In 2018, We Expect Nigeria to Consolidate on the Gains of Recovery from Economic Recession

Economic Outlook
Real GDP: In 2018, we expect Nigeria to consolidate on the gains of the recovery from recession on account of further improvements in oil production. Given the continued adoption of a conciliatory stance by the government in the Niger Delta, we are biased towards oil production averaging 2.11mbpd in 2018 (2017e: 1.91mbpd). On-streaming of Total’s 200-250kbpd Egina oil field poses upside to production forecasts. Furthermore, we expect the telecommunications sector to exit recession in Q2 2018 as subscriber growth recovers from the regulatory induced line disconnections that drove the sector into recession in 2017. In addition, we expect the positive trends in manufacturing PMI to increasing reflect in manufacturing GDP. Alongside higher oil prices, we expect improved oil output to drive adoption of expansionary fiscal and monetary policies which accommodate a higher level of economic activity in the non-oil sector. In all we look for headline 2018 of 2.6% from 0.8% in 2017.

Inflation: Set against a largely stable currency backdrop, sizable base effects and softening domestic food prices, we project an extension of current disinflationary trends over the first half of 2018. Having deferred electricity tariff adjustments to July 2019, we see limited appetite for the Muhammadu Buhari administration to allow an upward adjustment in the official petrol pump price, to capture changes in crude oil prices, ahead of the elections. In the absence of a formal subsidy regime, we see likely inflationary pressures from intermittent spells of petrol supply shortfalls. However, these are likely to be a side-show to the inflation story in 2018 due to existence of large base effects and forecast average inflation to slow to 12% (2017: 16.5%).

Fiscal balance: In 2018, Nigeria’s government plans to spend a record NGN8.6trn (up from NGN7.4trn) with capital spending set to account for 30% of budget. On the revenue side, the government projects a 30% y/y rise in fiscal revenues to NGN6.6trn with oil revenues at N2.4trn assuming average oil price of USD45/bbl, oil production of 2.3mbpd and an exchange rate of NGN305:USD1. Though stronger oil sales suggest higher fiscal revenues, we are less sanguine on projected non-oil receipts and harbour doubts over the credibility of the implementation of capital spending. Consequently, we estimate only an 11% y/y rise in projected fiscal receipts to NGN4.6trn relative to budget forecasts as we are less optimistic over fiscal projections for independent and other revenues. On the expenditure side, in line with historical patterns, we are not convinced on the FG’s credibility with regards budget implementation and assume only 75% execution. We expect capital expenditure to bear the brunt of fiscal containment and assume only 30% implementation which, in our view, will result in a fiscal deficit of NGN2.1trn (1.6% of GDP).

Current account: A combination of higher prices and improved production cascade into stronger exports outlook (2018e: up 14% to USD57bn). In line with the pick-up in economic growth and improved FX liquidity, we see a recovery in import growth following two years of contraction on account of FX curbs. We estimate imports at USD56.8bn for 2018 (up 12% y/y). After a slowdown in 2016 on account of CBN capital account curbs, remittance flows have returned to trend levels (2017e: up 7% y/y to USD21.2bn) following greater flexibility and we expect improving global economic picture to drive modest increases in the item over 2018 to USD22bn. However, we view the resurgence in imports as driving a moderation in the current account surplus to 2.2% of GDP in 2018 (2017e: 2.7%, 2016: 0.6%).

Risks
Given the size of oil receipts to fiscal revenues (~75% of total revenues) and exports (over 90%), steep declines in oil prices and resumption in militant attacks on oil installations pose downside risks to oil exports with adverse implications for economic growth, fiscal balances and the exchange rate. Ahead of the February 2019 elections, we see increasing political risk premiums on NGN assets which would diminish foreign interest in Nigerian financial markets.

FX, FI and Commodity Information

Banking sector information
Nigeria has the largest banking sector in Middle Africa. At end-2015 there were 19 deposit money banks (DMBs) with active operations in the country, regulated by the Central Bank of Nigeria (CBN). In FY2015 total banking sector assets declined by 5% in local currency (Naira) terms to an estimated USD132.8bn. Loans & cash, which account for 68% of total assets, both declined by 9% year-on-year.

The sector is highly concentrated, with the top six banks accounting for 67%, 68% and 69% of total banking sector assets, customer loan and customer deposit liabilities, respectively, at end-2015. However, the concentration risk raised by these six banks has been partly mitigated by the rigorous regulatory regime applied to Domestically Systemically Important Banks (D-SIBs). D-SIBs have to set aside higher loss absorbency (HLA) via an additional capital surcharge of 1% on top the minimum required CAR, which should be met with Common Equity Tier 1 (CET1) capital. They must also meet a host of additional requirements, including quarterly stress-testing of capital and liquidity, quarterly disclosure of the banks’ financial position and risk management, and detailed recovery plans that must be submitted annually to the CBN and Nigeria Deposit Insurance Corporation (NDIC).

