Nonso's Monthly Nigeria Economic Update – February 2019
Elections looming and supreme court drama, FDI Inflows – a note on rule of law, Stock Market under – 30,000, Inflation and Exchange rates, and fiscal capacity
Elections looming and supreme court drama
The presidential elections are set to hold in February and despite claims by some it looks set to be a tight race, although probably not for the “third force” candidates. According to INEC voter registration data there are 15 million new voters in this election. And if elections from around the world are anything to go by, we should not be surprised to get a few surprises. In general, this set of elections do not seem to carry the same political risks as some of the previous ones. Although the risk probably inched a bit higher due to the fiasco with the chief justice of Nigeria. For one there is almost no risk of unconstitutional regime change. The risk of violence is also lower than in previous elections. All that is good for Nigeria.
There are significant risks on the economic front though. The policy agenda of both governments on paper appears to be very different. The Buhari agenda appears to lean more towards state interventions while the Atiku tends to lean more towards markets. I know these are all pre-election agendas so no one can say for sure if they will stick to it. Still it is useful information. What this means is the direction of policy in general could change depending on who wins.
Regardless of who wins there are pound to be some policy shocks in the next year. The exchange rate is one which may need tweaking. Most forget that the official US dollar to naira exchange rate is still 306. This means things like FAAC allocations to states and LGAS, Eurobond conversions, and fuel prices are still transacted at that rate. The end of the election cycle may see new pressure on the central bank to abandon it. We already know, from Ngozi Okonjo-Iweala’s book that the governors were the brains behind the new year subsidy removal fiasco during the Jonathan regime due to what they perceived as shortfalls in their allocations. The grumbles of the governors has reduced due to the elections, but will no doubt resurface after it. A change in the dollar naira exchange rate from 306 to the market 360 will immediately provide more revenue for the FAAC so we may see that happen sometime during the year.
The market exchange rate is also under a bit of pressure as well. The foreign reserves saw a bit of pressure during the second half of 2018 and this was in spite of new Eurobond sales and the China Yuan swap implementation which happened during that period. Part of that was driven by capital flows partly due to global factors but also partly due to the expectation of policy change. A new regime will definitely lead to policy change but the central bank governor’s tenure ends in June as well so there is also a risk of policy change. So, we might see all of that play out in 2019
There is also the risk of changes to fuel and electricity prices which may serves as further shocks to the economy. Those prices have been fixed for a while now and been under some pressure. Although the pressure on fuel prices is likely to be a but lower due to the fact the crude oil prices have dropped from $80 to $60 per barrel. If the exchange rate changes then those prices will have to change as well. Still, politically, the best time to adjust those prices is right after elections if the Buhari regime wins, and right after handover if the Atiku regime wins. So, we may see those shocks happen in 2019. Morale of the story: regardless of who wins there is likely to be some turbulence.
FDI Inflows – a note on rule of law
The United Nations Conference on Trade and Development (UNCTAD) announced global FDI trends for 2018 during the month. For Africa as a whole FDI increased six percent to $40bn dollars although the fell globally by about 18 percent. Africa accounted for only two percent of foreign direct investment in 2018 so the 18 percent increase has to be put in perspective. On the Nigerian front, our insignificance in terms of foreign direct investment continues. FDI fell to $2.2bn or 0.1 percent of global FDI flows. No type there. At $2.2bn we were much lower the Egypt and South African, our Africa peers, and even lower than Ghana, whose entire adult population can fit in Lagos. Bottomline, we are still no an investment destination. Outside boutique investments with high yields and fast returns, which are few and far between, we are not competitive. Of course, you can always point to a few outliers.
This brings me to the brouhaha regarding the chief justice of Nigeria. I am not a lawyer so I will not comment on the legality of the actions. It does look bad though. If you combine it with all the other incidents in 2018, such as the MTN fiasco, then it says we are not a serious country. The things is we will probably see no significant effects in the data in terms of FDI because we are so far down the investment grade ladder that we can’t fall much further. Short of a Zimbabwe or Venezuela style implosion it is difficult to see Nigeria getting any worse as an investment destination. Still, it means that the job of climbing back up the ladder just got a lot harder. Rule of law is one those things that is really important for investment. And foreign investment is really important not just because people bring their money but because they tend to bring their knowledge and skills as well.
Stock Market under – 30,000
In January the NSE all share index dropped below 30,000 for the first time since 2017, at least for a few days. Indeed, the NGSE is almost 25 percent lower in Naira terms than it was at the end of 2019. More astounding if you recall what has happened to the Naira over the period. Of course, the story for the NSE 30 is a bit better and there are specific stocks that would still be in positive territory in dollars over the same period. Still it makes for sobering reading. Stock markets around the world are typically medium to long term investment options. The classic investment advice is to invest in money market instruments if you need your capital soon and equities if you need your capital later. The NSE however seems to only be useful for short term investments which is sobering. If you add the near absence of IPOs on the NSE then you have to wonder how exactly companies are expected to raise long term financing? Taking long-term loans from banks is not an option due to the interest rate environment, and the FDI numbers mean that road is difficult too. To be honest I do not know what needs to be done to turn the NSE into a long term financing option, but I know the solution has very little to do with motivational speeches.
