Exposing Nigeria’s vulnerabilities: Covid-19, crude oil downsides from weak global macro environment

• Geopolitical complexities with Covid-19 vaccines sourcing places Nigeria, Africa on backfoot
• Mass Covid-19 vaccination capable of creating herd immunity unlikely in Nigeria in 2021
• Inflation to peak at 14% – 15% putting further pressure on Naira
• High inflation reflects country’s weak economic fundamentals, need to be reined in for long-term prosperity
• Fx to be Nigeria’s most consequential economic issue in 2021
• Year’s 2% GDP growth, slow post-recession recovery, weaker than population growth, to test citizens’ resilience, to result in increased social fissures

Agusto & Co, indigenous African credit ratings agency, has come out with a report on Nigeria’s economic outlook in 2021, in which it examined key macro themes that will shape the country’s economic landscape in the year. Clearly, the ratings agency said, although 2021 could turn out to be the “year of the (Covid-19) vaccine,” yet weaknesses in the global macro environment pose significant downsides to the crude oil market, which further exposes Nigeria’s vulnerabilities.

Nigeria remains significantly vulnerable to the economic contagion arising from a weak global environment, the report states, adding that the discovery of new strains of the virus portends greater systemic risks to the broader economy and particularly to the nation’s health sector as the management of Covid-19 undermines the response to other ailments and the healthcare needs of the populace.

“Overall, we believe the geopolitical complexities with sourcing the vaccines places Nigeria and the rest of Africa on the backfoot,” the agency’s report titled “2021: The Year of the Vaccine,” stated.

Interest rates & inflation

The report warns that Nigeria’s inflation would rally this year at 14 per cent – 15 per cent up from the 11 per cent – 12 per cent rate in the last two decades. The new rise would put further pressure on the naira, the country’s currency that had already seen much strain since the 2016 first recession, which resurged last November 2020 for a second recession in five years.

“In 2021, we project that inflation will even surpass this long-term average to about 14% – 15% further putting the naira under pressure. Forward guidance from the Central Bank (of Nigeria) indicates that monetary authorities have an inflation target within the 6% – 9% range. The significant disparity (>600 basis points) between the upper limit of the CBN’s inflation target and the current inflation numbers further reflect the high inflationary trend of the country,” the report stated while analysing the country’s interest rates and inflation, said.

The ratings agency sent warning signals over Nigeria’s long-term high inflation, which has often been an overlooked economic indicator, with exchange rates rather enjoying greater prominence in the discourse, creating an absurdity. Often, the country’s monetary policy strategy unduly focuses on the pursuit of a stable currency, viewed largely from the prism of foreign exchange and inertia towards inflation.

“While Nigerians have long fantasised about a strong currency – often defined as one being at par with major currencies such as the British pound or US dollar – the long term high inflationary trend remains the underbelly of the naira. Agusto & Co. believes Nigeria’s high inflation reflects the country’s weak economic fundamentals, and needs to be reined to set the country on the path of long-term prosperity,” the Nigeria economic outlook report said.

The pandemic & the vaccine

The ratings agency said as the world battles Covid second wave, Nigeria’s numbers have shown steady increase to reach new daily new highs. That in December, the country’s virus positive cases surpassed a threshold of over 1,000 on five occasions, which has become the norm in the first five weeks of 2021. Nigeria might not possibly secure mass Covid vaccination that can create group immunity. “We believe a mass vaccination programme capable of creating herd immunity may not occur in Nigeria in all of 2021. Thus, the country will have to eke out effective ways of managing the spread of the virus and care for affected patients while pursuing measures for the vaccination programme,” it said.

Exchange rate management

On foreign exchange rate (FX), Agusto & Co. said, outside the management of Covid-19 related disruptions to the Nigerian economy, the subject of foreign exchange in Nigeria will be the most consequential economic issue in 2021. It said, the pertinent issue will include the management of foreign exchange liquidity, of which the Central Bank of Nigeria (CBN) has resorted to its demand management playbook of 2016, which had created a wide spread between the official market and the parallel market at the time.

“The outcome of the demand management playbook in this COVID era also mirrors that of 2016. The naira is currently trading at an unhealthy arbitrage of N80 to N100 to a dollar between the parallel and the official market as monetary authorities struggle to maintain stability in the foreign exchange market. The odds against the naira in the foreign exchange market are in two folds: the long-term fundamental issues. With naira inflation projected to be stubbornly stuck above 15% in 2021 and dollar inflation at a benign 2%, the odds against the naira indicate an inflation rate differential of about 14% between the two currencies. The principle behind the inflation rate differential implies that the erosion in the value of the naira measured by inflation is significantly greater than the dollar. Thus, the 13% inflation differential should result in the naira’s depreciation against the dollar in similar measures. Once again, this reiterates the need to pare back inflation in Nigeria.

