BY BAMIDELE FAMOOFO
While the Nigerian economy has recovered from the impact of the COVID-19 pandemic, pre-existing macroeconomic imbalances have become more pronounced, thus increasing the country’s vulnerability to shocks.
As observed with several economies across the globe, GDP grew substantially in the second and third quarters of 2021 as the low-base effect from 2020 magnified the impact of easing containment measures.
However, economic growth remains tilted towards the services sector while structural barriers continue to limit productivity in the agriculture and manufacturing sectors.
Without downplaying the threats posed by the Omicron variant, financial analysts do not envisage widespread institution of lockdown measures. Nonetheless, experts at Cordros research think the economy will be traversing a murky recovery path as pandemic-related disruptions continue to ease and activities normalise in contact-facing sectors.
“We expect growth to be supported by the non-oil sector, specifically the Telecoms, Finance & Insurance, Trade and Entertainment sub-sectors. In the oil sector, we expect terminal shut-ins due to decaying infrastructure and pipeline disruptions to limit crude oil production, although growth will be higher than in 2021” Cordros research projected.
“As of the last meeting held between OPEC and its allies on 2nd December, members agreed to maintain the easing of output cuts by a total of 400kb/d. The decision is in line with our expectations, as we expect oil supply restrictions to be eased gradually in line with the increase in demand
“
There are indications, according to economic pundits, that the Monetary Policy Committee of the Central Bank of Nigeria will come under increased pressure to switch its policy stance in 2022, as major global central banks commence normalisation of unorthodox monetary policies enacted in response to the pandemic.
Back home in Nigeria, the underlying tone of the Committee at the November meeting lends credence to this view that the MPC will likely revert to a hawkish policy stance from second quarter in 2022; a period that the Committee will judge that policy initiatives had substantially supported economic recovery.
Jolomi Odonghanro, Head of Research at Cordros Research and his team noted “We believe an increase in the monetary policy rate will also be necessitated by the need to attract portfolio inflows to mitigate currency pressures. Particularly as election uncertainties in H2-22 may compound risk-off sentiments towards naira assets.”
On fiscal policy, it is expected that revenue generation will remain challenged due to weak crude oil output.
“Also, with 2022 being a pre-election year, we believe the government will pursue an expansionary fiscal stance to reflate the economy. Accordingly, we expect the actual fiscal deficit to be significantly higher than the budgeted deficit, resulting in continued debt accumulation, and by extension, adding more pressure to debt sustainability metrics.”
Performance review as at Q3, 2021
The Nigerian economy continues to sustain its post-COVID recovery as the base effects from the prior year continue to magnify the growth of the non-oil sector despite the oil sector’s contraction. As of Q3-21, the economy recorded a fourth consecutive quarter of expansion underpinned by the (1) base-induced sturdy growth in the Trade sector, (2) overall favourable base from the prior year, (3) sustained reopening of the economy, and (4) sustained government’s real sector intervention. Overall, experts at Cordros research anticipate that the economy will grow by 2.94 y/y in 2021E.
Key growth drivers in 2021
Non-oil sector
The non-oil sector was the sole driver of the country’s economic growth in the first nine months of the year, supported by the reopening of the economy.
Non-oil GDP grew by 6.74% y/y in Q2-21 (Q1-21: +0.79%), reflecting the favourable base’s impact from the prior year when the government introduced lockdown measures to combat the COVID-19 pandemic. By Q3-21, the non-oil sector’s growth (+5.44% y/y) slowed compared to the previous quarter (+6.74% y/y) as the impact of the low base effect began to dissipate. Nonetheless, the Trade (+11.90% y/y vs Q2-21: +22.49% y/y) and Telecoms (+10.87% y/y vs Q2-21: +5.90% y/y) sub-sectors were the primary drivers of the non-oil sector’s growth during the period. Other drivers of non-oil sector’s growth included Finance & Insurance (+23.23% y/y vs Q2-21: -2.48% y/y), Manufacturing (+4.29% y/y vs Q2-21: +3.49% y/y), Agriculture (+1.22% y/y vs Q2-21: +1.30% y/y) and Transportation & Storage (+20.61% y/y vs Q2-21: +76.81% y/y).
