Little has changed since our last comprehensive macro updates on Nigeria in July 2021 and June 2020, with the economy still plagued by stagnant growth, persistently high inflation, an overvalued exchange rate, weak revenue generation, endemic insecurity and limited reform momentum. Indeed, we could nearly copy and paste our text from prior updates, barring some minor changes to the macro data.
The key change has been the sharp rise in oil prices, but sadly Nigeria has been unable to take full advantage due to declines in production and ballooning fuel subsidies. The other major change is the political backdrop, with just over a year remaining until the general election on 18 February 2023, which in our view stymies any hopes for meaningful reforms.
In the text that follows, we update our detailed macro views on Nigeria and unpack the outlook for the country in 2022. We also update our investment views, concluding that the local fixed income market will continue to be un-investable amid negative real rates, currency overvaluation and low FX liquidity, and that hard currency debt will continue to underperform its oil-producing peers in the near term and its EM peers over the longer term, amid persistent structural impediments to growth.
On the equities front, Nigerian equities are attractively valued but off-limits for foreign investors because of the obstacles to repatriation, whereas, for local investors who dominate trading activity, the dividend yield on offer is attractive compared to a deeply negative real interest rate.
Growth outlook improved but still stagnant
After a modest Covid-induced contraction of 1.8% in 2020, real GDP growth is estimated to have rebounded to 2.6% (IMF, January) to 2.7% (World Bank, November) in 2021, due largely to base effects. Growth is projected to rise to 2.7% (IMF, January) to 2.8% (World Bank, November) in 2022, and to settle around that level over the medium term. While this is an upward revision from projections of 2.3% and 2.1%, respectively, last spring, it is essentially flat in per capita terms when compared with projected population growth of 2.5% annually.
Nigeria’s post-Covid rebound will be hampered by scarring from the pandemic. In its recent development update on Nigeria, the World Bank estimates that many Nigerians were forced to resort to adverse coping strategies during the pandemic, such as reducing food intake or selling or consuming their productive assets, resulting in a loss in labour productivity and an associated decline of potential growth from 4% over the past five years to 3% from 2022-23.
Ambitious structural reforms will be required both to reach this downwardly revised potential growth rate and to boost potential growth to sustainably positive per capita terms. The World Bank identifies a number of key reforms that could boost growth to 3.3-3.9% on average from 2021-23 if oil prices remain high, compared with a counterfactual growth rate of 2.1-2.5% with a lower reform intensity.
The IMF also outlines its reform recommendations in its statement following the Article IV mission in November 2021 (the full Article IV was reviewed by the IMF Executive Board on 31 January and will provide a more complete look at the IMF’s macro views, but at the time of writing this has yet to be published, so any reference to IMF data refers to the November 2021 press release, October 2021 WEO, or January 2022 WEO for growth).
Aggregating our own recommendations with those of the IMF and World Bank, key reforms include:
Transition to a more flexible and credible FX regime;
The removal of unsustainable fuel subsidies;
Better control of inflation and CBN monetisation of the budget deficit;
Reduced trade restrictions;
Improved revenue mobilisation and public service delivery;
Improved governance and reduced corruption; and
· Improved business environment to attract private investment.
Unfortunately, meaningful reforms are unlikely as Nigeria enters a pre-election year, with the Central Bank of Nigeria (CBN) showing little willingness to adjust its unsustainable soft currency peg and the government recently backtracking on plans to remove fuel subsidies (more on these topics later). President Buhari’s stewardship of the economy has been nothing short of disappointing since he took office in 2015, recording average growth of just 1.2% from 2015-19 despite some improvements on global benchmarks (namely the Fraser Index of Economic Freedom and now-defunct World Bank Ease of Doing Business Index), leaving Nigeria mired in a prolonged period of stagnation.
Meanwhile, there has been limited progress, if not outright backsliding, on Buhari’s purported core strengths of insecurity and corruption, with Nigeria’s rank stagnating in the Global Peace Index and falling in the Corruption Perceptions index and Mo Ibrahim Index of African Governance during Buhari’s tenure.
International rankings like this should be taken with a grain of salt, and, to be fair, deaths from Boko Haram have declined notably since he took office. However, anecdotal evidence of an ongoing rise in kidnappings, banditry and violence on multiple other fronts across the country and a lack of progress on Buhari’s anti-corruption agenda support the negative narrative and, with just over a year until the election, there is little to suggest these trends will improve.
