Upgrading short term trajectory from negative to neutral as Jonathan heads for re-election

President Goodluck Jonathan will likely be re-elected in February (75%) following a polarizing campaign.

The pre-election period will be marked by patronage politics and policy stagnation but we do not expect major fiscal or monetary policy reversals.

Boko Haram attacks outside the northeast will continue to damage local communities and Jonathan’s standing, but they will not undermine national stability or derail Jonathan’s candidacy.

The next six months in Nigeria will be tense – there will be constant politicking, attacks by Boko Haram, oil theft, and policy stagnation. However, the emerging political landscape is likely to put a floor on the downside risks as the ruling People’s Democratic Party (PDP) steadily consolidates under President Jonathan. This will not resolve Nigeria’s structural vulnerabilities, but reduces the likelihood that the campaign season will completely upend the investment climate or reverse the country’s economic momentum. Over the next six months, we envision policy stagnation, but not sharp backsliding. The risk of fiscal or monetary policy upheaval under Finance Minister Ngozi Okonjo-Iweala or CB Governor Godwin Emefiele is relatively low, absent a major shock or combination of shocks. A Jonathan win could feed political unrest in the north, but makes it less likely that rebels in the Niger Delta re-ignite their attacks on oil infrastructure and personnel. Political risks are already elevated so our neutral forecast starts from a high-risk baseline. Downside pressures that could push our trajectory back in a negative direction would include some combination of an oil shock (price or production), a disorderly response to Fed tapering, a new wave of defections from the PDP, a sharp escalation (and southern creep) by Boko Haram and a prolonged rise of sectarian or political violence.

Jonathan ascendant

A recent research trip to Nigeria has reinforced our expectation that President Jonathan will be re-elected next February, despite considerable opposition in the north and a worsening security climate. This is a net positive for political stability: a desperate ruling party, facing the potential loss of its power (which dates back to 1999), would exacerbate profligacy, policy politicization, oil theft, and regional/sectarian tensions.

Following a shakeup in the party leadership, the ruling People’s Democratic Party (PDP) has stopped — and to some extent reversed — the trend of party defections to the opposition All Progressives Congress (APC). The APC is in disarray and recently lost the governorship and all 16 local councils in one of its ‘home turf’ states of Ekiti in its south western base. The opposition needs to win big in the southwest and the north if it is to displace the PDP in February.

In our base case scenario, Jonathan will announce in September ahead of a PDP primary win around November. The president will likely stave off an internal challenge from a northern governor such as Sule Lamido, although the festering resentment of northern elites over their marginalization since 1999 poses a structural risk to the party. It also creates an opportunity for the APC, which it has so far failed to seize. The leadership struggle inside the APC — which cuts across regional, sectarian and personality fault-lines — remains unsettled, with no obvious ticket that would neutralize the PDP’s incumbency advantages. The strongest candidate, former head of state and 2011 runner-up Muhammadu Buhari would sweep the north but probably alienate too many Christian and southern voters to win (as in 2011).

The APC still has a chance (25%) if it can mobilize behind a strong northern presidential candidate that has Buhari’s backing and a vice president who can deliver votes and high turnout in the southwest. This is proving to be a difficult challenge for the opposition, where personality clashes, disorganization and regional fissures are taking a toll. The opposition will likely announce its ticket a few weeks after Jonathan’s re-election announcement.

Security climate will remain tense

The threat posed by Boko Haram will not diminish ahead of elections, despite new international cooperation, containment measures by the government and the $1 billion proposed by the Jonathan administration for counter-terrorism initiatives. The trend, as we have highlighted, is towards more attacks and kidnappings outside of the group’s remote north eastern base, including the capital Abuja and the country’s second-largest city of Kano (please see NIGERIA – Boko Haram threat will continue to extend beyond the northeast). There have been relatively few attacks on westerners or foreign business but they may become more attractive targets over time as Boko Haram continues to evolve.

Lagos and the oil-rich Delta, long seen by businesses and locals as immune, may also be targeted in a sporadic fashion. While it received limited media attention, Boko Haram claimed responsibility in July for a deadly suicide bombing on a crowded fuel depot in Lagos that killed four but could have been far more deadly. Boko Haram’s limited infrastructure, personnel, and local knowledge in the south makes a sustained terror threat in Lagos or the Delta unlikely. Still, the risk of isolated attacks has become increasingly plausible as Boko Haram looks to extend its geographic reach and impact. Such an attack would hurt market sentiment in its aftermath but would probably not halt the broader macro-economic momentum. So far the APC has failed to capitalize on the administration’s inability to contain Boko Haram or find the kidnapped school girls; if anything, the terror threat may bolster Jonathan in the south and among Christians in the middle belt, an important battleground region in the elections.