Manufacturing spurred by stimulus
Despite lingering FX liquidity challenges during the period, the Manufacturing sector grew by 4.29% y/y in Q3-21 (Q2-21: +3.49% y/y) – the highest since Q4-14 (+13.47% y/y).
In our view, the growth was supported by the sustained recovery in aggregate demand and spillover impact of the government’s stimulus package in the prior year. On the latter, the CBN announced a NGN1.10 trillion stimulus package at the onset of the pandemic to support local manufacturing and boost import substitution, of which NGN1.00 trillion had been released as of September for 269 real sector projects (including 140 companies engaged in light manufacturing).
Meanwhile, Oil refining (-47.83% y/y vs Q2-21: -46.78% y/y) suffered its 11th consecutive quarter of deep contractions owing mainly to the ongoing rehabilitation works on the nation’s refineries.
“2022 being a pre-election year, we believe the government will pursue an expansionary fiscal stance to reflate the economy. Accordingly, we expect the actual fiscal deficit to be significantly higher than the budgeted deficit, resulting in continued debt accumulation, and by extension, adding more pressure to debt sustainability metrics
“
Security challenges and agriculture growth.
The persistent security challenges in the food-producing belt of the country continue to constrain farmers’ productivity, undermining gains from the government’s fiat-led intervention to the agricultural sector. Notwithstanding, the agriculture sector grew by 1.22% y/y in Q3-21. However, this was the lowest expansion recorded since Q2-18 (+1.19% y/y). Asides from the rising cases of insecurity in the country, we attribute the slowdown to climate change, which led to heavy rainfalls and destroyed farmland, and secondly to rising input costs. There is also the underwhelming harvest season due to reduced activities during the planting season. To underscore the scale of things, we note that the 1.36% y/y growth in crop production (c.88% of Agriculture GDP) in Q3-21 (vs Q2-21: +1.38% y/y) was the lowest since the NBS started keeping the current data series.
Oil sector weakens
The growth of the oil sector continues to weaken as the industry faces oil production challenges. Precisely, Nigeria continues to produce below the allocation in the current OPEC agreement, which allows the country to produce 1.68mb/d excluding condensates. The decline in production witnessed during the year was due to the impact of (1) infrastructure decay and (2) complexities of operating the oil wells, both of which led to terminal shut-ins in some of the country’s major production facilities. The former involves pipeline damages, low pressure, valves integrity issues, and challenges with water injection pumps. On the latter, given that some of the significant oil wells were closed during the COVID-19 pandemic, there have been difficulties getting them back to normal operations post-COVID due to the complexities involved in operating the facilities. Accordingly, crude oil production (including condensates) settled at 1.57mb/d in Q3-21, translating to a decline of 10.73% y/y in Oil GDP during the same period.
Inflation
Inflationary pressure persisted in 2021E, reaching a 4-year high in March (+18.17% y/y) before subsequently moderating primarily due to the base in the prior year. Despite the moderation, domestic prices remain significantly above the long-run average (+11.59% y/y) due to the confluence of factors, including; (1) persistent security challenges, (2) structural constraints in the operating environment, (3) high energy prices and (4) currency depreciation. Overall, headline inflation averaged 17.28% y/y in 10M-21 (10M-20: +12.79% y/y) and settled at 15.40% in November 2021 (October 2020: +14.98% y/y).
Analysing several factors shaping domestic prices in 2022FY, we expect inflationary pressure to persist next year, albeit at a moderate pace. Our base-case scenario suggests headline inflation will average 13.64% y/y in 2022FY, with the year-end figure settling at 13.55% y/y. We premise our forecast on our expectations for (1) a gradual increase in electricity tariffs towards a market reflective price, (2) a depreciation of the currency to NGN440.00/USD, and (3) non-deregulation of the downstream sector, which would keep the price of PMS at the current level.
