Nigeria on the brink

You can’t find a blunter assessment of the underlying problems facing Nigeria and the naira than that from BCA Research this week:

Nigeria has basically squandered away its oil bonanza of the past decade. It has failed to channel its oil windfall into infrastructure and productive capacities. As a result, the economy remains extremely dependent on swings in global oil markets.

On the surface, Nigeria’s oil sector has dropped in significance to a mere 13% of real GDP, while the services sector has climbed to 40% in real terms. Yet, the reality is that it is the country’s oil revenues that have supported growth and, to a large extent, maintained social order. Without oil, both would fall apart; government spending would be much smaller, interest rates much higher, and the currency’s valuation much lower.

In one phrase: a massively squandered opportunity.

One of the issues the BCA analysts, headed by Rajeeb Pramanik, hone in on is the country’s domestic savings rate, at a measly 20 per cent of GDP, is extremely low for a developing economy at this stage. A key reason being the government’s inability to tame chronically high inflation, meaning bank deposits have earned negative real interest rates for most of the past decade:

This low savings rate has in turn hindered infrastructure investment and limited productive capacity. So, even despite Nigeria’s much trumpeted GDP rebasement last year, the country’s gross capital formation is among the lowest in the developing world, lagging even that of South Africa and Brazil.

That’s a problem for a country whose vital public infrastructure is beginning to decay: Low capital investment, in turn, has eroded the country’s competitiveness. Basic infrastructure is severely lacking. In particular, already deficient electricity generation is shrinking.

Rampant use of diesel generator sets for electricity is driving up the cost of doing business. Finally, chronically high inflation has made the currency overvalued in real terms, further denting competitiveness.

It gets worse:

In the case of soft infrastructure, the country is also falling behind. The quality of institutions is poor, as is the quality of health and education. The World Economic Forum’s latest Global Competitiveness Index ranks Nigeria’s basic requirements (such as institutions, infrastructure, macroeconomic environment, health and primary education) at a lowly 140th out of 144 countries, down from 130 two years back.

There is not only a scarcity of qualified engineers and technicians, but also a lack of skill training for the lesser educated. Foreign investors often have to bring in their own workers to execute projects. As a result, the unemployment rate has remained high at 26%, even during the period of robust economic growth. Cumbersome regulations and rent-seeking officials make Nigeria an unfriendly place to do business. The World Bank’s Doing Business Report ranks Nigeria at 170th out of 189 countries in the “Ease of Doing Business” category. Other costs of doing business have also been rising, as terrorism lingers in certain parts of the country.

BCA Research argue that all of the above totally undermines the popular notion that Nigeria’s burgeoning middle class will be able to turn the country into a consumer powerhouse. That’s because the mere presence of a huge consumer pool does not atomically, they say, translate into prosperity.

The sad truth is Nigeria has used oil revenues to drive income and consumption over the past decade or so. But since the global market determines oil prices and Nigeria has little influence on their direction, the country cannot escape a negative income shock. As BCA research note:

It will have to curtail its domestic demand (both consumption and investments) substantially. This in turn will likely develop into a negative feedback loop of contracting fiscal spending, credit retrenchment, lower demand and lower income.

When it comes to the naira, the analysts add that while foreign reserves stand at a healthy $44bn and can be used to defend the currency for a while, if they’re completely deployed in foreign exchange markets, this will come at the cost of domestic liquidity and a credit contraction.

If the Central bank opts to raise interest rates instead, that too would only magnify the domestic liquidity problem. On which note:

There are already signs that liquidity is drying up in the inter-bank market. Inter-bank call rates spiked to an average of 24% in December and narrow money is already beginning to shrink (Chart 9). Such a squeeze in inter-bank liquidity means credit flows to the economy are set to contract going forward, which will knock down economic activity further and weigh on the stock market. Bottom Line: Nigeria is still all about oil. Therefore, swings in oil prices have a high correlation with Nigerian assets.

Small surprise then that Nigerian currency dealers are resorting to cryptocurrency strategies — (if we just refuse to sell naira the price can’t go down!) — to stave off further collapse. As Reuters reported this week regarding the blank quotes coming through screens for three hours last week:

Rather than a computer glitch or power outage — common hiccups in any frontier market — the lack of prices was deliberate: all Nigeria’s banks were refusing to trade while their top dealers met behind closed doors to chew over Emefiele’s pronouncements, according to those involved.

Among the decisions reached by the Financial Markets Dealers Association (FMDA), as the club of 40 banks, discount houses and brokerages is known, was an unofficial ‘circuit-break’ agreement to halt trade if the naira fell more than 2 percent in a day.

FMDA chief executive Wale Abe insisted no central bank officials were present at Wednesday’s meeting and said it was an entirely voluntary measure to curb volatility, in line with the body’s support for financial market stability and maturity.

Last and not least, there’s the political risk associated with this year’s national election, which falls on Valentine’s Day (February 14) and features incumbent president Goodluck Jonathan, a southern Christian, breaking with established convention and running for what is technically his third term in office. As the BCA analysts explain, that’s already causing a lot of resentment in the Muslim north, whilst hiking expectations of violence if and when the Muslim candidate wins.

The oil revenue factor, meanwhile, is only exacerbating the political divisions:

The influx of oil wealth had benefited primarily the Christian south (who were marginalized in the early years of independence), and not the Muslim north. The oil money has flipped the power relationship between the two groups. That said, steadily increasing oil revenues had helped assuage regional and sectarian tensions in the country.

Oil revenue is the political currency in Nigeria, greasing the wheels of politics and unifying the country’s political elite. As much as 10% of the country’s oil revenues disappear into the pockets of regional strongmen. Western commentators call it corruption; Nigerian elites call it stability. The loss of oil revenue will threaten that stability, as regional leaders will look to keep their own constituents happy.

In that sense, for as long as there was oil revenue, there was also a common interest bringing the politically divided elite together.

Izabella Kaminska joined FT Alphaville in October 2008. Before that she worked as a producer at CNBC, a natural gas reporter at Platts and an associate editor of BP’s internal magazine.