Weak oil production and fuel subsidy erode impact of rising prices
While oil production makes up just over 5% of Nigeria’s GDP, it comprises nearly 25% of government revenue and 90% of exports and is, therefore, an essential component of Nigeria’s macro outlook. One would think, therefore, that the sharp rise in oil prices (up 50% in 2021 and another 17% ytd) would be hugely beneficial for Nigeria’s budget and balance of payments (BOP). However, the positive impact of rising prices has been diminished by falling production and the government’s costly fuel subsidy, leading Nigeria to underperform its oil-producing peers over the past year.
On the production front, endemic insecurity (with an estimated 150,000bpd of crude lost due to oil theft and sabotage according to Nigeria's upstream regulator, worth US$4bn annually at current prices) and a lack of investment over the past decade (exacerbated by delays on the Petroleum Investment Act – PIA) have pushed crude oil production down from 2.5mn barrels per day (mbpd) 10 years ago to 1.5mbpd in 2020 and 1.3mbpd in 2021 (excluding condensates of 300,000bpd), with Nigeria now producing below its OPEC quota for the past 19 months. This means that oil exports only increased by 23% in the first nine months of 2021 despite a 53% rise in prices, with monthly oil exports sitting over US$1.5bn higher the last time prices were this high, in late 2018.
The fiscal impact has also been muted by Nigeria’s costly petrol subsidy, which we estimate at NGN1,630bn (US$4bn, 1% of GDP) in lost revenue in 2021. The subsidy is highly regressive, with the World Bank estimating that households in the bottom 40% of the income distribution account for less than 3% of all gasoline purchases. Further, a large share is captured by smugglers who sell it across Nigeria’s porous borders (Nigeria’s pump price of NGN165/litre is well below the average price of over NGN400/litre in neighbouring countries and NGN495/litre globally). The fuel subsidy also crowds out pro-growth spending, exceeding combined spending on education, health and social protection last year.
Although the PIA requires subsidies to be removed by February of this year, Finance Minister Zainab Ahmed announced recently that the government has asked for an 18-month extension to avoid contentious price increases before the election. This was followed by the approval of NGN3tn of subsidy payments in 2022 (US$7.2bn, 1.4% of GDP). The 2022 budget had made allocations for subsidy payments through mid-2022, but this implies a further 0.7% of GDP of slippage relative to targets in 2022, and will further crowd out necessary spending on public services, physical and human capital, and more efficient social support.
Moody’s reacted negatively to the policy reversal, saying it “illustrates Nigeria’s weak institutions and limited capacity to implement challenging reforms,” with which we wholeheartedly agree.
FX mismanagement continues to plague economy
Although Nigeria’s fuel subsidy is harmful, its obsession with FX stability has had an even more disastrous macro impact (we’ve written extensively on the topic – see “Related reading”). While there were some signs that the CBN was laying the ground for another devaluation towards the end of last year, it has stuck to its soft peg of c410-415/US$ for the naira. At the same time, the naira has depreciated to above 570/US$ on the parallel market amid FX supply shortages, and non-deliverable forwards are pricing a deprecation to 460/US$ over the next 12 months.
The stated reason for the CBN’s focus on currency stability is to avoid inflationary passthrough from naira depreciation, but FX shortages have contributed to Nigeria’s endemically high inflation and policies like import bans aimed at reducing official FX demand have pushed demand to the parallel market (despite misguided attempts by the CBN to discourage parallel activity – here, here and here). This has led to inflationary passthrough and undermined the CBN’s secondary goals of price stability and growth.
To be fair, FX shortages eased amid rising oil prices and foreign portfolio inflows, with monthly FX inflows to the I&E window rising steadily through H2 21. However, they remained well below pre-Covid levels of US$3bn-4bn, and more than halved month-on-month in January despite the sharp rise in oil prices. Further, a large US$37bn stock of foreign portfolio investment in Q3 21 (US$17bn OMO bills, US$1bn T-bills, US$15bn government bonds and US$4bn equities) means there is likely still a large backlog of FX demand by foreign investors wishing to repatriate their earnings ahead of any naira devaluation.