Lending has slowed down in response to the economic downturn
Corporate lending accounted for 88% of total outstanding credit in 2015, with public sector lending (7%) and consumer credit (5%) making up the balance. Nigeria’s oil & gas sector accounted for the lion’s share of credit – estimated at 26% of total credit in 2015. Manufacturing (15%) and trade (11%) were the other key sectors for bank lending. However, the economic downturn triggered by the slump in oil prices since mid-2014 has slowed lending in all sectors of the Nigerian economy, a situation that is likely to persist into 2018 as banks switch their focus away from lending and instead focus on portfolio management.

Foreign currency funding pressures persist
DMBs are reliant on deposits for funding, with customer deposits accounting for 85% of all funding liabilities (borrowings, debt notes issued and customer deposits) at end-2015. These are dominated by demand and contractual deposits (72% of all local currency deposits), with savings deposits accounting for the balance. In 2015 funding liabilities declined by 3% year-on-year in local currency terms to an estimated USD104bn, primarily driven by an 8% year-on-year decline in customer deposits. This decline was driven by the contraction in current account domiciliation, especially for oil & gas obligors. DMBs experienced severe foreign currency funding pressures in 2015; this was reflected in the comparison between the local currency loans-to-deposit ratio (LDR) which stood at 53% versus the foreign currency LDR which averaged 107%. We expect foreign currency funding pressures to persist into 2018-19, triggering a flurry of foreign currency debt fundraising activities in the global debt markets.

Provisions and funding costs have impacted revenues
In FY2015 DMBs’ total net revenues (net of loan loss provisions, funding costs and other direct costs) declined by 21% to an estimated USD8.3bn. Net funded revenues accounted for 68% of this total, with non-funded revenues making up the balance. Net funded revenues declined by 12%, driven down by an 81% surge in loan loss provisions and a 13% growth in balance sheet funding costs. This drove up the gross non-performing loans (NPLs) ratio from 3% in FY2014 to an estimated 11% in FY2016 as Nigerian banks chose to recognise bad loans. We expect this trend to continue in 2018-19. Non-funded revenues declined by 35%, pulled down by the slump in foreign currency revaluation gains (after the Naira stabilised) and the ongoing slump in commission on turnover (COT) charges levied on customers. DMBs spent 84% of their net revenues on overheads in FY2015, only retaining 16% as bottom line.

Commodity and trade information

Hydrocarbon & mineral production
Nigeria is Africa’s largest crude oil producer with average output of over 2mn barrels per day of crude oil and other liquid hydrocarbons per day. Since the first commercial discovery by Shell-BP in 1956, the country has enjoyed significant exploration success and currently all the major oil companies are operating on and offshore the country. Nigeria’s crude oil wealth is concentrated in the Niger Delta region which is estimated to hold 37bn barrels of crude oil. Nigeria continues to face insecurity challenges in the Niger Delta region fuelled by the dissatisfaction of the local population which feels marginalised. Nigeria is also the largest gas producer in Middle Africa, with output of over 2trn cubic feet annually and estimated gas reserves of 187trn cubic feet (three times the country’s crude oil reserves). Nigeria exports almost its entire crude oil production, refining little, and revenue from crude oil sales make up over 75% of government revenue. The country also exports Liquefied Natural Gas via its Nigeria LNG company, a joint venture with major oil companies.

Despite being Africa’s largest crude oil producer, Nigeria is one of the region’s largest importers of petroleum products. Nigeria has three refineries with a combined refining capacity of 405,000 bpd. However, poor maintenance and financing constraints have seen capacity utilization plummet to uneconomical levels. Nigeria consumed 20,000 tonnes of petroleum products in 2016, the largest consumption in Africa (after Egypt and South Africa). 85% of petroleum products consumed in Nigeria in 2016 were imported, with local refineries contributing just 3,000 metric tonnes. The country has the lowest pump price of gasoline across the region which makes imported products vulnerable to illegal export to neighbouring countries where prices are higher.

Nigeria has substantial hard mineral reserves, but they have been little exploited owing to the dominance of the hydrocarbon sector. There is marginal output of limestone, coal, gold and coltan, which could be greatly scaled up, and the potential to develop industrial-scale production of iron ore and uranium. Nigeria is believed to have Africa’s second largest reserves of iron ore, estimated at 2bn tonnes. In recent years Nigeria has become the largest producer of cement in West Africa, with total estimated installed capacity of 42.7mn tonnes in 2015. The surge in production is being driven by the Dangote Group, which is expanding operations across Sub-Saharan African and which plans to boost exports of clinker and cement from Nigeria to the sub-region.