The elections will see violence, including likely rioting in the north. A decisive PDP win would likely tamp down on some of the unrest, but investors should expect the immediate pre- and post-election period to be tumultuous. The losing side will reject the outcome, turn momentarily to the streets and then to the courts, which will likely uphold the outcome.

Absent shocks, economic policies point to continuity

The central bank is likely to maintain policy continuity ahead of elections despite initial concerns about a dovish turn under Governor Emefiele (please see NIGERIA: Emefiele will maintain policy continuity at central bank, minus the spotlight on corruption). Bank officials are predisposed to maintaining the 12% benchmark rate and N150-160/$ naira band unless there is a major shock to the economy. The chief risks they point to are election-fuelled inflation, fed tapering/capital flight, and renewed pressure on the naira. The bar is relatively high, though, to precipitate a policy shift at this point. Nor is there strong political pressure to deviate from the current policy stance despite grumblings from local businesses and civil society. On the fiscal side, the 2014 budget’s planned spending cuts will probably slip but not fall a cliff and the country’s current account surplus, low fiscal deficit and low debt should provide a cushion. Off-budget oil spending will rise, though, feeding patronage for the federal, state and local elections (elections will be held at levels of government).

Regarding foreign exchange reserves, bank officials believe they have breathing room and stress that there is no imminent crisis at current levels, but also stress that they will not defend the naira band “at all costs” should there be a sharp fall in reserves. The psychological threshold is probably around $30 billion, though reserves may have to fall a bit further than that to prompt a shift in the naira band, given the conviction behind maintaining it. Officials at the bank are hopeful that new restrictions on foreign exchange bureaus will help shore up reserves and are estimating up to $7 billion annually in savings from the new measure, though that seems ambitious.

Inflation, which has been edging upwards in recent months, is widely expected to rise further ahead of elections, including by the central bank. If it grows to double digits as some expect, the monetary policy committee will likely be divided on whether to implement a small rate hike. Given the business and political opposition to a hike, this scenario would pose a test of Emefiele’s independence. Following our research trip, we are less convinced that Emefiele will be fully independent over time in the face of political and banking sector pressure. We expect less scrutiny of oil revenues under Emefiele and an industry-friendly approach to banking supervision, for example. This could potentially tip the scales against a rate hike if the MPC is divided on the issue.

Energy: More stagnation ahead

The petroleum sector will continue to underperform ahead of elections. Once again, a regionally-divided parliament will fail to pass the Petroleum Investment Bill (PIB) before the February elections. The ongoing fiscal and regulatory uncertainties will deter new investment in the most promising opportunities – ultra-deep oil and gas exploration more broadly. That said, IOCs believe that no PIB is far better than passage of the current draft. Bunkering will persist, shutting in about 200,000-300,000 barrels per day, accelerating Shell’s phased divestments onshore (to local companies and juniors who will struggle to maintain production levels). The onshore shut-ins are fiscally damaging since the government yields up to 90% of the revenues from these joint ventures.

As gas exploration continues to stall and competitors boost global supply, the opportunity cost for Nigeria is rising. The major Brass project (potential output of 10 million metric tons of LNG), long favoured by President Jonathan, looks increasingly unlikely to move forward as costs continue to escalate. This project appears doomed on multiple fronts-doubts over financing capabilities of the NNPC, PIB uncertainties (and worse fiscal terms for gas should it pass), no replacement yet for ConocoPhillips’ 17% share, and a changing global supply market. More likely at this point is the seventh Nigeria LNG train, but the Jonathan administration remains distracted by its preference for Brass, which is located in Jonathan’s home state of Bayelsa.

The administration’s cherished power sector reforms also face headwinds from problems in the gas sector. The commercially non-viable pricing of gas mandated for the domestic market is causing a chronic undersupply for the country’s gas-fired power plants, many of them recently privatized or soon to be privatized. This has undermined the administration’s ambitious goal of upping power supply to 10,000MW (from about 4,000 MW). The gas price is set to rise to 2.5 per million cubic feet (mcf), but remains far below the market price for exports. The government, under pressure from a broader lobby now than just the IOCs, will likely accelerate its plans to raise the price further, but probably not enough to address the supply shortage ahead of elections.

PHILIPPE DE PONTET