In discussing the current state of Nigeria’s capital markets, I am reminded of Warren Buffet’s words: “It is only when the tide recedes that you discover who has been swimming naked”. Prior to 2015, the world witnessed a period of very high crude oil prices and relatively benign monetary conditions. The former was driven amongst other things by a ‘roaring’ China, the latter by expansionary monetary policies globally following the 2007/2008 financial crisis, as governments world over tried to stimulate growth. With these conditions came record portfolio and foreign direct inflows into emerging and frontier markets, as these were seen as the biggest beneficiaries of the new world order, so to speak. Nigeria benefitted even more from these inflows as the country’s impressive demographics, its high single-digit growth rates and its post-rebasing current account surplus made it an even more attractive investment destination over most other markets.
Fast forward to today and the picture is a totally different one. A peak-to-trough decline of 62 percent in crude oil prices, the end of China’s super-normal growth, the end of the US dollar carry trade (as a result of the US Fed indicating it will begin to raise interest rates soon) and heightened geo-political concerns have led to a higher risk premium in emerging and frontier markets. These have led to a 20%+ correction in equity prices in most of these markets along with substantial capital outflows. Mono-commodity exporters such as Nigeria and Kazakhstan that failed to save for the proverbial rainy day have fared a lot worse and suffered more than most.
What have countries done so far to fix this problem? Whilst most commodity exporters are in the same camp (i.e. they are facing/will face serious balance-of-payments problems), the adjustment is being executed in different ways. For countries such as Nigeria and to a lesser extent Egypt, there has been some degree of exchange rate weakness allowed, but it seems as though the bulk of the adjustment will be borne by a forcible contraction of imports, with negative consequences for growth. Other countries such as Russia, Kazakhstan and Zambia have simply allowed their exchange rates to adjust, which explains why their currencies have been hit so much harder in the current rout. The upshot is that once the initial shock dissipates, they will probably recover more quickly.
What should the government of Nigeria do? Here are my top five suggestions in order of importance:
1.) Remove the fuel subsidy: I think the president missed out on a unique opportunity to remove the subsidy immediately after he assumed office. Not only did he have tremendous goodwill from the populace, his victory coincided with a period when there was tremendous public angst at petroleum product marketers. The current sell-off in crude oil prices presents another opportunity to fix this: according to the latest pricing template from the downstream regulator, the landing cost plus distribution margins have fallen to NGN104/litre. For those who read academic literature, it is no surprise to hear that these subsidies are regressive as they disproportionately benefit the rich. I share the same view.
2.) Currency – draw a line in the sand: In the three years prior to 2015, the naira was relatively stable in the NGN160/USD range at a time when inflation averaged 10 percent. Going by interest rate parity expectations, one would expect a yearly depreciation of the currency as a result of this; otherwise, imports will become artificially cheap. Add to that the considerable sell-off Nigeria has seen in crude oil prices, its chief FX revenue earner, as well as the fiscal challenges the country is facing and it will be tough to argue against a need for an adjustment in the currency.
3.) Capex: There is a need to shore up public finances with a Eurobond, as well as reinstitute a capex budget. Up until now the federal government’s reaction to the need for adjustment has been to simply cut investment while maintaining recurrent spending at existing levels. However, with an external debt/GDP ratio of less than 12 percent, there should be room to take on debt in order to maintain capital expenditure and plug the current budget deficit that Nigeria has at the moment. Pro-cyclical monetary and fiscal policy will only make this crisis worse.
4.) Re-activate Nigerian Bulk Electricity Trading Company plc: This is perhaps the most critical next step for the power sector reforms to progress as planned. The power sector has been trapped in an interim rules period because the money required to capitalise the bulk trader just isn’t there. Sure this may cost US$500mn-1.0bn to get off the ground, but much more than that has already been invested in a power sector reform agenda that everyone agreed was sensible.
5.) Eliminate the Domestic Crude Allocation (DCA): About half of the oil pumped/earned by the NNPC is allocated via this mechanism, in a process that has been proven to yield poor returns to the nation. The swap agreements are already being reviewed but these only account for 235,000bpd out of a total DCA of 445,000bpd. Domestic refineries may be able to process as much as 100,000bpd but that leaves another 110,000 sold via opaque export arrangements.
Global financial markets are in a precarious state and most countries are rolling up their sleeves, making tough decisions and facing the onslaught head on. Nigeria should be no different.
Temi Popoola
Popoola is CEO of Renaissance Capital in Nigeria
