Managing looming crisis in dollar-dependent manufacturing sector
Nigeria’s manufacturing sector is facing a looming crisis from falling global oil prices. The United States West Texas Intermediate (WTI) crude oil dropped to $26 per barrel on Monday, the lowest since 2003.
Brent crude fell by 1.32 percent to $25.96 per barrel on Wednesday, from $26.20 on Monday. This is the lowest in four years.
Goldman Sachs slashed its oil forecast on Tuesday as Covid-19 continues to dislocate markets and cut demand. Analysts at Wall Street investment bank say oil demand is shrinking by an unprecedented 8 million barrels a day as a result of the virus and price war fuelled by OPEC-Russia-Saudi fiasco. The crisis will hit Nigeria’s revenue by over 100 percent as the country relies on crude oil for over 90 percent of its foreign exchange and 70 percent of revenue.
The general feeling is that oil price will drop to $20 per barrel or below, which is bad news for an oil-dependent Nigeria and its manufacturers, many of whom need dollars to import inputs and machinery.
The crisis is already exposing the fragility of the Nigerian economy as leaders after leaders fail to look beyond oil for revenue and budget benchmark.
The manufacturing sector is entering into a crisis mode as China, India and other countries where it imports inputs shut down on Coronavirus spread. Pharmaceuticals are hard hit as they mostly depend on India and China for excipients and other raw materials. Players in the industry are already rationing supplies as uncertainty hovers around when the virus spread will be over.
Drug stores are in panic over supplies and there are fears that drugs might be hoarded at some point in the future.
The reason why crisis like this continues is that Africa’s largest economy has no reliable and functional petrochemical industry which should produce resins, excipients and other raw materials needed by drug makers.
“Virtually every raw material in this sector has a high import dependency ratio. If you then face the scarcity of forex like we do have in this country, it poses further challenge,” Okey Akpa, chief executive officer of SKG Pharma, told BusinessDay in 2019.
Local input sourcing in the chemicals and pharmaceutical industries is below 50 percent as most of the resins and other excipients are imported.
“We need to have a petrochemical industry that will substitute what we are presently importing. It is a sector with a big potential, but this is largely unrealised because of lack of petrochemical industry,” Akpa further said.
All eyes are on the imminent Dangote Petrochemical Company, but an emerging economy like Nigeria must have more than one petrochemical company and should not rely on one company for essential things needed by the entire population, analysts say.
Apart from pharmaceuticals, many other sub-sectors are also importing raw materials from wheat to concentrate. They would need dollars to import these inputs and even machinery. Exporters too are affected because their business goes into other countries’ borders. With economic shutdown across the world and tighter border monitoring, Nigerian exporters are already in a fix and, like other manufacturers, might cut jobs and stop production process at some point in the future—unless the situation across the world improves.
The Manufacturers Association of Nigeria (MAN) has consistently pointed out that the best way to plan for and manage a crisis of this proportion is to look inwardly.
A lot of companies are already sourcing inputs and packaging materials locally to hedge against FX risks.
“We will continue to substitute imports with local production. We have moved quickly from 53 percent local sourcing two years ago to about 80 percent of total production,” Baker Magunda, managing director of Guinness Nigeria plc, told BusinessDay recently.
Many have embarked on multi-billion naira backward integration projects to reduce FX exposures, cut costs and maximise profits.
Dangote Group is investing billions in sugarcane plantations in several parts of the country. PZ Wilmar has put billions into palm oil plantations in Cross River State. Olam has also invested heavily in this area. This, according to experts, remains one sure way of managing the looming crisis.
But there is a twist to the whole story. Amid recession in the first half of 2017, many manufacturers sourced local alternatives to foreign inputs, pushing up percentage of local input preference to 60.72 percent, according to data from MAN.
But with several market interventions by the Central Bank of Nigeria (CBN), which resulted in foreign exchange stability, many manufacturers resumed chase for foreign inputs at the expense of local alternatives, pushing down local input preference to 57 percent.
“The relatively more available forex, resulting from the CBN intervention, may have been rubbing off negatively on backward integration agenda as firms prefer to import raw-materials as against inward looking,” MAN said in its latest economic review obtained by BusinessDay.
The CBN first gave manufacturers 40 percent preference in the FX market, meaning that they had exclusive right to 40 percent of available FX in the market. The apex bank subsequently created special windows for exporters and small businesses, leading to some stability in the market.
“Local raw-materials utilisation in the manufacturing sector has maintained downward trends since the first half of 2017 when the CBN commenced policy intervention in the official forex market,” MAN, led by Mansur Ahmed, said.
This is already a challenge. Some manufacturers say that they do not often get the type of inputs they want at the required quantity and quality. This is one area where investments are needed. For a fragile economy like Nigeria, the government and the private sector might do well to look closely at the quality of inputs in the economy.
Also, in 2016 crisis, manufacturers, especially small and medium-scale players, resorted to locally fabricated machinery. This was not an easy decision for many firms because it made commonsense. Higher demand for local inputs gave rise to higher demand for locally fabricated machines that were suitable for local raw materials.
What helped was the consciousness among manufacturers to look inwardly for machines suitable for local raw materials. However, some local institutions fabricating these machines did not show leadership in many areas as they delayed fabrication in some instances and produced some machines that were not suitable for a number of companies.
One manufacturer said in 2016, “This is why we have to change the Nigerian education system towards Science, Technology, Engineering and Mathematics (STEM).”
The manufacturer added, “Education should be tailored towards solving the problems of the industry.”
Another strategy adopted during periods of economic slump is cost management. Some manufacturers had to cut unnecessary costs without sacking workers. Others cut jobs and reduced departments or subsidiaries that were not contributing meaningfully to revenue or the company good.
Whether anybody believes it or not, crisis is looming and the best response is to cut FX exposures. The majority of the Nigerian population are poor and the looming recession will further deepen their misery. It is debatable whether manufacturers can shift high costs resulting from FX exposures to the struggling consumers.