2016 is crunch time for Nigeria

The Bible says in Genesis 41:29-30 that seven fat years in Egypt will be followed by seven lean years in the time of Joseph. It was to warn the profligate children of Egypt to reduce their ostentatious and extravagant ways. They were advised to save some wheat or grain in preparation for the tough times ahead.

Even in biblical times, the cyclicality of economics was acknowledged. Therefore, it is surprising that various Nigerian administrations in the last 20 years failed to heed this basic principle of putting something aside for the rainy day.

I am saying this today to illustrate the macro-economic cul-de-sac which Africa’s largest economy and country by population is facing. The country is confronted by its steepest decline in oil revenue by 57.25 percent to $4.12bn, leaving a significant shortfall to fund the budget for 2016. The funding gap which translates into an amount of N2.2trn is 1.93 percent of GDP. The countercyclical budget is meant to stimulate the economy into the path of recovery. There is also the more profound issue of the external sector imbalance resulting from the acute shortage of foreign currency, particularly US dollars from oil.

This external shortfall in dollars results more from the sharp fall in the yield (spread) for a barrel of oil which has fallen by 91.57 percent from $95pb to $8pb. This is more than the 65 percent fall in the nominal price of oil in the market. In the good old days, the quarterly dollar inflow was in excess of $18bn per year. This is now down to a paltry $8.48bn. The effect of this picture is that the Nigerian economy is now tottering on the edge of an extended period of slow GDP growth.

This is happening at a time of a crisis of false expectations. The people had been conned into believing that the economy was in good shape by an outgoing administration that tried to paint an optimistic picture to a miserable electorate. This paper is to situate the current Nigerian situation in the context of the global commodity crisis and seek to project the likely outcome in 2016, in what can be best described as a year of economic turbulence.

In layman’s language, we can say that most Nigerians should fasten their seatbelts in anticipation of the rough tide ahead. The first question that needs to be addressed is, what is the current commodity crisis and is it different from previous ones?

The present commodity crisis has its origin in the unexpected slowdown in China. The Chinese economy had been growing in double digits for a decade. Therefore a decline to 7 percent in the last two years had major repercussions to global commodity producers. The $10.36tn economy, which is the second largest in the world, had to cut back on its demand for many primary and secondary products. This also coincided with flat-lining in the Eurozone, which is also the third-largest market in the world.

The EIU expects the four-year slide in agricultural commodity prices to come to a halt in 2016-2017. The EIU FFB index fell by 18.2 percent in 2015, extending average annual declines of 5.4 percent in 2012-2014, but it will recover some ground in the coming two years, rising by 3.4 percent in 2016 and 4.9 percent in 2017. Tightening markets will be the prime drivers of this increase. Global demand for food and beverages will continue to grow steadily, underpinned by demographic and income trends. This is the global picture of agricultural commodities.

On the other hand, we see the outlook for the oil market has deteriorated sharper than we originally anticipated. However, the consensus is that in spite of geographical tension and the distortions created by the Saudi attitude towards forcing oil prices down, we should see some recovery in oil prices during the year. The EIU says also that although the oil supply-demand balance will tighten, putting upward pressure on prices, we do not expect crude oil price to come back to pre-2014 level in 2016/2017. Despite a dip in US production, global crude supply will expand further in 2016 on the back of continued output growth from OPEC and to a lesser extent Russia.

Therefore, the revenue and foreign exchange earnings picture for Nigeria in 2016 will remain bleak to challenging. For example, the price of oil has been below 50pb for over 15 weeks. This has blown a huge hole in the budget of the FGN but more for the states. The Nigeria budget of 2016 is based on a benchmark price of $38pb which is very conservative in real terms, but will be tested in a market that is now trading at $33pb. What does this mean to the two main economic constituencies?

The FGN has accepted that the party is over. In other words, a reality check. Luckily, the Nigerian electorate endorsed the APC government because of its lack of trust and confidence for the PDP. The APC has not shown a proper understanding of economics and is still trying to figure out what the problem is. It has run out of time, because the honeymoon is over. Now the government has to reignite the economy to life and simultaneously convert economic wealth into economic wellbeing for the people.

Therefore, the key decisions that will put the economy into a path of general dynamic equilibrium requires for the reduction or possible elimination of subsidies. This will reduce distortions, increase government revenue whilst empowering the government to fund the social safety net for the poor and underprivileged. The Federal Government is embarking on an ambitious fiscal programme increasing its spending by 25 percent at a time when revenues are sharply lower. It is to make three critical decisions:

The removal of subsidies, which will reduce expenditure by N1trn or 25 percent of the previous budget. It will automatically increase available revenue for sharing by the same amount for the states of the federation. This singular and important decision will not only change the economic destiny of Nigeria but also reduce its import bill by over 20 percent and allow the naira some breathing space. What is happening is that government has refused to accept that market economics works in African countries. That economic reform is not incompatible with patriotism. The fundamental misconception that a strong currency is synonymous with a strong economy is defining the national economic narrative. Therefore, we see a Central Bank that is attempting to defend a currency at a value which is unsustainable. It therefore appears to send panic and frantic signals into a market that is extremely nervous.

The CBN means well but is confusing economic agents with mixed signals. Therefore the key issues facing the government are the fact that adjustment of the naira is now imminent, inevitable and imperative. This adjustment will have huge consequences for government finances, investment flows, export values and trade patterns. There will be short-term pain, but medium-term gain. Therefore what do we expect? The currency will be allowed to glide into a path of quasi-equilibrium. An initial band of 185-220 will open the floodgates of demand, but will also encourage some investment inflows. Foreign Direct Investment in 2011 was as high as $8.1bn and fell to $1.4bn in 2014. However, FDI had crashed to near zero in the last few months.

Nigeria‘s gross external reserves are now below $29bn and can barely cover four months of imports and payment. Therefore any resistance to a currency adjustment and the adoption of a policy framework that allows for appreciation of the naira when the fundamentals improve and slide when conditions deteriorate will be foolhardy. Therefore, the Nigerian public has run out of patience and now wants forex availability at a market price instead of rationing that is open to abuse.

The beauty is that the people, the markets and the CBN have the same objective, i.e., to ensure macro-economic stability. Therefore in 2016, we expect an adjustment of approximately 10-15 percent of the naira even after oil prices recover. We believe that the import bill will fall by approximately 20 -25 percent because of the fictitious import of refined products.