The month of November 2014 has been very eventful on the global and local scenes. Global oil price reached a four-year low of US$78 per barrel, from US$115 in June, ostensibly triggering an announcement of ‘austerity measures’ by the coordinating minister for the economy. Heightened capital outflows from Nigeria also saw market capitalization drop from a peak of N14 trillion in June to N11 trillion in November, just as external reserves dipped to US$38 billion, forcing a devaluation and further ‘policy tightening’ by the Central Bank of Nigeria (CBN).
The initial twin global shocks (commodity price shocks and foreign capital outflows) are increasingly becoming a smaller part of the story as the dual policy response – utterances by the finance ministry and the CBN in November – have become fresh sources of confusion and uncertainty about Nigeria’s economic outlook. Genuine concerns are also being raised about why Nigeria is unable to stir up manufacturing exports to offset the country’s dependence on oil for foreign exchange and government revenue.
First, we attempt to put the dual policy response – namely, the fiscal policy proposals and the monetary policy actions – in context; next, we offer some thoughts on outlook of the twin global shocks, namely, the outlook of oil price and the outlook of foreign capital flows; then, we offer some thoughts on how best to boost Nigeria’s manufacturing output and exports; and, finally, we sum up with an evaluation of the impact of the twin shocks and the dual response on Nigeria’s economic outlook.
Austerity measures
I have never seen any government announcing austerity measures in a growing economy. It is something that governments are only forced to do in periods of economic downturns. The Nigerian economy is not in recession; still cruising at more than 6 percent real growth, yet the government is announcing spending cuts. The Nigerian fiscal processes have clearly disconnected from economic realities.
Oil GDP of about N10 trillion was just about 13 percent of the N80 trillion GDP that Nigeria was believed to have generated in 2013, the remaining N70 trillion or 87 percent being non-oil GDP. So how would a 30 percent drop in the price of oil call for spending cuts? Why should oil that is just 13 percent of GDP account for 70 percent of government revenue, and non-oil activities that are 87 percent of GDP account for 30 percent?
The fall in oil price should push Nigeria to raise more non-oil revenue which is currently about 3.7 percent of GDP and 5 percent of non-oil GDP (compared to an average of about 25 percent of GDP in the other African countries with large economies – South Africa, Egypt, Algeria, Angola, and Morocco.
The government may however lack the moral spine to do so, being unable to produce the savings expected to have accrued from the oil price benchmarks of recent years, unable to prevent crude oil ‘theft’; unable to verify how much oil revenue was said to be missing from government coffers, saying that foreign forensic auditors will be invited, and unable to prevent payment of trillions of naira in ‘subsidies’ to politically-connected individuals who never imported any fuel.
The austerity proposal highlight the inability of the government to raise adequate revenue levels required to run the government from Nigeria’s booming non-oil sectors. Nigeria’s Value Added Tax (VAT) rate of 5 percent across the board is too low. South Africa, Egypt, Algeria, Angola and Morocco all have VAT rates of 10 percent (standard) and up to 25 or 30 percent (on luxury goods).
The fiscal disconnect currently puts a thick cloud on Nigeria’s economic outlook. It is better to fix what is wrong with the fiscal process than let the fiscal contraction halt the economic growth. Media reports seem to be claiming that McKinsey and the IMF will offer Nigeria ideas on how to generate additional non-oil revenue of US$3 billion over the next three years, when we actually need to start generating that extra sum on a monthly basis.
I believe the austerity measures are misguided. Although the markets already deem the austerity proposals as fait accompli, the announced measures actually remain proposals until they are ratified by the National Assembly. It remains to be seen if they will eventually be ratified.
Devaluation and further tightening of monetary policy
I believe the devaluation had truly become inevitable and it was appropriate that the CBN took the step in good time as a way of stabilizing the foreign exchange market by adjusting the price to restore equilibrium between the forces of demand and supply. I do not however see the rationale for hiking the policy rate or raising the cash reserve requirement in addition to the devaluation.