The defence of an overvalued exchange rate also undermines President Buhari’s flawed import substitution industrialisation strategy, eroding the price competitiveness of Nigeria’s exports and preventing meaningful diversification. The IMF estimated that the naira was 18.5% overvalued last February, and it is unchanged in real effective terms since, suggesting a fair value for the naira of c490/US$ (the just-concluded Article IV could provide a more detailed update when it is published).
Although CBN Governor Emefiele has promised more naira flexibility when the Dangote oil refinery comes online (estimated for Q3 of this year, with the possibility of further delays), a delayed adjustment or a one-off devaluation to a new soft peg would cause imbalances to build back up given Nigeria’s wide inflation differential. Nigeria’s FX regime will continue to impede growth and investment and exacerbate inflation, but is unlikely to change under current leadership (ie at least until the February 2023 election).
Inflation likely to stay in the double digits
Nigeria’s flawed FX policy has contributed to endemically high inflation, with inflation staying above the CBN’s 6-9% target for the past 80 months. Other factors have contributed, too, such as pervasive insecurity in the middle belt of the country that has hampered food production (rising food prices have accounted for nearly 70% of the increase in inflation over the past two years, according to the World Bank), and, more recently, a sharp rise in global commodity prices.
Inflation has been trending downward since its March 2021 peak of 18.2%, but strong holiday demand and rising energy prices led to a slight uptick from 15.2% to 15.6% yoy in December, and inflation remains well above its target range. This has eroded the well-being of ordinary Nigerians and hampered business decisions. The World Bank estimates that, if inflation had been closer to 9% in 2021, consumption would have been 15% higher and 8mn fewer Nigerians would have fallen into poverty.
Unfortunately, the CBN is unlikely to be able to bring inflation sustainably into single-digit territory without major reforms to its monetary policy framework, with its monetary transmission mechanism all but broken and consistently undermined by Nigeria’s FX regime. The CBN has held its policy rate at 11.5% since September 2020, including at its most recent MPC meeting on 25 January, even as other EM central banks have embarked on hiking cycles (the CBN last hiked in July 2016). That said, prevailing market yields remain untethered from the policy rate, with one-year T-bills yielding less than 6% and giving Nigeria a real interest rate of -10% (among the lowest among major frontier markets).
Although policy rate hikes are likely later in the year if disinflation slows or reverses, it is unclear how this will impact the CBN’s underlying policy stance and is unlikely to meaningfully reduce inflation. The IMF expects inflation to average 13.3% in 2022 and 12.6% by year-end (in line with our forecast of 14.6% and 12%, respectively), but to remain at 11.5% annually over the medium term, absent reforms to Nigeria’s monetary policy framework. At this level, price stability (or the lack thereof) will continue to be a major impediment to growth in Nigeria in the years to come.
Budget not fit for purpose and debt problems growing
Nigeria’s relatively low debt/GDP ratio masks severe underlying fiscal problems, with a rising budget deficit, a large stock of debt hiding off balance sheet, and weak revenue collection leading to a high debt service burden and limiting public investment and service delivery. Including the debt of the Asset Management Corporation of Nigeria (AMCON, which was created in 2010 to acquire the non-performing loans – NPLs – of three distressed banks) and advances to the government from the CBN via the Ways & Means account, public debt has risen sharply from less than 10% of GDP in 2010 to over 20% in 2015 and 35% in Q3 21 (including US$15bn, or 3% of GDP, of eurobonds), and is projected by the IMF to rise further to 43% of GDP by 2026.
CBN advances have ballooned in recent years despite regulations limiting their use to 5% of the prior year’s revenue, ranging from 35-45% since 2019. As of Q3 21, the stock of CBN overdrafts reached NGN16.6tn (9.8% of GDP). CBN overdrafts are not integrated into official data, reducing visibility on Nigeria’s debt position. They also muddle the monetary transmission mechanism, effectively monetising the budget deficit and expanding the money supply. Plans to securitise them by end-2021, bringing them onto the government balance sheet and reducing the cost of debt servicing, have yet to materialise.