In line with our expectations, headline inflation sustained an upward pressure in 2021E in line with the price increases across the food and core baskets. We believe the upward pressure on food prices was due to the combined impact of (1) persistent security challenges, (2) higher transport prices, and (3) poor distribution network and (4) high cost of farm inputs. On the core basket, we attribute the rise to the (1) high fuel and energy prices, (2) increase in VAT from 5.0% to 7.5%, (3) depreciation of the currency, and (4) increased prices of pharmaceutical and medical products. Based on the factors above, headline inflation rose by 24bps to 15.99% y/y between December 2020 and October 2021 amidst the favourable base effects from the prior year.
Naira
In 2021FY, the Naira remained relatively stable (NGN410.00 – NGN415.00/USD) at the Investors and Exporters Window after the CBN devalued the local currency by 3.9% to c. NGN410.00/USD at the end of March.
Similarly, the CBN merged the official exchange rate with the NAFEX rate in May as the calls to eliminate the multiple FX windows intensified in the face of the FX liquidity crunch.
Meanwhile, it is common for currencies to overshoot or undershoot their fundamental fair value when the apex monetary authority embarks on massive FX intervention and controls while suppressing the market forces (which are in search of a clearing price). Thus, we believe the Naira overshot its fair value at the parallel market in 2021FY as the (1) CBN deliberately maintained the exchange rate stable at the IEW despite low FX liquidity and (2) market participants moved en-masse to the parallel market to cover FX needs not permitted at the official channels amidst the CBN’s halt of FX sales to the BDCs. Consequently, the average parallel market rate in 11M-21 (NGN509.13/USD) was 10.4% above the CBN’s fair value estimates (NGN462.00/USD) for the Naira. Moreover, at an average rate of NGN554.95/USD at the parallel market as of November, the spread between the official and parallel market rates increased to 33.8% in November from 20.4% in December 2020.
Despite the currency stability witnessed in the year after the Q1-21 devaluation, the Naira continues to trade below its fair value estimates (CBN’s Relative Purchasing Power Parity: NGN462.00/USD as of June 2021 vs Cordros REER: NGN464.23/USD) at the IEW. We think devaluation concerns and the CBN’s capital control measures have led foreign investors to remain on the sidelines. At the same time, the FX rationing at the IEW has magnified the demand pressure at the parallel market. Given our expectations that the accretion to the FX reserves would be weak in line with the low crude oil production levels, it suggests that the ability of the CBN to defend the Naira is limited to the one-off inflows from recently issued Eurobond and the IMF’s SDR.
Accordingly, the CBN would need the support of foreign investors to boost FX liquidity over the medium term. Overall, our baseline expectation is that the CBN will devalue the Naira between NGN440.00/USD and NGN 460.00/USD at the IEW.
FX Liquidity
Although liquidity conditions have improved at the IEW, it remains significantly below pre-pandemic levels. Specifically, the average inflows into the IEW in 2019FY stood at USD2.90 billion per month, the bulk of which came from the FPIs (45.3% of total inflows). In comparison, the CBN accounted for 18.9% of the average monthly inflows during the same period. Contrastingly, between April 2020 and December 2020, average monthly inflows declined significantly to USD771.68 million as inflows from the FPIs dried up (average of USD52.57 million between April 2020 and December 2020 vs pre-pandemic level of USD1.31 billion). As of 10M-21, average monthly inflows to the IEW amounted to USD1.08 billion, supported by improved inflows between July and October (c.60.0% of total inflows in 10M-21). Inflows from the CBN and non-bank corporates, which jointly accounted for 61.6% of the total inflows, were responsible for the USD1.58 billion average monthly inflows between July and October.
