For Muhammadu Buhari, winning Nigeria’s presidential election in May, in which he became the first ever opposition candidate to defeat a sitting president, proved to be easier than expected. His next task – reforming the country’s oil dependent economy – is a much tougher prospect. In the second quarter of 2015, the country’s growth domestic product growth rate dipped to 2.35%, down from 6.54% a year earlier, largely as a result of slumping oil prices. The outlook for the rest of the year appears equally bleak. Investment bank Renaissance Capital has lowered its GDP growth forecast for Nigeria to just 2.8% in 2015.
Meanwhile, the dip in the value of the naira has edged up inflation in the country, which hit 9.3% in August, exceeding the central bank’s target range of 6% to 9%. Projections from Standard Chartered indicate that this number could hit 9.4% by the end of the year, before increasing to 9.7% in 2016. This has occurred as interest rates have remained set at a record high of 13% since November 2014, with the associated drag on private sector growth that this implies.
Currency controls
These inflationary pressures form part of the Central Bank of Nigeria’s (CBN) justification for propping up the naira through the imposition of currency controls. Yet the overvaluation of the naira and restrictions on foreign exchange are hitting the ability of the private sector to function effectively, particularly in business segments that require dollars to purchase imports. Moreover, this dollar shortage is also starting to impact companies that have issued billions of dollars of dollar-denominated debt in recent years, according to reports from Reuters.
“We do need to resolve the currency issue so that capital flows can resume. It’s not just about capital flows from foreign investors. It’s also about the Nigerian diaspora, who are investing and remitting to a lesser degree. It would be better to devalue the currency now rather than when we have no choice,” says Abubakar Suleiman, chief executive of local lender Sterling Bank.
In addition, the CBN has been trying to prevent the further deterioration of Nigeria’s foreign exchange reserves. By September, CBN data showed a month-on-month decline in reserves of 2.97% to $30.69bn. Year on year, this figure represents a drop of about 22%. Since these holdings are also being used to prop up the naira, this may prove to be a difficult task.
Diversity drive
Significant though these current difficulties are, they represent something of a divergence from a decade of solid growth. According to data from Moody’s, the Nigerian economy has grown in real terms by 8.3% per year over the past 10 years. This trend culminated in a rebasing of GDP in 2014 to assume the mantle of Africa’s largest economy.
Under this rebasing, the total contribution of the oil and gas industry to the economy was discovered to be 14%, a figure representing less than half of the previous estimate. In turn, a number of non-oil sectors enjoyed a corresponding bump to their overall GDP contributions.
Indeed, considerable success in diversifying the economy has been achieved in recent years. Total oil revenue from crude oil sales, petroleum products taxes and royalties fell to $32.3bn in 2014 from $45bn in 2011, according to the International Monetary Fund (IMF). Additionally, non-oil growth has accounted for much of the country’s upward momentum in recent years, with the services and manufacturing sectors leading the way.
Despite this gradual process of rebalancing, the federal government still relies on hydrocarbons to source about 90% of the country’s export revenues and 70% of total fiscal revenues. As such, there is a drastic need to accelerate this diversification process to other productive sectors. The dominance of oil revenue in an economy that has enjoyed sustained non-oil growth also points to a broader failure to extract enough revenue from these sectors.
Overhaul needed
As the IMF notes in its latest country report, Nigeria’s tax code and system of exemptions needs overhauling. The country’s value-added tax sits at 5%, marking it out as one of the lowest in the world. Similarly, the country’s corporate income tax, at 30%, is regarded as having ‘low tax efficiency’ relative to global peers, with the use of exemptions being identified as a key impediment.
Similarly, greater fiscal discipline and oversight at both the state, federal and agency level will be needed over the long term. Here, it is hoped that the new president will deliver effective change. In June this year, Mr Buhari dissolved the board of the Nigerian National Petroleum Corporation (NNPC), the state-owned oil company. This followed the release of evidence – through a government audit – detailing a significant volume of missing funds from the sale of crude oil.
Building on these efforts, in September the NNPC announced that all existing production sharing contracts would be renegotiated. This will apply to agreements signed with some of the world’s largest oil companies, including Shell and ExxonMobil. Though linked to the broader overhaul of the oil sector, the move also appears to have industrial implications given that Nigerian officials have suggested that they will maximise the value of these contracts.
Investor uncertainty
While rooting out corruption and enforcing greater discipline on public sector spending are at the forefront of Mr Buhari’s agenda, the absence of an appointed cabinet since his inauguration in May, as well as the absence of any firm economic policy, has for the moment elevated investor uncertainty over the country’s trajectory. The president has claimed that time is required to select appropriate government ministers who are both dedicated and graft-free, and set himself a deadline for the end of September.
Nevertheless, reforms enacted by the government to date, including the introduction of the Treasury Single Account, while providing some short-term pain for the banking sector, are widely considered to be a step in the right direction. “I think Nigeria is going to become more business friendly. This isn’t due to the country becoming more market focused. But our existing regulatory and business structures will become more transparent thanks to the changes being enacted by the government,” says Mr Suleiman.
In addition, the federal government’s restructuring of state-level debt has helped to clean up regional government balance sheets, while providing enough relief to focus on opportunities for local revenue generation. “Some will feel that this restructuring is rewarding bad behaviour, but I would say that for many banks they are taking a significant haircut in rates, by as much as 50% in many instances. This is therefore no reward. I believe by imposing strict covenants to improve the quality of state government borrowing and balance sheets, the industry will also be better off,” says Ladi Balogun, chief executive of First City Monument Bank.
Despite the uncertainties surrounding the new president’s policy outlook, his performance to date has been broadly welcomed by players in the domestic market. While banks and other large corporates may agitate for a more transparent policy environment, it may be worth waiting for if good leadership can be secured. The difficulties of the past, including rampant corruption and the associated corrosion of official institutions and public trust, have played a significant role in hampering the country’s economic development. If the new government can work to avoid these, the benefits could be substantial.
Given Nigeria’s vast potential, this prospect is encouraging. On the ground, most private sector players, including the country’s banks, are looking past the current economic problems to future opportunities. “We must align our activities with the developmental priorities and the comparative advantage that the country has in order to ensure sustainable and inclusive growth: a large, young population with a growing middle class means significant retail opportunity; fertile and varied soil with good rainfall means agribusiness opportunity; and we have an under-industrialised economy with great industrialisation potential,” says Mr Balogun.
