In the first half of 2022, just as it appeared that COVID-19 fears were fading and countries across the globe were easing lockdown restrictions and reopening businesses, Russia invaded Ukraine, further complicating an already fragile and uneven global economic recovery. Both nations are important contributors to global food and energy supplies (jointly accounting for 34% of global wheat exports while Russia was the 2nd largest oil exporter – 7.8mbpd – before the war), and markets have reacted accordingly. Food and energy prices soared, exacerbating global inflation, which was already on an upward trajectory due to excessive stimulus in many countries in support of post-pandemic economic recovery, as well as persistent supply chain bottlenecks. In some nations, inflation rates are now at multi-decade highs, triggering earlier-than-anticipated interest rate increase which is having far-reaching consequences for the global economy – particularly emerging markets and developing economies.
Commodity prices fueling Inflation Spiral
For Nigeria, deep-seated structural deficiencies, which have heightened the country’s susceptibility to external shocks, have become even more apparent. Despite a strong recovery in the non-oil sectors, GDP growth slowed in H1’22 to 3.28% (from 4.01% in H2’21), but the overarching development was the ripple effect of the Russia-Ukraine conflict, which manifested primarily in the form of a surge in headline inflation. The global wheat price surge (up 22.3% since January to $9.27/bushel as at June 30th) is being exacerbated by the exchange rate pass-through effect, which is driving food inflation (up by 208bps YTD to 17.71% in May). Meanwhile, the surge in diesel prices (by circa 300% in H1’22 to just over an average of ₦800/litre as at June), has given Nigerians a glimpse of the realities of a deregulated petrol market and is contributing significantly to higher production and logistics costs which are driving inflation.
While the empirical evidence indicates that inflation has risen to 17.71% in May 2022, the anecdotal evidence suggests a more astronomical increase as real monthly incomes continue to shrink. High and persistent inflation, on the other hand, is weighing significantly on consumer purchasing power, particularly in poor and vulnerable households. pushing Nigeria. The World Bank estimates that an additional one million Nigerians could be plunged into poverty in 2022 as a result of the Russia-Ukrainian war, on top of the six million already projected before the war. It also puts even more people at risk of food insecurity. The rising tide of insecurity across the country, the slowdown in the reform momentum and policy uncertainty have continued to deter private investment.
Oil Prices: Double-edged Sword
In the first half of the year, Nigeria was unable to maximise the benefits (fiscal & external) from what should have ordinarily been an oil windfall as vandalism, ageing infrastructure and inadequate investments in oil fields ensured that output remained significantly below the 1.77mbpd OPEC quota to an average of 1.35mbpd between January and May 2022. Higher crude oil prices have largely amounted to a higher subsidy bill while the lack of domestic refining has led to recurring incidences of petrol scarcity which weigh on productivity. International Oil Companies (IOCs) also continued to divest from Joint Venture arrangements to more profitable deep-water assets where they have a greater share of the profits.
Policy Shift at Last
After 70 months of taking a dovish stance and maintaining monetary unorthodoxy, the Central Bank of Nigeria (CBN) initiated a monetary tightening regime to curb inflation. It raised the benchmark interest rate by 150bps, from 11.5% to 13%, to rein in inflation, moderate capital flow reversal and strengthen the weak naira. Following the interest rate hike, the sustained depletion of the foreign exchange reserves has reversed its trend. After a steady decline, by 5.18% from the start of the year, to $38.42bn as at June 6th, it gained 1.9% to end H1’22 at $39.15bn. However, the naira has depreciated at the parallel market by 8% to ₦615/$ from ₦567/$ at the start of the year on weak supply relative to demand (driven by electioneering and speculation) pushing up the exchange rate premium to ₦190/$ as the CBN maintained the naira at ₦425/$ at the NAFEX window.
Foreign Direct Investment (FDI) inflows fell to $313.61mn Q1’22, the lowest levels for a first-quarter since 2017 while JP Morgan has now delisted Nigeria from its Emerging Market list, signaling a loss of confidence in the economy, with negative consequences for Nigeria’s international borrowing costs. Nigeria’s total debt stock continued to climb (now at ₦41.6trn – March 2022) and so have debt service costs, which were estimated at 96% of government revenue in 2021.
H2 outlook: More of the same
The IMF and the World Bank have both revised their 2022 forecasts for global growth downwards by 0.8 and 1.2 percentage points to 3.6% and 2.9% respectively to reflect substantial negative global spillovers from the Russia-Ukraine conflict such as bottlenecks in global supply chains and significant increases in the price of many commodities. Globally, policymakers are confronted with a trade-off between the need to moderate inflation but also stimulate economic growth, with varying degrees of policy space available in different nations. Stagflation fears no longer seem misplaced and accelerated policy tightening could also escalate stagflation risks – particularly in sub-Saharan Africa.
