2016 Roundtable Special Edition
This piece has been adapted from the lead presentation by Bismarck Rewane, economic expert and Managing Director at Financial Derivatives Company, at the Business Eye Roundtable, which held at The Wheatbaker, Ikoyi, Lagos on 14th January 2016, where stakeholders such as public leaders, economic experts, analysts, captians of Nigerian industries and government officials gathered to discuss the Nigerian economy and in 2016 with a view to charting the way forward.
The Global Context and Nigeria in a Tumultuous 2016
2016 is a year of vulnerabilities, downsides, risks, unexpected changes and solutions. Time magazine in its Year Ahead edition has the following summary expressions for 2016: “In a world of emergencies, leadership, matters;” “In 2016, it will be unavoidably obvious that the world lacks leadership;” “In the past, the G7 controlled geopolitics and the global economy.” But now that the G20 is much larger and unwieldy – including India and China, the result may be a G-zero.
The US will no longer pretend to play global police officer, although it will hope to still do so. There will be multilateral cooperation against ISIS. The Shiite and Sunni divide will continue to haunt the Middle East and OPEC. The European Union (EU) will be too busy with migrants, Greece and keeping the UK within its fold. China will pursue narrow interests and become an international lender to emerging economies like Nigeria. The Middle East will become more chaotic what with Saudi Arabian ailing and aged leadership, bloodshed in Yemen, as well as Iran hoping and coping with post sanctions era.
China will go strong but refuse to lead. China, Japan and India will be preoccupied with important domestic issues. East Asia will be calm, compared to other hot beds. China will use its $3.4trn in external reserves to finance ambitious alternatives to the International Monetary Fund (IMF), London and Paris Clubs. So we will find a lot of African leaders going to China to raise money and to talk about infrastructural development. In other words, China will be a lender of first resort for developing countries. In return, emerging markets will pledge commodities at basement prices for extended periods for China because China is not going to do this for free. They will need to be rewarded in some form.
Vladimir Putin of Russia will be less confrontational in 2016. After winning the stalemate in Europe.
The Economic Reality of 2016
The BBC had a special feature on: “What will 2016 look like?” It observed that 2015 was a tough year for Sub-Sarahan Africa (SSA), but that 2016 will be worse. Prices of SSA commodities fell sharply in 2015, falling below 18%.
The EIU’s Food and Beverage Index also fell by about 16% but is expected to increase 3% in 2016. In Zambia, copper the main export now sells for less than 50%. Some mining companies have halted production. The Kwacha has lost 71.59% of its value since 2015. Several African countries including oil producers like Nigeria and Angola are in the same boat. A few countries, excluding Nigeria, will seek assistance and support from the IMF; and Christine Lagarde, IMF’s helmsperson, has been around in a coincidentally convenient visit to Cameroon and its neighbor. Commodity price fall is mainly due to Chinese economic slowdown as well as the Chinese market volatility.
The knock-on effect is that there will be job losses and fall in fiscal revenues. Africa will have to cut public spending or increase taxes or do both. The turmoil in Chinese markets is also a cause for concern.
The Yuan is projected to fall from 7 to 1 USD, coinciding with the rate of growth of China. China has been growing at double digits but it is now growing at 7%, sometimes 6%, and people are now talking about 5%. From Cape Town to Cairo and, from Dakar to Mombasa, most currencies have crashed.
In Zambia, a national day of prayer was even devoted to support the struggling Kwacha.
The increase in US interest rates is hitting emerging market currencies badly. And even though we expected it to happen, it happened and will continue. The US is on uncharted territory, politically. We have extreme views and loss of confidence in the establishment, so we don’t know what will happen in ten months from now. The South African Rand is the biggest casualty so far. It was at 11 to 1 USD, but now trading at 17 to 1 USD. Angola has adjusted its currency downwards by more than 15% and also removed petroleum subsidies with the economy is still gasping.
Government Debt – Awakening the Sleeping Lion
The sleeping lion in the room for all African countries is government debt. African countries have tried their hands at the Eurobond markets. Nigeria, Zambia and Kenya were successful, but interest payments on these bonds are due in 2016. Investors are increasingly worried about debt sustainability ratios and for African governments, their credit ratings are between near junk and junk status. Zambia issued its first Eurobond in 2012 at 5.4%. With falling copper prices, its third Eurobond was priced at 8.5%. East and Southern African countries are especially vulnerable. There is a potential for a drought and food crises. El Nino weather phenomenon is causing widespread high temperatures and low rainfall. 29 million people are at risk in Southern Africa. For Nigeria, we produce 13, 000 children every day. So where is the good news?