The CBN appears to continue to be transfixed on short-term considerations about financial markets and government finances, to the exclusion of medium-term considerations about the realities of supply-side and demand-side real economic activities. The apex bank said nothing about the domestic aggregate demand conditions that would be needed to determine whether a rate hike and increased reserve requirement made sense or not at this time, especially in view of the adverse effects that the steep fall in global commodity prices and domestic equity market contraction must have already inflicted on private incomes, spending, and employment in Nigeria.
The rate hike and higher reserve requirement could well be hurtful to consumer and business spending growth that is needed to underpin Nigeria’s economic growth and employment. Is the central bank suggesting that Nigeria’s growth and employment is so strong that you can add proposed cuts in government spending, the devaluation, the higher interest rate, and the higher reserve requirements, to the personal and corporate income losses already inflicted by lower commodity prices and contraction in the stock market, without slowing real economic growth and employment?
The CBN’s lack of capacity to relate global shocks and domestic financial developments to real economic activities is the other big source of uncertainty about the outlook of the economy. A fact that we must not shy away from is that as long as non-economists continue to dominate and lead the Monetary Policy Committee (MPC) and the board of the CBN, the central bank will continue to take actions that are most certainly likely to make already bad macroeconomic situations worse.
Outlook of global oil price
On the global scene, it seems likely that the high-cost tight oil production surge in the US and Canada will be derailed by the low oil price regime being orchestrated by low-cost OPEC and non-OPEC conventional oil producers, and the glut in the market will be wiped out once unconventional oil production falls, and oil price should climb back towards US$100 or more. What is difficult to say is how soon this will play out. Two to four more quarters? It remains to be seen. But the point to take away is that the low oil price regime will not last.
But the big domestic issue is why Nigeria cannot refine its own crude and export the refined products as many other developing countries now do.
Outlook of foreign capital flows
Capital flows to Nigeria have been sensitive to recent volatility in global liquidity levels triggered by concerns about US policy normalization. But perceptions of fiscal weaknesses and dwindling reserves in Nigeria have also precipitated domestic push factors that heightened recent precautionary capital outflows. You can call it a growing ‘crisis of confidence’ in the ability of the government to keep things under control. Talks about fiscal austerity in the second half of November had only confirmed such fears, forcing the central bank to do the needful.
The other problem with capital inflows to Nigeria however is the continued dominance of short-term capital inflows to the private sector, often referred to as ‘hot money’. The government can attract longer term inflows by offering strong enough medium to long-term value propositions in the form of foreign-currency savings-bonds, targeted at Nigerians in Diaspora, or foreign-currency investment-bonds such as rail bonds or LNG bonds, open to anyone out there looking for attractive long-term investment opportunities. But a government that is struggling with the present can hardly contemplate the future, much less engage others to come and invest in that future.
On the global scene, it seems likely that the quantitative easing planned by the European Central Bank and the Bank of Japan should more than eventually compensate for the end of United States’ liquidity injections and ensure a higher level of global liquidity in 2015. But perceptions of policy weaknesses in Nigeria might mean Nigeria will attract much less of the increased global liquidity than it had attracted in recent years.
Nigeria’s manufacturing output and exports
Nigeria’s economic activity and growth is concentrated in sectors that are being stimulated directly by favourable global commodity prices such as crops, trading, oil & gas, telecoms & communications, and real estate. These are Nigeria’s five largest sectors. Manufacturing is sixth, and food, beverage, and tobacco (dominated by beverage) constitutes 70 percent of it. Food, beverage and tobacco contributes nearly 5 percent of GDP but the other 12 manufacturing sub-sectors remain miserably small, with none of them individually accounting for up to 0.5 percent of GDP!
