July 23, 2012

Half Year Macroeconomic Review And Outlook

Real GDP growth projections in major economies continue to be revised downwards as events in the Euro zone remain an issue. With this in mind, the Nigerian government is carrying on with policies aimed at boosting growth and job creation in 2012. Nevertheless, economic performance has been slower than the corresponding period of 2011 and budget 2012 projections.

While information on 2012 budget implementation is yet to be available, recent report shows that 87% of capital expenditure was executed in 2011. Given the policy stance of fiscal authorities, implementation of 2012 budget may surpass 2011. However, if oil prices and production maintain same trend in the second half of the year, fiscal deficit may increase by N500bn to N1.6trn or 2.95% of GDP, with implications for budget financing and execution.

Nigerian Economy underperforms 2011 levels and 2012 Budget

Introduction

This edition of CSEA policy brief presents a half year review of the performance of the Nigerian economy against the backdrop of global developments and the 2012 budget. The report first presents a global economic update, followed by key domestic policy developments and macroeconomic performance. The brief then discusses the policy implications and macroeconomic outlook for the second half of the year.

Global Developments and Implications

Events in the Euro zone where unemployment rate stands at 11.1% and real gross domestic product projected to contract by 0.5% this year continue to dominate the global economy. Although the emergence of a left-of-centre government in France initially raised concerns over talks on rescuing the zone, there seems to be some progress in developing a framework of financial responsibility that will guide finances of respective governments in the zone. However, financial markets continue to respond in see-saw manner due to the delay in completing the talks. Therefore, because of growth and related concerns, the European Central Bank and the Bank of England recently boosted monetary stimulus to support growth.

In the US economic performance remains unimpressive, with unemployment and underemployment rates stuck at 8.2% and 14.9%, respectively. Aside from domestic challenges, external factors contributing to the weak economic performance of the US include the slowdown in the Chinese economy, a key export market for the US, as well as the Euro zone crisis. It is therefore not surprising that the International Monetary Fund (IMF) reduced its forecast for the US growth in 2012 by 0.1% to 2%. To this end, the Federal Reserve of the US is expected to leave its official rate unchanged later this month in line with its pledge to hold rates low till 2014. It also bought $2.3 trillion of securities in two rounds of quantitative easing from 2008 to 2011 to support the economy and is considering another round of quantitative easing.

In the BRICS (Brazil, Russia, India, China and South Africa) countries, growth has also slowed in 2012, with India growing only 5.3% in quarter 2 (Q2), the lowest since 2003. The Q2 growth in China was also down to 7.6%, from 8.1% in quarter 1 (Q1) while the government recently lowered benchmark interest rates for the second time in a month. There have also been three cuts in banks reserve requirements since November 2011. In South Africa, the Reserve Bank noted that the economic outlook has deteriorated as the debt crisis in Europe persists while the Brazilian central bank also cut its economic growth forecast for 2012 to 2.5% from 3.5%. Russia experienced 3.2% real GDP growth in Q1, down from 4.3% in 2011.

These global developments are affecting commodity prices, especially crude oil, which at some point dropped to below $100pb, with significant implications for Nigeria. In this context, the trading relationship between Nigeria and the Euro zone countries as well as US, India and China, means that Nigerias volume of trade will be affected when the countries experience slowdown. The slowdown will reduce import prices and the Q1 figures show that Nigerias imports came mostly from China (16.1% of total imports), United States (11.9%), United Kingdom (11.5%), Brazil (10.3%), and India (6.9%). The destination of exports which comprises mostly of petroleum, shows that 13.9% went to India, US (12.3%), Netherlands (9.7%), Spain (7.9%) and Brazil (6.6%).

