VOLUME 5 ISSUE 28 Research Weekly July 22, 2016 Inside This Issue 1. Nigeria s Macroeconomic Review in 1 st Half 2016 and Outlook for 2 nd Half 2016 Nigeria s Macroeconomic Review in 1 st Half 2016 and Outlook for 2 nd Half 2016 Nigeria s economy was in bad shape in the first half of 2016. All major macroeconomic indicators deteriorated. In the first quarter (Q1 2016), the economy contracted; and given slow fiscal interventions in the second quarter (Q2 2016), it is almost certain that economic output growth in the second quarter would again be negative. The economic contraction worsened employment generation as both unemployment and underemployment rates soared. Foreign exchange (FX) inflows nosedived, culminating in negative balance of trade numbers, foreign reserves depletion, and naira depreciation at all FX markets. The high price of imported goods and rising energy costs propelled sharp increase in the consumer price index, such that by June 2016, the headline inflation rate had risen to 16.48% the highest rate in 11 years. GDP Growth Rate Ifeanyi Uddin augustine.uddin@first banknigeria.com Tunji Inaolaji Olatunji.J.Inaolaji@first banknigeria.com The Nigerian economy witnessed a slower growth rate in 2015. In the first three quarters, the gross domestic product (GDP) growth rate declined, from: 6.21% in Q1 2014 to 3.96% in Q1 2015; 6.54% in Q2 2014 to 2.35% in Q2 2015; and 6.23% in Q3 2014 to 2.84% in Q3 2015. We, however, expect a paradigm shift in the domestic economy in 2016. With the expansionary budgetary provisions of the federal and state governments, the GDP growth rate outlook for the year looks bright. For instance, the federal government s appropriation bill for 2016 (N6.08 trillion) is about a third higher than the preceding year s budget; and unlike in 2015 when there was poor capital project implementation, we expect a very high traction in infrastructure development in 2016 What actually happened in 1 st Half of 2016 (H1 2016) Our projection was based on early passage and implementation of the federal government s N6.06 trillion budget, the complementary role of subnational government s expenditure (especially by leveraging the bailout funds to pay civil servants), and the political will to implement important reforms early enough in 2016. Unfortunately, the delay in implementing these tasks had negative impact on the economy. Rather than grow, the economy then contracted (by 0.36%) in Q1 2016. The Q2 2016 output growth would likely remain in negative territory, since not much was done early in Q2 2016 to reverse the negative slide. Economic contraction over two consecutive quarters would mean the economy is technically in recession.
PAGE 2 Source: NBS, FirstBank Research Outlook for the 2nd Half of 2016 (H2 2016) The domestic economy may still witness negative output growth in H2 2016, in spite of the positive signals from the FG s capital budget implementation, liberalisation of the interbank FX market, deregulation of the downstream portion of the nation s oil industry, and the putative boost to consumer expenditure (since the nominal naira gains from the FX liberalisation and the removal of subsidy payments on refined petroleum products have enhanced the capacity of subnational governments to pay civil servants their salaries). The main downside considerations to the output outlook include the adverse impact of the renewed violence in the Niger Delta region, spearheaded by the Niger Delta Avengers attacks on oil pipelines which has lowered crude oil exports revenue for H1 2016 and the projected revenue for H2 2016, and has reduced electric power supply and infrastructure investment. Consistent with most commentators on the economy, including the International Monetary Fund (IMF), we have revised downwards our projection for domestic economic growth in 2016 from positive to negative. Oil Price The oil price trend since August 2015 has, particularly, been appalling. It now trades below $40 per barrel. Worse still is the oil price outlook, which some analysts and research institutions, including the International Monetary Fund and Goldman Sachs, have projected to touch $20 per barrel in 2016...The supply/demand imbalance will persist. Ensuing glut will continue to weigh on price, with the benchmark blend trading c.us$30-32 per barrel Average crude oil price per barrel for H1 2016 ranged between US$28.37 (Venezuela s Merey crude oil grade) and US$41.37 (the United States LLS Light Louisiana Sweet crude oil blend). This falls within our year-end 2015 projection of US$30-32. Source: OPEC, FirstBank Research