The second major issue is the demand-supply dynamics in the foreign exchange market. Nigeria has entered a period of low oil and gas export revenues. In 2021, we project about $30 billion in oil & gas exports, down 20% from about $36 billion in 2020. With net foreign investment also likely to be in negative in 2021 due to the demand management strategy of the Central Bank, there will be significant pressure on reserves and the naira/US dollar exchange rates. With foreign reserves stubbornly stuck below the $40 billion threshold since mid-November 2019, and currently around the $35 billion mark, the CBN has less dry powder to defend the naira at N390/$.”

Big call on devaluation amid illiquidity

The ratings agency said, the Nigeria apex bank (CBN) will have to make a big call on devaluation with very little leeway to this decision. It warned that it was because of CBN’s indecision to devalue in 2016 that resulted in the recession. It warned that the 2021 scenario is even more complex as Nigeria is now caught between a rock – the pandemic – and a hard place – the foreign exchange illiquidity. “The cost of indecision this time around will come with greater consequences than in 2016,” it said.

By far, Agusto & Co noted that there are three significant upsides inherent in the unification of the exchange rates in the market: unification of exchange rates will pare back currency speculation as more high networth investors (HNIs) are divesting from the naira while increasing FCY exposures; the currency unification will stimulate investor confidence and shore up foreign direct investment and foreign portfolio investment once again; and businesses operating in the country are subjected to increased operational difficulties owing to the currency situation. “As more businesses are unable to meet FCY demands on the official market, they resort to the parallel market and then pass on the higher exchange rate costs to consumers thus stoking inflation,” the ratings agency said.

It also said that despite the grim foreign exchange position, Nigeria is not overleveraged in foreign currency terms, especially when compared to other key economies in sub-Saharan African peers. “While Nigeria has a foreign currency debt position of 56% to its current account receipts, Kenya and Ghana have positions of over 180% and 70% respectively. However, with local currency debts especially the short-term treasuries being raised at less than 3% – thus leaving investors with over 10% in negative real interest rates – the federal government is quite incentivised to raise more local currency debt than FCY debt. Overall, the big question for followers of the foreign exchange market will be “if the CBN will cave in and devalue the naira in 2021.”

On fiscal position in the current year, Agusto & Co said, the federal government’s increased borrowing from the CBN that has risen by more than 500 percent in five years will likely continue in 2021, thus reducing the dependency of the government on financial markets in a period of higher demand for government securities.

“Our outlook for 2021 is that real interest rates will remain negative, thus enabling the government to cheaply finance its deficits,” the ratings firm said.

Embarking on macro reforms in 2021

Agusto & Co said it believes that the Nigerian federal government should seek bolder actions on asset reforms by reducing its exposures to moribund state-owned enterprises such as the refineries. “Funds earned from such divestments can then be channelled into other high-impact assets such as critical infrastructure,” it said.

The bright spots

The ratings firm said there are bright spots for Nigeria amid a pandemic that has raised the country’s risk profile. “Amidst the slew of risks, opportunities abound: telecommunications and fintech space. The telecommunication sector particularly the data segment will continue to show significant upsides in 2021 as work-from-home (WFH) trends continue into the year. We project double digit growth of about 10% in the telecommunications sector GDP in 2021. Other growth drivers that will drive the telecommunications sector’s performance include the increased adoption of virtual engagements for business meetings and conferences, schooling, and even social gatherings, in addition to increased social media consumption,” it said.

The second bright spot is in the fintech space as more consumers take to digital payment solutions due to the social distance protocols. We project that in 2021, the value of e-payment transactions will surpass the N100 trillion mark thus becoming larger than the country’s GDP.  The growth drivers will be the increased adoption of fintech solutions especially on mobile devices.

Another risk-free yield is a major benchmark for pricing corporate debt instruments. “We believe the corporate debt markets will become more attractive especially for firms that can issue investment grade debt instruments. Overall, we project that over N1 trillion will be raised in corporate debt instruments in 2021, representing a 10% increase from the N910 billion raised in the previous year,” the ratings firm said (shown in Figure 2).

It equally said that the CBN’s reforms in the foreign exchange market, which now permits recipients of diaspora remittances to access their funds in foreign currency represents the brightest spot in the FX market. We believe this reform policy will increase the competitiveness of the official foreign exchange market against the parallel market.