Key Domestic Developments

Given that the objective of policy is to move the economy from the present state to a desired state of improved macroeconomic performance, the federal government has initiated some policies in 2012 aimed at boosting economic growth and job creation. While these policies cut across sectors, those in the petroleum and agriculture sectors are worth discussing. In the petroleum sector, the government has partially deregulated the downstream sector and changed the management of the Nigerian National Petroleum Corporation (NNPC). Progress is being made on the Petroleum Industry Bill (PIB) as the executive and legislative now agree on the need to speed up the passage of the bill. Nigeria also recently signed an estimated $4.5bn deal with a US company and its Nigerian partner for the purposes of building six refineries in the country. The recent announcement by government that efforts will be made to increase the excess crude account to $10bn, if implemented, will protect the economy from negative external shocks in light of the unclear signals in the global economy. The government is also reportedly finalising plans to appoint members of the Sovereign Wealth Fund (SWF) Board of Directors, including the management team. All of these measures are expected to put Nigeria in a position to judiciously manage earnings from crude oil sales. However, the problem of crude oil theft through illegal bunkering which is reportedly leading to an estimated monthly loss of $1bn is one area that demands urgent attention by the government.

Earlier in the year the Debt Management Office issued sovereign guarantees to banks, securing up to 70% of the principal of loans granted by banks to agro dealers in Nigerias agricultural sector. Also, the Ministry of Agriculture is ensuring that banks lend to seed and fertilizer companies and agro-dealers to supply agricultural inputs directly to farmers, instead of government using its funds to do direct procurement and distribution. With these and other policy measures, coupled with the reported World Bank grant of $500 million, Nigeria is set to unlock the value chain potentials of the agriculture sector which contributes about 40% of GDP and employs over 60% of the population.

Macroeconomic performance review

Real GDP Growth

The Nigerian economy as shown in Figure 1a grew by 6.17% in Q1 2012, driven by the non-oil sector which grew by 7.93% as against the oil sector decline of 2.32%. The sectors in the non-oil economy that grew the fastest as depicted in Figure 1b include solid minerals which grew 11.69%, telecoms 32.83%, building and construction 13.25%, manufacturing 5.15% and agriculture 4.15%.[1]The Q1 growth rate is however slower than the previous quarters 7.68% and the 7.13% in the corresponding quarter of 2011. The Q1 growth is also slower than the 2012 budget assumption of 7.2% and the conservative estimate of 6.5% by the National Bureau of Statistics (NBS). The implication of this is that in the subsequent quarters of 2012, the economy must grow at a rate higher than the 6.17% in Q1 if the 2012 budget target of 7.2% and the 6.5% projection of the NBS are to be achieved.

Figure 1a: Real GDP and Non-oil GrowthFigure 1b: Sectoral Growth Rate

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Source: NBS Source: NBS

Oil sector

In the 2012 budget, the government assumed oil price of $72pb and oil production of 2.48mbpd, with a corresponding oil revenue projection of N1.94trn. Figure 2a shows that oil price averaged $96.5pb after dropping from over $100pb in March and April. Although the average oil price is higher than the budget assumption of $72pb, if compared with the first half of 2011 when oil price averaged $101.4pb, it means that average oil price in 2012 has dropped from the corresponding period of last year. The decline in oil price from its 2011 level is also accompanied by lower average oil production of 2.101mbpd which 15.3% lower than the budget target of 2.480mbpd. The implication of the declining oil price and lower production is that meeting the projected oil revenue of N1.9trn for 2012 may be challenging.

Figure 2a: Oil Price Movement Figure 2b: Nigeria – Oil Production

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Source: OPEC Source: OPEC

An overview of the oil rig count, a leading indicator of direction of future oil production, shows that the performance in the first half of 2012 is better than the corresponding period of 2011. Figure 3a shows that average oil rig count according to Baker Hughes was 17 in the period, higher than the average 13 in the first half of 2011. We do not expect oil rig count for the rest of the year to be lower than 2011 because there are no signs to suggest that the oil rich Niger Delta region will witness major disturbances to oil exploration in the period. However, it is important to note that more rigs have been explored offshore in 2012 as shown in Figure 3b, an indication of the risk-averse sentiment of oil explorers. Offshore fields explored in the first five months of 2012 averaged 12.2, higher than average 9 explored in the first half of 2011. The implication of having more offshore oil fields explored is that it reduces the federal governments share of the oil revenue in the short term due to the agreements in the Production Sharing Contract.