We don’t expect the manufacturing sub-sectors that are incapable of meeting local demand to get anywhere close to being competitive on the export market, do we? But the issue to address is why manufacturing cannot fire in Nigeria in the face of large and growing domestic demand and a surfeit of raw materials. The answer is simple: the absence of domestic cargo rail transportation in Nigeria. Egypt, South Africa and Morocco pull their weights in manufacturing output and exports because of lower freight costs made possible by functioning cargo rail transportation.
Nigerian manufacturing collapsed in the 80s after the collapse of the once-functioning rail transport system in the country. Nigerian government needs to do to its rail transport sector what it has successfully done to its telecoms and power sectors; namely, end government monopoly, carve out the country into rail zones and allow private firms to bid for the rights to build and/or operate the lines under the oversight of a new regulatory commission. Not just rail, but pipelines, gas, and refineries. If these are successfully done, manufacturing will become spontaneously competitive and manufacturing exports should grow. Not just manufacturing will benefit. All other sectors will benefit from the competitiveness and scale that functioning cargo rail transport system will afford.
Impact of the twin shocks and the dual response on Nigeria’s economic outlook
Since July 2014, after a remarkably favourable half year in which oil price raced to a peak of US$115/b and equity market capitalization touched an historic peak of N14 trillion, the Nigerian economy has been buffeted by the twin shocks of global commodity price slump and global liquidity volatility that have translated to dwindling of income and net capital inflows for the county. Oil price bottomed at US$78/b in November, defining a four-year low, just as market capitalization dropped to N11 trillion, and external reserves dipped to US$38 billion.
After hoping against hope for five months that the tide will turn, the Nigerian government responded with a series of fiscal and monetary policy pronouncements by the end of November. These have put a lot of new angles on the shape of things. Far from resolving the puzzles posed by the twin shocks from abroad, the pronouncements have added two more puzzles at home – a fiscal puzzle and a monetary policy puzzle – triggering a debate about which is more damaging to the outlook: the twin global shocks, or the dual policy response. Watchers of Nigeria’s economic evolution thus face a year-end challenge of resolving four puzzles about Nigeria’s economic outlook!
The twin shocks from abroad had inflicted five months of income and spending losses on households, businesses, banks, government and the central bank. A robust response by Nigeria required a methodical evaluation of the plights of each of these units for a holistic intervention. The dual policy response sought to address only the last two units largely by aggravating the negative impact of the external shocks on the first three units, thus compounding their woes.
The statement from the finance ministry recognized the negative impact of the weak oil price on government’s oil revenue and offered some thoughts on how that problem will be dealt with. Government will cut spending, not on salaries or capital projects, but overheads, and government will seek the wisdom of McKinsey and the IMF to raise some additional half a trillion or so non-oil revenue over the next three years.
The statement from the CBN recognized the negative impact of the twin global shocks on the exchange rate and announced steps to address it. The naira was devalued and monetary policy instruments were tightened further, meaning a hiking of monetary policy rate by a percentage point from 12 percent to 13 percent per year, and the cash reserves banks were required to hold against private sector deposits were jacked up from 15 to 20 percent of the deposits.
Neither the finance ministry nor the CBN acknowledged any of the woes that the twin global shocks might have inflicted on Nigerian households, businesses, and banks. None therefore attempted to quantify or mitigate the woes! Both indeed inadvertently pronounced actions that will worsen the economic woes, thus further dimming the overall outlook of the economy for the coming year. Reducing government spending after all segments of the economy have suffered income losses is hardly positive for the outlook. Hiking the policy rate in that situation could only be a grave policy error on the part of the CBN.
Both the finance ministry and the CBN now urgently need to develop the capacity to think about the requirements of the health of the wider economy – households, businesses, and banks – before considering how to use the budget and monetary policy instruments to provide those requirements. This is the only way to ensure a positive economic outlook for Nigeria at this time or at any other time for that matter. Right now, Nigeria’s economic outlook is bleak. Not so much because of the twin global shocks, as sensible policy responses can mitigate the adverse effects of those, but much more because of the mediocre dual policy response.
Ayo Teriba
