Nigeria’s policy makers are in a fix. The country is saddled with a major economic conundrum and is struggling to find solutions to its mounting problems.
With the steep plunge in the global oil price exposing Nigeria’s structural vulnerabilities, policy makers are now faced with difficult and politically challenging decisions in order to manage the economic headwinds which the country faces. With many analysts calling the current situation a “perfect storm” – due to the confluence of security, political and economic factors coming to a head simultaneously, the spotlight has now fallen firmly on the Nigerian government and the Central Bank of Nigeria (CBN) to intervene with credible and effective polices to stem the negative tide. The economic malaise comes amidst severe market pressures, election related uncertainty, rising security threats, deteriorating investor sentiment, the erosion of foreign reserves and recent ratings action by a major ratings agency.
The postponement of the general election from 14 February to 28 March sent the interbank foreign exchange market into a tailspin. The naira breached USD/NGN200 in the aftermath of the announcement, brushing off the CBN’s attempts to slacken the pace of depreciation. Sustained capital flight, the potential removal of Nigerian benchmark bonds from JP Morgan’s Government Bond Index – Emerging Markets, and Standard & Poor’s placement of the country’s long-term foreign and local currency sovereign credit ratings on negative watch (which was subsequently downgraded from BB- to B+ on Friday 20 March), further aggravated depreciatory pressures, destabilising an already weak currency.
Nigeria is also still heavily dependent on a high oil price to ensure macroeconomic stability, despite the fanfare following the country’s GDP rebasing in 2014. About 90% of the country's export revenue comes from crude oil, while the gas and oil industry contributes around 70% of the government's overall tax revenue. Consequently, for the first time since 1998, Nigeria’s current account balance is expected to register a deficit. There will also be a significant hit to tax revenue from falling oil prices which will manifest in a budget deficit. The recent collapse in the oil price is clearly a significant shock and will translate into a macro-economic environment characterised by higher inflation, tighter monetary and fiscal policy and weaker GDP growth.
This decline comes at a time when the Nigerian oil and gas industry is encumbered with several challenges, including oil theft, pipeline vandalism and the lack of progress of the Petroleum Industry Bill that seeks to overhaul the industry. With strain emanating from both the volume and value side of the equation, the country’s revenues are currently facing enormous price and production pressures.
Nigeria’s concerns, however, are not exclusively confined to the oil price - the erosion of the country’s forex buffers, the political sensitivities in making budget cuts and the need for tight monetary policy mean that Nigeria has very little room to manoeuvre from a policy perspective.
The big question with respect to the currency and the sustainability of the external accounts is how the authorities respond to pressure on the currency. The naira has already come under severe strain as a result of these external account woes leading to foreign portfolio investors exiting the market. Consequently, foreign exchange reserves have been run down substantially in recent months and are edging closer to the psychologically important US$30bn level.
Fiscally, the authorities will have a difficult task in reigning in expenditure, in the midst of an extremely tightly contested election race. According to the Fiscal Responsibility Act, Nigeria needs to keep its fiscal deficit below 3% of GDP which may prove difficult in the current environment, especially as both reserves and the oil savings account have fallen in recent years despite elevated oil prices. Furthermore, a planned sovereign wealth fund has also largely failed to get off the ground. Nigeria’s buffers in the event of a protracted slump in oil prices are weak, reflecting the country’s huge vulnerability at present.
These increasing revenue constraints have forced the finance ministry to make drastic cuts to its budget. In March, the national assembly formally agreed to the revised US$53 per barrel benchmark oil price for the 2015 budget. Despite the government’s efforts to reprioritise expenditure, the budget remains skewed towards (non-debt) recurrent spending, hampering development efforts. In addition, the lower house is yet to approve the state’s medium-term expenditure framework (2015-2018) which means the proposed figures are likely to change after parliamentary debates. Authorities have indicated that the budget will be approved before the national vote; however this may not be possible amidst the highly polarised political environment. Further delays will certainly not inspire confidence amongst investors who are seeking fast and efficient policy responses to manage the current crisis.
With oil prices set to remain low, the currency will depreciate further; continued negative market sentiment could lead to further outflows. This will put pressure on Nigeria’s capital account, as the gap created by portfolio outflows will need to be plugged either through the use of foreign reserves or new borrowing.
The unsettling prospect for Nigeria is that irrespective of the monetary policy response, the economy will be subject to painful adjustments, reinforcing the need to diversify the country’s export base and fiscal revenues.
All these problems are further compounded by the political cycle. The change of the election date was attributed to security advice from security chiefs, and Nigeria’s Independent National Electoral Commission (INEC) announced that the deferment was intended to allow the military to launch an operation to secure the northeast from Boko Haram and guarantee the safety of voters in the region. However, these motives have been questioned in various quarters.
President Jonathan’s popularity has suffered over the last year. Public dissatisfaction continues to grow over the government’s handling of the growing threat of Boko Haram, its perceived lack of action on corruption and concerns about economic mismanagement.
Political tension is likely to rise further as what looks likely to be closely contested polls move closer therefore raising the spectre of policy paralysis. An election result where neither the ruling People’s Democratic Party nor the opposition All Progressives Congress has an outright majority in both houses will complicate matters further. In such a scenario, a strong possibility exists that policy actions will be delayed due to protracted parliamentary debates. This would reduce the prospects for efficient policy design and implementation, which Nigeria can ill afford at this stage.
With these negative headwinds underway it is clear that the new government taking office has an incredibly difficult mandate. With no control over external factors, the management of internal economic dynamics has assumed critical importance. The CBN’s tighter monetary stance will only be really effective when paired with a tighter fiscal stance by the Ministry of Finance. Any delays in responding to these risks will erode sentiment. Therefore, the manner in which Nigeria responds to its perfect storm is key, with clean elections and snappy policy implementation now non-negotiable.