Figure 3a: Oil Rig Count Figure 3b: Onshore and Offshore Rig Count

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Source: Baker Hughes Source: Baker Hughes


Inflation

Figure 4a shows that the year-on-year inflation in the first half of the year averaged 12.52%, higher than the 11.7% recorded in the corresponding period of 2011 and the 9.5% target in the 2012 budget. The 12 month-moving average inflation rate of 11.05% as shown in Figure 4b, although lower than the average 12.9% in the first half of 2011, is still at double digit compared to the single digit target in 2012. Inflation in 2012 has been driven partly by the impact of the deregulation of the downstream oil sector according to the NBS while other drivers of inflation include structural bottlenecks such as continued poor power supply and the disruption in distribution of goods, especially agricultural products from the Northern part of the country which is predominantly agrarian. Thus both the year-on-year and 12MMA inflation rates are expected to rise in the coming months.

Figure 4a: Year on Year Inflation RateFigure 4b: 12-MMA Inflation Rates

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Source: NBS Source: NBS

What should however be of more concern to the economic managers are the core inflation rates as shown in Figure 5a. The core inflation averaged 14.07% in the first half of the year, higher than the headline inflation of 12.52%. This implies that inflation is actually driven more by the structural and institutional challenges other than the seasonal variations in the food basket index (Figure 5b). This higher rate of core inflation is one of the key factors that the Monetary Policy Committee (MPC) of the central bank will be monitoring closely in the second half of the year.

Figure 5a: Core Inflation Rates Figure 5b: Food Inflation Rates

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Source: NBS Source: NBS

Exchange rate movement

In the 2012 budget, the naira exchange rate was assumed at N155/$. However, Figure 6a shows that in the first half of 2012 the naira has been more depreciated in both the official and unofficial markets. It depreciated to average N156.90/$ in the official market from N151.79/$ in the corresponding period of 2011 while the unofficial rate depreciated to average N160.92/$ from N157/$ in 2011. Factors such as inflationary pressure and the general sentiment associated with rising security concerns are increasing the demand for foreign exchange as shown in Figure 6b.

Figure 6a: Exchange Rate Movement Figure 6b: Foreign Exchange Sales by CBN

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Source: CBN and FDHL Analytics Source: CBN

The central bank sold a total of $2.4bn in June, higher than the $1.62bn and $1.02bn in May and April (Figure 6b), thereby preventing a free fall of the naira. The implication of increased forex sales by the central bank is the 2.4% decline in the external reserves to $36.8bn in June from $37.7bn in May. Another factor that is putting pressure on the naira is the recent development in the Nigerian legislature where lawmakers are aiming to amend the CBN Act of 2007 which may lead to undermining the independence of the central bank. This had negative impact on the markets sentiment as depicted by the inverted bond market yield curve in Figure 7.

Figure 7: Bond Market Yield Curve in 2012

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Source: FDHL Analytics

The stock market

The stock market has also under-performed in the first half of 2012 when compared with the corresponding period of 2011. Figure 8a shows that the all share index averaged 21,227.54 in the first half of 2012, 16.9% lower than the 25,559.54 recorded in the corresponding period of 2011. As a result, the average stock market capitalization of $43.18bn in the first half of 2012 as shown in Figure 8b is 19.8% lower than the $53.84bn in the corresponding period of 2011. Apart from the sentiment about macroeconomic developments, the see-saw activities in the stock market in 2012 have also been attributed to factors such as the probe by the legislature of the activities of the Securities and Exchange Commission (SEC), a move that sent mixed signals to the market.

Figure 8a: Stock Market All Share Index Figure 8b: Stock Market Capitalization

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Source: Nigerian Stock Exchange Source: FDHL Analytics

Response of the central bank and direction of market interest rates

The central banks monetary policy stance in 2012 has been neutral as it has left the monetary policy rate (MPR) unchanged at 12% as shown in Figure 9a. When compared with same period in 2011, the MPR has been higher in 2012 despite the neutral stance of the central bank. However, average year-on-year headline inflation rate of 12.52% in the first half of the year higher than the MPR of 12%. Also, the average year-on-year core inflation rate of 14.07% is higher than the MPR. The central bank may therefore increase the benchmark interest rate later in the year in order to maintain a positive real interest rate.