Though the inflows from the IMF’s SDR and Eurobond issuance should enhance CBN’s intervention in the IEW over the short-to-medium term, we do not expect liquidity conditions to retrace towards pre-pandemic levels due to still weak inflows from foreign investors (53.8% of total IEW inflows in 2019FY). We think foreign investors will need more convincing actions from the CBN regarding flexibility and clarity in the foreign exchange framework before there is a resurgence of interest in the market, as witnessed in 2017FY when the IEW was established.
Monetary policy
The central theme at the policy meetings in 2021 was that (1) supply-side factors were the predominant drivers behind the elevated inflationary pressures, and (2) economic growth remains fragile given the lingering security challenges and structural impediments in the business environment. Accordingly, the Committee reiterated the need for the monetary and fiscal authorities to consolidate administrative measures to spur economic growth. In addition, the Committee expressed optimism that the CBN’s intervention in the real sectors of the economy will further moderate the inflationary pressure as the negative output gap closes over the short-to-medium term.
Therefore, in justifying its decision to maintain the key policy rates at current levels, the Committee stressed that although tightening would help address the stubbornly high inflation, it will constrain the flow of credit to the private sector and upset the economy’s fragile recovery. On the flip side, the Committee believed that loosening would make it more difficult for the apex bank to achieve its core mandate of price stability though it would further complement the government’s efforts in restoring the productive capacity of the economy.
Over the rest of the year, we believe the CBN will continue to use CRR debits, OMO auctions and the special bills to monitor system liquidity to nullify the indirect direct channels through which system liquidity amplifies inflationary pressures. Furthermore, we expect the apex bank to continue direct intervention in the growth-stimulating sector to support its pro-growth objective. In addition, we think the CBN will continue to prioritise allocating FX to legitimate needs to ease liquidity constraints in the economy.
Positive outlook maintained for Q4-21
Over Q4-21, it is not expected that the Oil sector’s production challenges will diminish, given the nature of challenges constraining output. Hence, we are more pessimistic with our expected output losses from terminal shut-ins in Q4-21 than we forecasted in Q3-21. Accordingly, it is estimated that crude oil production (including condensates) will settle at 1.61mb/d in Q4-21 (prior estimate: 1.75mb/d), translating to a growth of 3.21% y/y. In contrast, we expect the non-oil sector’s growth to moderate to 2.40% y/y in Q4-21, driven by the Service and Agriculture sectors amidst the waning base effects from the prior year. Overall, experts expect growth to settle at 2.44% y/y in Q4-21.
2022FY Outlook: Economy to remain on growth path
Economic pundits expect the economy to remain on the path of growth in 2022FY. However, they anticipate that growth outcomes will remain below potential as (1) economic activities continue to normalise and (2) the impact of government stimulus fades. In addition, we do not expect dramatic changes to the current woes in the oil sector, given that the nature of the challenges is centred around underinvestment in infrastructure. That being said, the favourable base effect from the prior year will result in a growth in Oil GDP for 2022FY. Meanwhile, the non-oil sector is expected to grow slowly in line with the dissipating impact of the base effects from the prior year. Overall, Cordros research project the Oil and Non-oil sectors will grow by 9.42% y/y and 2.11% y/y, respectively.
Oil sector to grow on favourable base effects but risks remain
As of the last meeting held between OPEC and its allies on 2nd December, members agreed to maintain the easing of output cuts by a total of 400kb/d. The decision is in line with our expectations, as we expect oil supply restrictions to be eased gradually in line with the increase in demand. However, the threat of the Omicron variant of the COVID-19 pandemic could allow the OPEC+ to pause supply easing over the short term if total demand significantly reduces. Indeed, the cartel in its last meeting stated that it would continue to monitor the market closely and make immediate adjustments if required. Notwithstanding, we still expect a moderate production level for Nigeria in 2022FY due to the issues mentioned – terminal shut-ins due to decaying infrastructure and pipeline disruptions. Consequently, we estimate Nigeria will produce c.1.80mb/d (including condensates) of crude oil in 2022FY (2021E: 1.63mb/d). Accordingly, we expect the Oil sector to grow by 9.42% y/y in 2022FY compared with an estimated decline of 6.04% y/y in 2021E.
