large shadow banking in the economy. The possible risk of disorderly unwinding of the property market in China could be disruptive, thereby complicating the ongoing rebalancing of the economy and induce volatility in the financial markets, depress commodity prices, possing a headwind to the Nigerian economy. Global recovery remains fragile especially in advanced economies amid uncertainties of the Brexit process and trade policy uncertainties following Trump s victory in the US, which could slow external demand for Nigeria s exports and lower capital flows. The shortages of energy remain a constraint to economic activity and rising energy tariffs are feeding into inflation. Projections suggests that inflation will remain elevated to average 17.1% in 2017 (IMF WEO, 2016). The banking sector could also weaken further if the economy continues in recession. Rising fiscal deficits will raise the need for both domestic and external financing. The pace of recovery of the economy will depend on how fast reforms and measures to boost the economy, such as increased spending on infrastructure are implemented and disbursement of external loans. 7 Opportunities in the Nigerian economy Despite attendant risks, there are a number of investment opportunities in the Nigerian economy. Nigeria has huge infrastructure deficits especially in power. With respect to power, the country is characterised by power outages and low household access, which is raising the cost of doing business and reducing competitiveness. Only 56% of the population have access to electricity in Nigeria, compared with 100% in Mauritius, 99% in Algeria and 85% in South Africa. Addressing power shortages requires huge investment in generation, distribution and maintenance of existing facilities. The government is intensifying efforts to rehabilitate and expand infrastructure across the country and is looking for private investors to collaborate in developing the country s infrastructure. Development of infrastructure will also catalyse growth in other sectors. Nigeria is the biggest economy in Africa with GDP of US$ 415 billion which is projected to grow to about US$595 billion by 2020, which presents a big market for goods and services. GDP per capita currently at 2,260 is projected to leap to $2, 907 by 2020, which could boost consumption and domestic demand for goods and services. Nigeria has a relatively youthful population and a growing middle class, which represents a new emerging market. The population between years in Nigeria is estimated at 53% of total population, while the number of middle-class population is estimated at 30% of the population and expected to grow further in the coming years (AFDB, 2011). The rise in the 19

21 middle class consumers represents an expanding workforce, rising disposable incomes, and a growing market for goods and services. In addition, Nigeria is urbanizing rapidly, with fast-growing cities such as Lagos and Abuja and Kano presenting growing needs for job creation, urban infrastructure and basic services. Current estimates suggest that about 52% of the population live in urban areas, and the figure is projected to rise to 65% by 2020 (AEO, 2016). These growing cities presents high potential for innovation and job creation opportunities in sectors such as construction, information communications and technology (ICT), retail trade and consumer sectors. Mckinsey Global Institute (2016) estimates suggest that per capita consumption is more than double the national average in these cities. Rapid urbanization will also support the emergence of business clusters that stimulate productivity, innovation, and the creation of new businesses. Also, booming population growth in these cities is expected to increase demand for utilities such as water, power and roads, which are currently being provided insufficiently. Economic diversification is at the heart of the new development policy of the government, with a focus on value addition and value chain development especially in agriculture, manufacturing and services, thus presenting considerable opportunities in these sectors. Manufacturing in Nigeria has the potential to grow further and drive economic diversification, as it constitutes 9.5% of GDP, well below other peer African countries: Kenya (11%), South Africa (13%), Mauritius (16%). Visible opportunities are in creating industrial clusters to increase value addition in resource sectors (oil refinery) and agro processing value chains as well as in service sectors. Although Nigeria exports crude oil (90% of total exports), it imports refined oil which accounts for about 16% of total imports. Refining oil in Nigeria could save a significant portion in foreign currency, while boosting employment and domestic demand. There are ample opportunities in fast growing consumer service sectors such as telecommunications, tourism and real estate sectors which continue to growth at robust paces averaging 15%, 19.5% and 7.3% over respectively (CBN, 2015). According to Mckinsey Global Institute (2016), Nigeria will remain SSA s single largest consumer market, accounting for 15 percent of overall growth in consumer spending to 2025, especially in food and beverages, housing, consumer goods, education, telecommunications and transportation services.telecommunications sectors with links to financial infrastructure are creating significant value in new financial products such as mobile banking and fostering financial inclusion. Rapid new technology adaptation is driving growth of consumer industries and altering the way people connect, transact and interact and offering the country a huge opportunity to enhance growth and productivity. The tourism and hospitality sector currently contributes about 1.7% to GDP, which is much lower than the SSA average of about 7%, and other peer countries such as Kenya (10%) and Tanzania (12%) (WTTC, 2016), suggesting further upside growth potential. Nigeria has a sovereign wealth fund with about US$1.4 billion in assets, drawn from oil receipts and geared towards economic stabilization, savings for future generations and infrastructure 20