Soft commodity production
Although Nigeria’s agriculture sector has long been overshadowed by the hydrocarbons industry, Nigeria is an agricultural powerhouse producing an array of cash and food crops. Nigeria is the world’s largest producer of cassava and yams, the key staples of the population, with estimated output of 55mn tonnes and 45mn tonnes in 2016, respectively. The country is also Sub-Saharan Africa’s second largest producer of maize, with estimated output of 6.9mn tonnes in 2017. However, Nigeria produced just 60,000 tonnes of wheat in 2016, necessitating huge imports of the grain to close the domestic deficit, while milled rice production – estimated at 2.8mn tonnes in 2016 – also falls well short of domestic demand – estimated at 6.3mn tonnes. Major investment led by Dangote & BUA aims to substantially boost domestic production and milling of rice over the next ten years.

Nigeria produces and exports an array of cash crops. Nigeria is Africa’s third largest cocoa producer, with estimated production of 230,000 tonnes in 2016/17 (August-July). The government has long-term plans to boost production to 500,000 tonnes, well above peak output of 300,000 tonnes achieved in the early 1970s. But competition from other crops, erratic weather and endemic diseases (notably Black Pod) will restrain any increase in production in the near term. Nigeria is a small cocoa grinder, with estimated grindings of 45,000 tonnes in 2016/17. This reflects the constraints facing Nigerian grinders, ranging from the lack of supply of beans to high production costs (the result of erratic power supply).

Nigeria is Sub-Saharan Africa’s largest producer of palm oil, with estimated output of 980,000 tonnes of crude palm oil (CPO) in 2017. However, CPO production has stagnated in recent years, owing to a lack of investment in new plantations and dry weather that has cut yields. The country also produced 151,000 tonnes of natural rubber (NR) in 2014, making it the region’s second largest producer, after Côte d’Ivoire. Nigeria is Africa’s fourth largest producer of cashew nuts, with estimated output of 190,000 tonnes of raw cashew nuts in 2017, representing 5.7% of world production. However, the cashew nut sector is undermined by rampant smuggling, with up to a third of the crop being smuggled to Benin, Cameroon, Togo and Ghana as farmers search for higher prices. Nigeria is Sub-Saharan Africa’s largest producer of tomatoes, with output of around 2mn tonnes per year, representing two-thirds of West Africa’s tomato output. However, around half of annual production rots before it reaches market, owing to poor infrastructure and logistics, necessitating Africa’s largest imports of tomato paste. Nigeria also produced an estimated 50,000 tonnes of sesame seeds and 50,000 tonnes of cotton lint in 2016.

In recent years Nigeria has developed the world’s largest sugar refining complex in Lagos, as part of the government’s backward integration programme. The government has phased out imports of packaged and refined sugar, and today Nigeria refines raw sugar imported from Brazil into fortified refined sugar, both for domestic consumption and for export to the sub-region. Major investment is underway to boost production of sugarcane, with the goal of meeting all of Nigeria’s demand for sugar from domestic output, while continuing to boost exports of refined sugar to sub-regional markets.

Trade flows

Imports
Nigeria’s imports totalled US$30.4bn in 2016, sharply down on previous years owing to acute dollar liquidity constraints. Capital goods, petroleum products, consumer goods, industrial raw materials and food made up the bulk of imports. Imports of machinery, vehicles and ships were the largest category, worth US$4.6bn in 2016, reflecting the strong demand from Nigeria’s industrial and transport sector, as well as the relatively undeveloped manufacturing sector. Imports of industrial raw materials, notably iron & steel and plastics, were also high, at an estimated US$2.8bn. Nigeria imported US$5.3bn of petroleum products in 2016, mostly from Western Europe and the USA, reflecting the weakness of Nigeria’s domestic refining sector.

Despite producing large volumes of food stuffs, Nigeria is heavily dependent on food imports, importing US$1.2bn of cereals & flour, US$450mn of fish, US$277mn of dairy products, and US$618m of raw sugar for refining locally in 2016. Overall, Nigeria accounted for 28.4% of Sub-Saharan Africa’s wheat imports and 5.4% of its palm oil imports in 2016. Officially Nigeria imports little rice, but an estimated USD2bn worth is smuggled in from neighbouring countries, notably from Benin and Niger.

Exports
Nigeria’s exports totalled US$35.5bn in 2016, almost three-quarters lower than the peak in 2012 owing to the slump in world oil prices. Hydrocarbons dominate export flows, representing an estimated 91.4% of total export earnings in 2016. That year Nigeria exported US$26.9bn worth of crude oil and US$4.6bn of gas, with just US$34mn of petroleum product exports. The largest soft commodity exports are cocoa and cocoa products, worth US$900mn in 2016, most of which were exported to Western Europe. These included 192,000 tonnes of raw cocoa, 17,000 tonnes of cocoa butter, 12,000 tonnes of cocoa powder and 120 tonnes of cocoa paste. Nigeria also exported US$281mn worth of sesame seeds (making it West Africa’s largest exporter after Burkina Faso), of which the majority went to Turkey and Japan. The rest of Nigeria’s commodities are exported raw to world markets, including small volumes of timber, cotton lint and natural rubber.