PAGE 3 Only two crude oil grades recorded average prices above US$40 in H1 2016 (Sahara Blend Algeria, and Merey). The average price per barrel of other crude oil blends, including the common crude oil grades (Arab Light Saudi Arabia, West Texas Intermediate (WTI) USA, Brent United Kingdom, Bonny Light Nigeria, etc.), was below US$40. Crude oil supply glut, the unfolding macroeconomic dynamics of the UK s exit from Europe, China s slowing economy, regional politics, and uncertainties in crude oil production in some oil producing nations (e.g. Nigeria) will continue to influence the direction and pace of crude oil price movements. We expect the average crude oil price to hover around US$45-50 in H2 2016 higher than the US$38 used for the 2016 appropriation act. Nigeria will only benefit partially from the increase in crude oil price, given the renewed violence in the Niger Delta area, which has significantly reduced the country s oil production and exports. Foreign Reserves Not surprisingly, the country s foreign reserves have taken the heat for the huge and persistent drop in oil prices. So far in 2015, there has been no meaningful accretion to the reserves. Instead, we have seen a sustained depletion in the reserves, which is now below $30 billion. Attempts to meet the increasing legitimate forex demand led to the drop in the reserves, from US$39.5 billion on October 2, 2014 to US$29.1 billion on December 29, 2015. A depletion of US$10 billion in less than 15 months!...[in 2016], accretion to foreign reserve balance will be attenuated, even as the CBN [Central Bank of Nigeria] reduces the rate of depletion on the reserve The depletion in foreign reserves continued in H1 2016. In six months, the external reserves fell by US$2.62 billion: from US$28.98 billion on January 4, 2016 to US$26.36 billion on June 30, 2016. This compares favourably with the US$6.03 billion drop in foreign reserves in H1 2015 (in spite of the intense FX demand management policy embarked upon by the regulator during the period) and US$5.49 billion depletion in H1 2014 (despite higher FX inflows). Source: OPEC, FirstBank Research In an attempt to reduce the rate of depletion and facilitate a more flexible exchange rate, the CBN on June 20, 2016 relaxed the FX policy.
PAGE 4 Now that the FX market has been fully liberalised, we expect a restoration of investors confidence in the domestic economy, which should facilitate a notable increase in FX inflows. But before this happens, the CBN may have further recourse to the foreign reserves in H2 2016 (howbeit at a slower pace) if it is to support market liquidity. Exchange Rate The pressure on the naira exchange rate reached a climax in February 2015 when the CBN closed down the Dutch Auction System (DAS) segment of the forex market...we expect the CBN to continue with its forex control measures until the emerging realities in forex management compel it to consider another round of naira devaluation. If recent experience (e.g. naira devaluation in November 2014) is anything to go by, the naira may be devalued to N230-240/$ at the interbank forex market. This may happen in the first half of 2016 The CBN s management of the FX peg failed to either dampen FX demand pressure or facilitate a stable naira exchange rate. Naira depreciated at all FX markets, even as the gap between the naira exchange rate at the interbank and parallel markets widened. At the interbank FX market, for instance, naira depreciated by N82.95 from N199.37/US$ on January 4, 2016 to N283/US$ on June 30, 2016. Source: OPEC, FirstBank Research To engender a more flexible and stable naira exchange rate, close the gap between the naira exchange rate at the interbank and parallel FX markets, and encourage foreign investment and remittances inflows, the CBN on June 20, 2016 dumped the fixed exchange rate system for floating exchange rate system. In order to accelerate the limited gains from the recent liberalisation of the interbank FX market, the CBN removed some elements in the revised FX guidelines that were perceived as obstacles to full FX liberalisation. We expect the refined guidelines to enhance investors confidence in the domestic economy by H2 2016, thereby facilitating a more stable and market-determined naira exchange rate.