In the short term the major drivers in the NSE movements seem to be foreign portfolio outflows which are driven partly by conditions international markets with the US raising rates and partly by the expectation of potential shocks to policy after the elections here. My guess is there will be no major movements until the policy environment, especially around exchange rate shocks becomes clear. That will be either after elections or after a resolution of the next CBN regime. Still, there will be short term plays around specific stocks as there always is. Don’t call me a prophet though. I may be wrong.
Inflation and Exchange rates.
The slow upward trend of inflation continues coming in at 11.44 percent year on year. Conventional monetary policy suggests that if the CBN has inflation as its core mandate, and if inflation is above its target (which is six to nine percent for the CBN) then it should raise rates. The monetary committee policy met in January and unsurprisingly decided not to raise rates and hold everything fixed with the MPR still at 14 percent. If you read any of my articles in Business Day or on Medium then you know my thought on that already. The MPC is really just an obligation now and the CBN does not actually do what it says via the MPC. What does it do? Well judging by the rates on 91-day treasury bills and OMO securities it has gone from a tightening to an easing and back to a tightening cycles all in the space of 24 months. According to conventional monetary policy, it is wiser to pick a path and stick to it for a while. Going up and down and back and forth is typically worse than sticking to path regardless of which path is chosen. Then again maybe the path chosen is to keep exchange rates fixed.
Speaking of exchange rates, the CBN governor was asked about a statement by the Atiku campaign group that they would float the Naira if elected. His response? Floating the naira would be a road to perdition, a disaster for the Nigerian economy, and would be as good as going back to the “era of Structural Adjustment Programme (SAP)”. Nothing fires up Nigerians like mentioning SAP and I guess that was not thrown in there by accident. Still it is sad to see that we have gone full circle already and look like we will have another set of “should we devalue, or should we float, or should we fix” debates all over again. Learning be damned. To be clear I don’t think a free floating currency would be the best case scenario. We are still hopelessly exposed to volatility in the crude oil market which will imply volatility in a free floating currency. If you think of volatility as short term then I think the CBN should still act to smoothen out short term volatility. My major gripe is with the long term trend. The current regime is hopelessly out of touch in terms of ensuring the Naira is close to its long term trajectory. Whatever that trajectory is everyone know it cannot be 360 forever and ever. Which means the longer we stay stuck at 360 the more likely we are setting ourselves up for some 2016 type shock event which is really bad for economies. I think the CBN can act to smoothen out short term volatility while ensuring that we are never far from our “equilibrium”, something the Soludo regime did relatively well with its managed float. That being said, I think a full free float is better than the nonsense we are doing now. The pain from short term volatility is smaller than the pain from big future adjustments. And given how smart our financial people are, I would not be surprised if the private sectors create instruments to deal with volatility anyway.
Fiscal capacity
As per my update last month, the federal governments revenue position is precarious with targets that do not look achievable. As part of the measures to increase revenue the government has announced that it is “studying a possibility of a VAT increase”. Not on all goods but on selected items. Does a VAT rate increase make sense? I don’t know. There was apparently a study done which is not public, so I don’t know what they found or how they found it. One the one hand the VAT rate in Nigeria is much lower than in many other African countries. In Egypt it is 14 percent. 15 percent in South Africa. 16 percent in Kenya. It’s only five percent here.
On the other hand, in practice Nigeria charges a sales tax not a VAT. It is called VAT but trying to argue about the value added with FIRS. Then there is the fact that the federal government only gets 15 percent of the VAT pool with state and LGAs getting the lion share. Much like with VAIDs and personal income taxes, this does not seem like something that is really going to do much for the federal government’s finances simply because of where the lion share of the increases, if they happen, go to.
Then there is the risk of pushing more businesses into non-compliance. Because we mostly don’t report the VAT in prices, consumers only see the final price which includes VAT. An increase in VAT therefore means that to the consumer, prices for compliant firms go up while prices for non-compliant firms do not. Should we be focusing more on compliance as opposed to the rates?
In general, I do not think an increase in the VAT would be such a bad thing if it is done in such a way that it doesn’t reduce compliance and if the proceeds from the VAT are spent in productivity enhancing projects. But if we increase VAT and the states and LGAs use it to buy Prado jeeps (which by the way officially count as capital expenditure) then we risk tipping the economy back into recession, which would be a worse outcome than have a federal government with constrained revenue.
I still think broader tax reform should be the real agenda in terms of solving the fiscal challenge for all the tiers of government. The current fiscal structure was designed for a time when the question was how to distribute oil revenues. We have to migrate to a structure that’s based on how to collect taxes in exchange for public services and we probably can’t do that with what we have now.
That’s all for this month. Questions or comments can be sent to me at me@nonsoobikili.com. If you have colleagues who you think this update will be useful for you can share the subscription link with them.