Still, Nigeria’s 35% of GDP debt stock is well below the 50% of GDP average across low-income countries. However, Nigeria’s debt vulnerability stems not from the size of its stock, but from severe liquidity constraints. Nigeria collected an estimated c7% of GDP in revenue last year and retained just c2.5% of GDP at the federal level (ie after state and local transfers), giving it one of the lowest rates of collection in the world. At the same time, rising debt service costs pushed interest payments to 76% of aggregate federal revenue and 98% of federally retained revenue in the first 11 months of 2021.
Failure to boost revenue will push Nigeria closer to debt distress and increasingly limit the space for non-discretionary spending on physical and human capital or the social safety net, which will result in a looming infrastructure gap and constrain growth in the years ahead. There has been little progress on the government’s plans to more than double aggregate revenue collection to 15% of GDP by 2025, with weak service delivery and rampant corruption undermining the social contract and hampering efforts to widen Nigeria’s threadbare tax net.
The 2022 budget targets a decline in the federal deficit from 4.5% of GDP in 2021 to 3.5% in 2022 based on assumptions of 4.2% real growth, 13% inflation, 1.88mbpd of oil production (including condensates), a US$62/barrel oil price and an NGN410.15/US$ exchange rate. However, budgets in Nigeria seldom have any relation to reality, with large revenue shortfalls (due in part to deductions for the oil subsidy) and debt service overshoots (due in part to the failure to include service on CBN overdrafts) typically partially offset by large capex cuts, resulting in a federal deficit that is wide of the target and worse in composition.
The failure to remove the fuel subsidy will likely add another 0.7% of GDP to the deficit (see above). Meanwhile, although the oil prices assumption looks conservative, production is assumed to be 400,000bpd above current levels, which will result in a net 0.2% of GDP boost to federally retained oil revenue based on current prices and production. Non-oil revenue, on the other hand, is likely to undershoot given the overly optimistic 4.2% growth target, which will likely be offset, as usual, by capex cuts.
Overall, the federal deficit will probably be wider than the 3.5% of GDP target in 2022, and is likely to end the year just marginally lower relative to 2021, as projected by both the IMF and World Bank. Absent substantial progress on revenue mobilisation, which looks unlikely pre-election, Nigeria’s budget will continue to impede growth and debt, despite favourable solvency indicators, will remain at a relatively high risk of distress given the large debt service burden.
Balance of payments improved by oil increase but weighed down by FX peg
Nigeria’s BOP has improved on the back of rising oil prices, but weak oil production and the FX peg (see above) have combined to limit the improvement. The current account balance swung from a 4% of GDP deficit in 2020 to a 0.6% of GDP surplus over the first three quarters of 2021, and we project a further rise to a 1-1.5% of GDP surplus in 2022.
However, the overall reserve improvement has been limited due to Nigeria’s weak investment backdrop and overvalued exchange rate. Although portfolio and other investment were bolstered by a US$4bn eurobond issuance and the US$3.3bn special drawings rights (SDR) allocation, respectively, in Q3, FDI remained stagnant at less than 1.5% of GDP through the first nine months of the year, and endemically large net errors & omissions hint at possible capital outflows behind the scenes.
Stripping out the eurobond issuance and SDR allocation, reserves remained below post-Covid lows in January despite the sharp oil price increase. The lack of meaningful reserve accumulation hints at underlying BOP pressures, with reserves likely to resume their downward trajectory if oil prices decline (they currently sit at cUS$40bn, or c6.5 months of imports).
CBN Governor Emefiele expects the 650,000bpd Dangote oil refinery to result in a major BOP improvement when it comes online in Q3 this year by meeting Nigeria’s 450,000bpd demand for refined oil and eliminating the need to import, but we estimate an impact of US$4bn-4.5bn based on current oil prices – a material but not a transformational improvement. As such, there is limited logic to Emefiele’s assertion that the naira will be allowed to float once the refinery comes online.
Overall, Nigeria’s BOP is in a relatively healthy position but further improvements will be limited by naira overvaluation and a weak investment environment. A BOP crisis is unlikely, given external public amortisations of just US$1.65bn on average over the next five years (including less than US$500mn owed to bondholders, or US$1.5bn including interest).
However, the still large stock of portfolio investment in the country (US$37bn in Q3 21 – see above) raises the risk of capital flight and, although capital controls will likely be deployed to limit the impact, this will hamper Nigeria’s ability to attract new investment. And, if oil prices reverse their recent gains, reserves could once again come under pressure and force the CBN to decide whether to preserve the currency peg or finally allow an adjustment.