PAGE 5 Inflation Rate The single digit inflation rate regime that re-emerged in January 2013 was sustained in 2015... Notwithstanding this relative comfort zone of the price level, there were fears of a possible return to double digits inflation rate. The fears became stronger in June 2015 when the food consumer price index (CPI) rose to double digits, and the resultant effect of the increase in the food CPI pushed up the inflation rate to 9.2%...The rise in inflation rate so far...is a pointer to a higher inflation rate regime in 2016 when both the federal and subnational governments begin to fulfil their campaign promises. Thus, inflation rate may rise to double digits in H1 2016 In line with our CPI forecast, double digit headline inflation rate re-emerged in February 2016, and has remained above that threshold ever since. The rate rose by 16.48% in June 2016 the highest headline inflation rate since November 2005. Source: NBS, FirstBank Research June s headline inflation rate is 632 basis points higher than the National Bureau of Statistics (NBS) inflation rate outlook (10.16%) for 2016, and 448 basis points above the Monetary Policy Rate (12%). Rising inflation since February 2016 is due to: depreciation of, and volatility in, naira exchange rate; high costs of petroleum products; and the 50% 65% increase in electric power tariffs. In H2 2016, we do not expect the drivers of the spike in CPI to exert the same degree of pressure they exerted on CPI in H1 2016. As the cost push impact of energy and imported goods components of CPI reduce, we expect a moderation in the headline inflation rate in H2 2016 although the index would still remain in double digits bound all through the year. Interest Rate The accommodative monetary policy since September 2015 has facilitated an increase in the banking system liquidity. And given the narrowing window of investment opportunity for the banks deposits, and the dwindling capacity of companies to gain access to loans from the banks, there was excess liquidity in the banking system in the last quarter of the year... In order to entrench its price stability mandate, the CBN may, instead, return to contractionary policy stance as it mops up excess liquidity emanating from the expansionary fiscal policy
PAGE 6 In March 2016, the CBN s rate-setting committee the Monetary Policy Committee (MPC) returned to contractionary monetary policy when it raised both the Monetary Policy Rate (MPR from 11% to 12%) and Cash Reserve Ratio (CRR from 20% to 22.5%), and narrowed the asymmetric corridor around the MPR from +200 and 700 basis points to +200 and 500 basis points. Source: CBN, FirstBank Research In May 2016, the CBN retained its decision on its main monetary policy levers, hinting of its plan to be more flexible in the inter-bank FX market a decision that was implemented on June 20, 2016. The unfolding development in the economy (negative output growth in Q1 2016, slow fiscal interventions, negative balance of payments, etc.) may compel the MPC to retain the monetary policy tools at the current levels in H2 2016, even as the CBN continues to monitor the impact of recent reforms on the domestic economy. Unemployment Rate The unemployment rate in Nigeria is high. At least one out of every four people within the labour force population that is actively looking for job is either unemployed or underemployed... So in 2016, we expect government s focus on agriculture, manufacturing (e.g. textile), and infrastructure (especially power, road, and rail) to yield immediate gains. More stable electric power supply, for instance, should aid the return of artisans that erratic electric power supply drove away from their trade. There are also benefits for industry. Employment in the manufacturing sector, for instance, should pick up; and since the industry is labour intensive, the potential aggregate benefits to the domestic economy are enormous In 2015, we were overly optimistic that the federal government would embark on important reforms and implement the 2016 expansionary budget early in the year. But events in H1 2016 belied that outlook.
PAGE 7 Source: NBS, FirstBank Research Delayed budget implementation and policy response to domestic economic challenges worsened the jobless rate in H1 2016. The combined unemployment and underemployment rates rose: from 24.2% in Q1 2015 to 31.2% in Q1 2016. This means that nearly one of every three people within the labour force that actively looked for work in Q1 2016 (compared to one out of four people in Q1 2015) was either unemployed or underemployed. As government begins the implementation of the capital budget and social welfare projects (about N500 billion already earmarked as special intervention fund for school pupils feeding programme, soft loans to market men and women, engagement of 500,000 teachers, conditional cash transfers to extremely poor and unemployed Nigerians, etc.), we expect increased economic activity, which should scale up employment generation in the country. Economic activity generated should fit the country s labour force profile: 24.5 million people out of 78.5 million labour force are either unemployed or underemployed; 20 million (out of the 24.5 million) unemployed/underemployed people fall within the 15-44 years age group; while 3.5 million (out of the 24.5 million) people have post-secondary school qualifications. Tellingly, these are not the best of times for Nigeria and Nigerians. The reality of the deteriorating economy has compelled government to embark on important (even though belated) reforms, which at present appear painful to people and businesses. But if government follows the reforms through and exercises stronger political will in implementing other wellcalculated reforms promptly, there is hope that the domestic economy will soon experience the gains of the reforms. But before the turnaround, the economy may witness further shocks in the second half of 2016. Disclaimer: This Research Weekly has been produced by FirstBank Research Unit to provide initial information on all issues which form the subject matter of the document. FirstBank Research hereby certifies that all the views expressed in this document reflect analytical views that we believe are reliable; however, no representation is made that it is accurate or complete. Whilst reasonable care has been taken in preparing this document no responsibility or liability is accepted for errors or fact or for any views expressed herein by any member of the First Bank Group for actions taken as a result of information provided in this report.