According to BBC, 2016 seems to be the toughest year for Africa. But there are some winners amongst the losers. And some silver linings to the darkest clouds. Exporters of manufactured goods from Africa who use local content are well positioned. The politically well-determined and focused are likely winners. Three leaders were singled out of the 54 countries as winners. They are Mohammadu Buhari of Nigeria, John Magufuli of Tanzania, and Macky Sall of Senegal. So there is no shortage of hope this year. The first duty of any African government therefore is the welfare of its citizens. So now to Nigeria. How and what is Nigeria going to do with oil below $30 per barrel?
Nigeria and the Impact of Oil Below $30pb
We saw oil below $30 per barrel some 13 to 14 years ago. At that time, our population, our requirements, the quality of our manpower, and the general circumstances were totally different from what they are today. The meaning, scope and impact of the commodity shock on Nigeria has to be evaluated. There is an article in the January 2016 edition of Business Eye that addressed crunch time for Nigeria and how Nigeria can cope in an era of turbulence and turmoil. How much has the price of oil declined? What does $30 per barrel mean to Nigeria?
In 2014, the price of oil was $116 per barrel. The cost of production was $25 per barrel. The yield on every barrel was $91. Cost of production per barrel is still $25 and the price is $30. So the yield has gone from $91 per barrel to $5 per barrel. That is the magnitude of the problem. But people are still going around eating the same steak, eating some pork chops, going to the same super markets, buying the same cars, flying on the same airplanes and so on, as if nothing has changed. Then consider that with an exchange rate adjustment, the 2016 Federation Account Allocation Committee (FAAC) will be much higher. And there will be a subsidy rebate.
So in times like this, one would ask: Have we been here before? Yes, we have been! And then what happened? In 2008/2009, we also had downtime. But we were fatter – there were buffers – and we were wiser and the problem was short-lived. People in government then, especially those in oil producing States, know that when the price of oil goes up, there will be higher revenues; and when it goes down, oil producing States suffer more. In 2008 what happened was that oil price dropped from $140pb to $38pb. But in 9 months, it bounced back. Then in 2009, the price of oil was $61.9. In 2016, the average price is projected at $45. In 2009, $1.47 was needed to buy €1. Today, it is $1.08. Even the Euro has adjusted by more than 35%.
From 2008 to 2009, Nigeria’s exports dropped from $58 to $53b. Imports came down from $40b to $31b. The trade balance, which is the difference between the two came down from 45 to 25. Guess what it is this year? Exports are going down to about $42b, while imports will be $47b. This will result in a negative trade balance of $5b.
External reserves in 2009 were $53b. Gross external reserves today stand at $28b. Net foreign direct investments in 2009 was $7b. This year, it is $1.3b. Terms of trade was positive 103 in 2009; today it is 39. The exchange rate in 2009 was N150 to $1 at the Bureau de Change, with official rate standing at N154. That means the official rate was even higher. Today, it is N300 at the Bureau de Change, with official standing at N199.
Excess crude account was $22b in 2009; it is $2b today. In all of these, we funded it with a budget deficit of -3.2% of GDP. This year, we are funding it with -2.3%. Total debt in 2009 was $10.4b; total external debt today is $17.1b. A lot of things have changed since 2009. Can lightning strike the same place twice? What do you do?
One way out of this is the fiscal strategy.
Decline in oil revenue means at least 60% in fiscal and 80% in exports. When you are in this kind of situation, you must spend your way out of it. You cannot ask a man who has ulcer to fast. Therefore, you need to spend. This is what is called Keynesian deficit funding to stimulate recovery. The budget is projecting a 25% increase in expenditure. This throws up a deficit of N2.2tr which translates to 2.16% of GDP. This comes with the multiplier effect and borrowings. Internal borrowing, N900b; external borrowing, $4.5b. Subsidies will go or have gone, so there will be increase in government revenue by 20%. Therefore, the fiscal strategy is intact. What is missing is the monetary policy strategy to re-inforce and make the fiscal strategy effective.
The saying goes that ‘you have nothing to fear but fear itself.’ It is during wars that generals are made. You cannot make omelettes without breaking eggs. Therefore, what is the truth? The truth is that the exchange rate policy, when your price of oil was $114, cannot be the same exchange rate policy when the price of oil is $30. Exchange rate policy and interest rate policy, when the yield was $91 per barrel, cannot be the same as when the yield is $5 per barrel.