On the domestic front, we expect governance and policy-making to take a backseat as electioneering dominates the headlines for the rest of the year. The Nigerian economy is likely to continue to expand, albeit at a slower pace in H2’22 as the lingering effects of the Russian-Ukrainian conflict, heightened insecurity and higher interest rates take their toll. While elevated crude oil prices should provide support, production constraints are likely to persist and continue to limit the impact of elevated oil prices on oil revenues and weigh on GDP growth.
Source: National Bureau of Statistics, * = Agusto & Co forecast
However, the economy (particularly the non-oil sector) will be supported by pre-election spending which we expect to stimulate aggregate consumption and is likely to be felt more significantly in certain sectors of the economy. As election campaigns intensify, political travel across the country will benefit the transport (aviation) industry as well as the hospitality industry – especially hotels. Public works and construction, especially abandoned projects in strategic locations, are likely to benefit from efforts by incumbent politicians to display tangible accomplishments. This will be positive for the cement sub-segment of the manufacturing industry. The demand for advertising services, branded items as well as print and digital services are also expected to soar. Trade sector growth is expected to continue following the reopening of four more land borders.
The CBN’s development finance intervention schemes (estimated at ₦6.8trn so far) will continue to channel funds to credit-hungry sectors, such as agriculture and manufacturing, despite deep-seated shortcomings ranging from power outages to heightened insecurity to import restrictions. On the other hand, the liquidity surge (from CBN intervention schemes and pre-election spending) is also likely to exacerbate inflationary pressures stemming from higher energy and food prices in the coming months, further eroding the purchasing power of households. However, we note the moderating impact of the CBN’s persistent use of CRR debits (about 15% of total assets of the banking sector) on banking sector liquidity. We forecast that inflation will peak at just over 18.5% before beginning to ease to 17% by December 2022.
Source: National Bureau Statistics (NBS), * = Agusto & Co Forecast
The CBN, which we envisage will maintain its hawkish stance to combat inflation, could hike its benchmark interest rate by another 50bps to 13.5%. However, it remains to be seen how effective interest rate hikes will be in curbing inflation in the face of excess liquidity injections via the CBN’s massive lending to the FGN and its credit intervention schemes to the private sector. With interest rates rising, fixed income securities are expected to perform better in H2’22 which could be bad news for equities. However, the rise in system liquidity and rising inflation, could also support the demand for equities.
Funding the widening fiscal deficit as subsidy payments (forecast to reach ₦5trn in 2022) continue to soar will remain a challenge. Given low crude oil output, we expect a budget deficit of about ₦8.8trn (4.9% of GDP) by the end of the year – the largest since the 1990s. We expect debt servicing costs to rise even further. Interest payments as a percentage of government revenue, could reach 115% if petrol subsidies continue to limit the NNPC’s remittances to the Federation Account. However, FGN borrowing from the CBN is expected to rise further to ₦23.2trillion, pushing its local currency debt to circa ₦46trillion by years-end and limiting the supply of debt securities. By implication, this will continue to keep T/Bill rates artificially low (365-days: 4-6.4%) for the rest of the year.
Source: CBN, DMO, Agusto & Co Research
Election-related uncertainty will severely limit capital inflows in the rest of 2022 even if domestic interest rates rise further. As a result, external reserves accretion, which has been ostensibly triggered by the CBN’s MPR hike, is expected to be constrained. This will also impair the CBN’s ability to intervene in the foreign exchange market and we forecast that the reserves level will stabilise at about $41bn by the end of 2022. We expect the naira to weaken further at the parallel market to trade within the band of ₦615/$-₦630/$ as demand pressure is expected to continue at the parallel market owing to forex scarcity. We do not expect the CBN to officially devalue the exchange rate despite sustained pressure and expect the naira to hover around ₦419/$-₦425/$ through the end of 2022.
For Nigeria, global monetary tightening means increased debt service costs on foreign debt, increased costs of financing trade transactions and a likely decline in diaspora remittances as advanced economies lose steam and job losses ensue. Much of the outlook for H2’22 depends on how the Russia-Ukraine conflict plays out and how quickly the world can fill the Russian-sized hole that is now constraining global supply chains. Sanctions on Russia are expected to remain in place even after hostilities cease, keeping food and energy prices elevated with the inflationary impact wreaking havoc across much of the global economy. As Sweden and Finland finetune plans to make the switch from ‘neutral’ to joining The North Atlantic Treaty Organisation (NATO), tensions could escalate further as Russia has labelled their actions a “Direct threat”. This could raise the stakes and increase the risks of a full-fledged war between the West and Russia. The impact would be a magnified version of what is currently happening, with significant consequences, particularly for developing countries such as Nigeria.