February 2023 election will limit reform prospects
With the general election on 18 February 2023, Nigeria has entered into a pre-election year, which will limit the prospects for reform. In theory, the removal of a market-unfriendly leader like President Buhari (whose two-term mandate expires at the next election), and the potential replacement of his unorthodox acolyte at the CBN (Emefiele), should pave the way for more positive economic prospects. Vice-President Yemi Osinbajo may be viewed by markets as the preferred choice for the time being, given his relatively orthodox and technocratic background, but he has yet to throw his hat in the ring and it is unclear if he can navigate Nigeria’s power politics to emerge as Buhari’s successor.
Meanwhile, senior members of the ruling APC party have started to express interest in the job, including Ebonyi State Governor David Umahi, Senate whip Orji Kalu, and, most prominently, national APC leader, former Lagos State Governor and political heavyweight Bola Tinubu. The APC is expected to hold its convention next month before organising the process to select Buhari’s successor, with more candidates likely to join the fray in the meantime, and the informal practise of switching between northern and southern presidents favouring aspirants from the south. The opposition PDP, meanwhile, has no clear flagbearer, with Rivers State Governor Nyesom Wike already announcing his candidacy and others soon to follow, while fluid party lines mean it could leach politicians from the APC after the succession process if unsuccessful candidates feel snubbed.
Given the endemic problems with Nigeria’s political system, it is unclear if any candidate will be able to right the ship (see here for an interesting op-ed from the Financial Times on the topic). And, in any case, there is a long road to travel until the election. In the meantime, Nigeria will continue to muddle through without any meaningful economic reforms (the fuel subsidy debacle is a potent illustration of this).
Fixed income will continue to underperform absent reforms
On the local currency front, despite what might seem like attractive nominal yields of 12% at the longer end of the curve, there is limited rationale for foreign investment until real interest rates rise into positive territory and the exchange rate is devalued to a market-clearing level. Even if these conditions are met, foreign investors will likely require evidence of post-devaluation flexibility and the removal of capital controls to ensure imbalances don’t simply build back up and that they can repatriate their earnings.
On the hard currency front, Nigeria will likely continue to trade firmly on the back of high oil prices. However, with low production and fuel subsidies limiting the positive impact of higher prices, Nigeria will continue to underperform its oil-producing peers. And, without significant economic reforms, Nigeria will likely underperform its EM peers over the longer term, notwithstanding the current boost from oil prices.
Against this backdrop, we maintain our Sell recommendation on NGN and domestic government debt and our Hold recommendation on hard currency debt, with the NGERIA 8.747 01/21/2031s trading at an 8.04% YTM (650bps z-spread) on a mid-price basis at cob on 2 February on Bloomberg).
Nigerian equities still off-limits to most foreigners
Nigerian equities (NGX All Share index) are up 12% ytd, versus down 3% and down 1% for MSCI FM and EM, respectively. Over the past 12 months, the equivalent figures are up 8%, up 18% and down 10%.
Taken in isolation, top-down equity valuation still looks attractive: forward PE is 9.5x, a 10% premium to the five-year median, alongside 18% consensus earnings growth. However, FX restrictions keep Nigeria off-limits for fresh capital from foreign investors (and, given this is the second time in a decade that foreigners have been trapped, there is a question as to how quickly they might ultimately return, assuming they have fully repatriated their prior positions).
Nigeria equity strategy is of interest mainly to local investors. The share of value traded driven by locals has increased from 45-50% in 2016-2019 to 66% in 2020 and 77% in 2021. And, for local investors, a forward equity dividend yield of 5.2%, while less than the 11.2% available on local currency five-year government bonds, is compelling alongside a negative 4.1% real interest rate.
Nigeria: Stealth devaluation possibly underway, November 2021 (Curran, Ogunkoya & Omole)
Nigeria: FX overhaul promised post-Dangote refinery, October 2021
Nigeria: Ban of abokiFX furthers FX folly, September 2021
Central Bank of Nigeria adds fuel to the fire by banning BDCs, July 2021 (Curran & Ogunkoya)
Our discussion with Nigeria’s IMF Mission Chief, April 2021
Nigeria policy rate and FX regime left intact, March 2021