Figure 9a: Monetary Policy Rate Figure 9b: Lending & Deposit Rates June 2012

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Source: CBNSource: CBN

With respect to market interest rates, Figure 9b shows that in June 2012, sectoral lending rates were above 20% while the government and its agencies got a relatively cheaper lending rate of 19.94%. However, deposit rates remained very low, with demand deposit rate averaging 0.55%, savings deposit 1.71% and time deposit 5.5%. The implication is that the gap between lending rates and deposit rates remain high, with the latter discouraging savings and the former putting off borrowers.

Policy implications and outlook

The half year review of the global and domestic developments has a number of policy implications. First, the global environment remains shrouded in uncertainty, especially with respect to developments in the Euro zone. To this end, the policy efforts of the federal government such as those in the agriculture and petroleum sectors, including the announcement that the excess crude account will be shored up to $10bn are essential. Second, the economy in the first half of 2012 under-performed when compared with the corresponding period of 2011 and 2012 budget as shown in Table 1. This means that the government must devise measures to turn around the slowing economic performance if the objectives set in the 2012 budget are to be achieved. Although progress report on 2012 budget is yet to be available, the recent report on budget 2011 by the Budget Office of the Federation (BOF) shows that 87% of capital expenditures were implemented. Therefore, given the policy stance of the fiscal authorities, implementation of 2012 budget may surpass 2011 and this will boost overall economic performance for the year.

Table 1: Budget 2012 Benchmarks/Targets Vs Half Year 2012 Performance

2012 Budget Benchmark/Target

Half Year Average

% Change

GDP Growth (%)

7.200

6.170 (Q1)

-1.03

Oil Price ($pb)

72.000

96.500

34.1

Oil Production (mbpd)

2.480

2.101

-15.3

Inflation (%)

9.500

12.52

3.02

Exchange Rate (N/$)

155

159.35

-2.8

Sources: MoF, NBS, OPEC and CBN

Third, events in the oil market as well as domestic oil production will be crucial in the second half of the year. While the average oil price of $100pb in the first five months of the year is higher than budget benchmark of $72pb, the relatively low oil production of 2.101mbpd means that estimated oil revenue for the period is about $3.78bn or N585.9bn.[2]When annualized, Nigeria may earn about $9.08bn or N1.4trn in 2012 compared with the budget projection of N1.9trn, resulting in N500bn shortfall in expected oil revenue. This will shoot the projected fiscal deficit from N1, 136.19bn to N1, 636.19bn (2.95% of GDP) and will result in budget financing and implementation challenges.

The outlook for the second half of 2012 is that real GDP growth may remain above 6% but reaching or surpassing the 7.2% target for the year may be challenging. Also, given the trend in core inflation, the central bank may change from its neutral posture in the second half of the year and increase the official interest rate. We also see the central bank allowing the naira to float should oil prices decline faster than expected even when the surge in inflationary pressures may make this necessary in order to maintain export parity. There is in addition a slim chance that the central bank will cut rate in its MPC meetings for the second half of the year as this may put more pressure on the exchange rate amid inflationary pressures. On the fiscal side, the government will have to devise measures on improving the economic performance in the second half of the year if the Misery Index of 35.5% (inflation plus unemployment) is to reduce or at best remain the same. Fiscal authorities will consolidate on government finances and probably shore up the excess crude account as announced. However, in light of the see-saw activities in the oil market, if oil prices decline further, the government may not only resort to depleting the excess crude account, it may increase borrowing and this will expand the overall deficit level in 2012.



[1]With theagriculture and manufacturing sectors contributing over 50% of the non-oil GDP, their growth rates of 5.15% and 4.15% suggests that the Q1 non-oil GDP growth of 7.93% may have been over-estimated.

[2]Using exchange rate of N155/$




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