On the Cusp of Recovery.

Recently, the Research Desk of Vetiva Capital Management Limited released its Macroeconomic Outlook for H2’21, titled On the cusp of recovery. Below is a summary of our outlook for Nigeria:

Ascending from pandemic depths

On the back of a favourable base year, the Nigerian economy is expected to rebound strongly by 3.13% y/y in 2021. Given the accommodative monetary policy environment, zero likelihood of lockdowns, and easing of OPEC+ production cuts, Nigeria could record a strong one-off recovery in the current year.

Agriculture could ride on the interventions of the Central Bank to sustain its resilient growth outcomes. However, headwinds from herder-farmer clashes could limit the pace of growth. The manufacturing sector could also maintain its expansion path as COVID-19 restrictions on labour hours are non-existent and innovative marketing strategies are deployed to cater to depressed consumer wallets.

Source: NBS, Vetiva Research

The oil sector could experience a breather from the gradual easing of OPEC+ production cuts. However, headwinds could arise from the return of shale producers and the introduction of more OPEC+ production cuts, should severe waves of the virus arise, or the Iranian nuclear deal pulls through.

We look forward to slower growth in the financial services and ICT sectors due to business climate hostilities and NIN-SIM linkage restrictions, respectively. High contact industries in the services sector could recover slowly on the back of restoration of supply chains, reopening of the borders, amid slow adaptation to the post-lockdown era.

Inflation: Base effects versus Reforms

We see base effects subduing inflationary pressures in H2’21 as food pricing pressures ease as we approach the harvest season. However, there is room for more uptick in core inflation, should there be fuel subsidy removal upon assent to the PIB.

Thus, we expect inflation to rise to 17.34% in 2021 (FY’20: 13.21%).

Source: NBS, Vetiva Research

Given our base case assumption of moderation in inflation, we expect the CBN to lay its monetary policy tools on the table as the Bank allows its expansionary policies to permeate the economy. Thus, we expect the Monetary Policy Rate to remain frozen at 11.5%.

Fiscal Policy: In a bundle of dilemmas

Historical evidence shows that fiscal deficit rises quicker during an oil price shock before a subsequent slowdown. However, due to the resurfacing of fuel subsidies, Nigeria could record a higher fiscal deficit in 2021 as COVID-19 holds back export demand while subsidies buoy expenditure obligations.

According to our estimates, more is being spent on subsidies than is remitted to the states. With the upsurge in oil prices, Federation Accounts Allocation inflows could be the opportunity cost of fuel subsidy maintenance. While this could change with the full removal of fuel subsidies upon assent to the Petroleum Industry Bill (PIB), social resistance to reforms could spring up.

As Nigeria repays some of its external loans, the debt stock has receded slightly from 2020 levels. While multilateral debt has dominated our external debt stock mix, commercial debt is on the rise stoking our debt service-to-revenue ratio. The Debt Management Office has rolled out its medium-term debt strategy, which raises the debt ceiling to 40% of GDP and prioritizes domestic debt over external debt (70:30).

External Sector: A déjà vu scenario

Despite higher oil prices, the discovery of the infectious Delta variant held back crude demand in India. Thus, the merchandise trade deficit has deepened since the pandemic struck. Due to increased travel requirements and the proliferation of virtual meeting platforms, the services deficit has moderated. The deficit in the income segment has moderated due to unattractive yields in the fixed income market and currency overvaluation. The surplus in the transfers segment has been upheld by remittance flows, yet they remain shy of pre-pandemic levels. Going forward, while we expect a recovery in export demand, the reopening of the borders could increase the import bill as previously smuggled goods make way through the borders, resulting in a wider merchandise trade deficit. A pick-up in travel and tourism could expand the deficit in the services segment. The income segment could record a facelift from exchange rate unification efforts over the medium term.

The Naira has witnessed twists and turns over the years. With every oil price shock comes an adjustment in the currency peg. When oil prices recover, the Naira never does, as these shocks correct the pre-existing overvaluation of the currency. Unless exports are diversified and imports are substituted with local production, the Naira could continually be strained by downcycles and commodity price shocks.

We expect oil prices to average $64 - $66 in the second half of the year. Despite the plunge in the external reserves, we expect the proposed Eurobond raise to lift reserves to $34.1 billion by the end of the year. We see the NAFEX rate fluctuating between N411/$ - ₦414/$ while the parallel market is expected to average ₦496/$ - ₦499 in H2’21. Should the country take advantage of the increased Special Drawing Rights (SDR) allocation, we could see considerable accretion in reserves and appreciation in the Naira.