Every currency in the world is in turmoil. We cannot be any different. Therefore, what needs to be done is to come up with a set of parameters and variables. But first of all, let us clarify that we had money, we squandered it. We had opportunities, we gave them up. Therefore, we can spend all of the day talking about why we are where we are, or who brought us to where we are. But the truth is that, if your father is dead and you refused to work; even if you like, you can go into the river and come out, it would not change anything. You have to move forward. And so, how do you move forward? How can we use monetary policy to compliment and re-inforce fiscal policies? In the end, what do we want? We want economic wealth converted into economic wellbeing, economic wellbeing converted into political stability, political stability converted into a functional society.
There are six parameters or variables that can be used to measure economic performance and that will decide the exchange rate policy. If these parameters are moving upwards, the exchange rate will appreciate. If they are going downwards, the exchange rate will adjust downwards. These variable are the price of oil, the level of oil production, the level of external reserves, the inflation rate or interest rate differential, the purchasing manager’s index – that is the confidence of the investors and how much inventory they are buying, and more than anything else, the consumer confidence index – that is the degree of confidence that the consumers have.
PPP: Is the Naira Overvalued? – N221.96
Based on the analytics I have seen today, an exchange rate adjustment from N200 – N221 to $1 will be arithmetical. We could get away with that, but that’s not all. It’s a dynamic issue. Rencap says that we should be looking at around N250 with a band of 10% or above. Exotic says N280 up and above. The REER model suggests N305 is a fair value, but may be exaggerated. But what Nigeria is looking for is not an exchange rate. They are looking for an exchange rate mechanism that will ensure that leakages are blocked and that there is minimum corruption. But more than anything else that there is investment and that we cannot deal with an exchange rate policy that is inefficient.
Basically there are three things that are important. The terms of trade of Nigeria stand at negative at this time, but they will change for the better. Our trade balance is negative, and this trade balance can be made up by enabling investors to bring money in. More important, Nigeria is number 7 in the world of the countries that has the highest remittances by its Diaspora. Nigerian Diaspora had $21b a year. What we are looking for, $21b in one year can cover it. So all Nigeria needs is the confidence of her own Nigerian people to bring their money home. Thereafter, foreign investors will follow. So, we have Diaspora remittances, we have foreign direct investments, we have concessionary loans. Recall that ex-Lagos governor Babatunde Fashola was talking on television recently about Lagos State and how Lagos State lost an opportunity of a 40-year loan and now dealing with a 25-year loan, because of political ignorance.
The truth is that the currency misalignment is not temporary. A lot of people talk about it as if it is temporary, this is not temporary. This is going to be with us for some time to come. The Bible says in Genesis that, ‘…there will be seven fat years followed by seven lean years, and the children Egypt should keep whatever it is …’ and therefore, unto him who has, much has been given, unto him who has none, even the little he has will be taken away from him. So, if our monetary policy re-inforces our fiscal policy and we have a strong government that has credibility and that can sell this sacrifice to the people, then the 2016 will be the beginning of tough but better years. And I would like us to imagine that if the waste, ignorance, inefficiency and corruption of the past continued after the last election, we won’t be in this room today. We’ll probably be in the bush.
How Currencies trade against their REER Rate
Green shows where we are now
For Nigeria, it shows the dollar peg is not very suitable
The currency rarely finds itself around fair value – extremes of being too strong or too weak are common.
What are the Risk Footprints?
The first is macroeconomic misdiagnosis which emerges from factors such as underestimating the depth of problem, misunderstanding the crisis, decayed reaction – allowing for economic gangrene to set in, doing nothing as a result of being overwhelmed, under dose – doing the right thing in wrong quantity and wrong timing, pushback by misinformed and angry populace, State government insolvency and delay in fiscal adjustment, monetary policy conflicting with fiscal policy, the Eurobond markets reflecting the Nigerian debt proposal and initiatives, a possible downgrade by rating agency, as well as the continued fall of oil prices.
The Outlook for 2016, according to EIU, are therefore as follows: Growth will remain below potential – forecasted at 3.3%, there will be low prospects for strong recovery, there will be increased inflationary pressures with the expectation that inflation will average 9.6%, there will be mounting exchange rate pressure – Naira is projected to depreciate to N235, there will be currency adjustment expected in the first quarter of 2016, ongoing public frustration and instability will continue, there will be political maneuverings within APC, trade ties with Asia will expand, non-oil tax collection will increase, and fiscal deficit will increase moderately to 2.3% of GDP.
Published in the Business Eye’s print version, Feb 2016 edition.
Featured image credit: change.news