Agriculture sector’s growth to remain below long run average
We expect the Agriculture sector output to remain under pressure given the persistent banditry and farmer’s-herders crisis. However, we believe the (1) sustained government fiat-led intervention in the sector and (2) the fight against banditry and kidnapping could tether the decline. Consequently, we believe the Agriculture sector’s growth will remain below its 12-quarter long-run average growth (+4.23% y/y). In modelling our growth expectation for the sector in 2022FY, we discounted our expected output growth by several identified downside risk factors, including (1) security challenges, (2) poor farming practices and low-quality seedlings, and (3) flooding in the food-producing states. Thus, on a balance of factors, we expect the Agriculture sector’s growth to settle at 1.94% y/y in 2022FY (2021E: +1.53% y/y).
Service sector’s growth to slow on activities’ normalisation
We expect the normalisation of activities to continue to support the Services sector buoyed by the Telecoms, Finance & Insurance, Real estate and Entertainment sub-sectors. On the one hand, we expect concerted efforts by telecommunication companies in driving internet penetration and CBN’s approval of Payment Service Banks (PSBs) to sustain the impressive growth in the ICT sub-sector as the drive towards improving financial inclusion gathers momentum. We highlight that the CBN has granted Approval in Principle (AIP) for MTN Nigeria (MOMO PSB) and Airtel AFRICA (SMARTCASH PSB) to operate Payment Service Banks (PSBs) with the final license expected to be given not earlier than six months after the AIP. Meanwhile, 9Mobile has launched its 9 PSB operations after the CBN granted it operational approval last year, while Globacom’s Money Master is yet to commence operation despite the CBN’s approval. Overall, we expect the growth in the mobile money space to support the ICT sector given MTN and Airtel’s vast network of agents to deploy their services and huge subscriber base.
On the other hand, we expect the gradual improvement in macroeconomic conditions, which should improve private sector demand for credit, will support banks’ creation of risky assets.
Consequently, we expect the Financial institution sub-sector to support the Service sector’s growth despite the high base impact from the prior year. Overall, we modelled telephone and internet subscribers to grow by an average of 5.8% y/y and 9.9% y/y, respectively. Thus, on a balance of factors, we expect the Service sector to grow by 2.19% y/y in 2022FY (2021E: +5.11% y/y).
“Therefore, barring significant acceleration in vaccine administration in Nigeria and other African countries, we believe that the possibility of COVID-19 resurgence and its impending restrictions remains a critical downside risk in 2022FY
“
Fading stimulus impact to slow manufacturing growth
Although improved FX supply bodes well for the manufacturing sector, we expect the (1) dissipating impact of the government’s stimulus program and (2) demand moderation to limit the Manufacturing sector’s growth compared to the prior year. Consequently, we expect the Manufacturing sector to grow at a sub-2.0% level, similar to that recorded between 2018FY and 2019FY.
Therefore, we project the Manufacturing sector’s growth will moderate to 1.84% y/y in 2022FY (2021E: +3.64% y/y). Having modelled our expectations across the oil and non-oil sectors, we expect full-year growth of 2.65% y/y in 2022FY (2021E: +2.94% y/y).
Inflationary pressures to moderate in 2022FY
In forecasting Nigeria’s headline inflation rate, we analysed various factors that may shape the domestic prices over 2022FY, which include but are not limited to:
Security challenges: In the past year, the rise of insurgency was a significant deterrent to production and distribution activities, leading to a surge in food prices. While we do not downplay the government’s efforts to reduce the spate of attacks in the country, the possibility of increased insecurity in the coming year is elevated, given that it is a pre-election year. In addition, we expect the psychological and physical effects of the persistent security challenges to slow down household engagements in typical livelihood activity (farming) which then limits typical seasonal improvements in harvests.
Currency pressures: Although the local currency has been relatively stable against the USD at the Investors & Exporters Window (IEW), pressure remains unrelenting at the parallel market given the considerable demand in the face of thin supply. We expect a further devaluation of the currency in 2022FY based on our expectations of (1) a need to attract FPIs given weak US Dollar inflows into the IEW and (2) limited ability in obtaining commercial borrowings compared to 2021E due to tightening monetary conditions as central banks in developed economies commence normalisation of monetary policy.
Electricity tariffs: The Vice President, during a stakeholders’ meeting organised by the Nigerian Electricity Regulatory Commission in August 2021, reiterated that from 2022, customers would be paying the market reflective price for electricity services as the government expects the electricity sector to generate its revenue from the power sector. We expect the adjustment to be made gradually to avoid public backlash akin to what played out in 2020.
Market determined fuel prices: The finance minister revealed that the Federal Government is considering the complete deregulation of the downstream oil & gas industry in H2-22 as it only factored in subsidy payment for H1-22 in the proposed 2022FY budget. However, we think it is unlikely the government will eliminate the PMS subsidy in July 2022 as it would create room for opposition parties to score cheap political points, particularly as the 2023 general elections would be a few months away. Besides, similar statements have been made in the past with labour unions restraining the government.
FX supply constraints: Thus far, in 2021E, the CBN’s FX demand management strategy led manufacturers and importers to source US dollars at the parallel market. The spillover effect was increased cost of importation, which translated to higher domestic prices. Although we expect FX supply to improve in 2022FY given the higher FX reserves, we think overall supply to the market will remain below pre-COVID levels as we expect foreign inflows to remain tepid.
Supply chain disruptions: Although there has been a sustained reopening of the Nigerian economy, the recent resurgence of COVID-19 cases induced another wave of trade restrictions that culminated in border congestions. For Nigeria, the operational modifications at the ports also meant that consignments required by major manufacturers for production were delayed, inhibiting supply. Therefore, barring significant acceleration in vaccine administration in Nigeria and other African countries, we believe that the possibility of COVID-19 resurgence and its impending restrictions remains a critical downside risk in 2022FY.
Trade
For 2022FY, we expect the trade position to remain positive compared to 2021E levels due to our expectation of increased crude oil production and favourable prices. However, we believe the trade surplus will be significantly lower than 2018FY levels (USD20.47 billion) due to (1) terminal shut-ins and (2) oil companies’ divestments in line with the growing talks of energy transition and cost of operating the oil assets. On the flip side, we expect the improvement in FX liquidity to lead to a rise in non-oil imports just as the importation of petroleum products continues to increase give weak domestic capacity to refine crude. Accordingly, we model total exports and imports growth of 19.4% y/y and 10.6% y/y, respectively. Sequentially, we expect the trade balance to settle in a surplus of USD4.51 billion in 2022FY (2021E trade balance surplus: USD219.29 million).
We expect global mobility to increase in 2022FY compared to 2021E because of an anticipated slowdown in virus cases amidst higher vaccination rates. Accordingly, we expect the increased demand for foreign currencies for service-based transactions to widen the deficit in the service account by 24.3% y/y. Notwithstanding, the downside risk to this expectation is the impact of the omicron variant of the COVID-19 virus, which could induce countries to limit foreign travellers into their economies. Similarly, we expect the net income payments to increase by 34.5% y/y to USD12.13 billion (2021E: USD9.01 billion) as foreign investors repatriate their investment income – we expect the CBN to ease implicit capital control measures given the increased FX reserves.
Elsewhere, we project a 5.4% increase in the net current transfers to USD26.22 billion (2021E: USD24.88 billion).
On a balance of factors, our model suggests that the CA deficit will settle at USD7.74 billion in 2022FY, a 51.7% increase above our projected CA deficit of USD5.10 billion in 2021E. This translates to a 1.7% CA deficit as a percentage of GDP (2021E: 1.3%) at an effective exchange rate of NGN415.00/USD.
