The dominant narrative on the Nigerian economy in the first half of 2023 centred mostly around election-induced uncertainty and the constrained rebound in crude oil output due to persistent acts of vandalism and oil theft. This was evident in the loss of momentum as economic growth slowed to 2.31% in Q1’23 from 3.52% in Q4’22 and 3.11% in Q1’22.

The slowdown was exacerbated by high inflation, scarcity of foreign exchange (FX), and the impact of a cash crunch triggered by the hasty execution of a currency redesign initiative (ostensibly aimed at cracking down on vote buying) on lives and livelihoods. The rapid withdrawal of 75% of cash in circulation proved to be disruptive to business transactions (particularly B2C), with the banking system’s digital payment infrastructure unprepared to cope with the massive move to digital banking. As a result, private consumption and investment spending shrunk. Consumers prioritised the little available cash for food consumption, while demand for durables, garments, luxury items, and so on was severely constrained, resulting in an unplanned buildup of inventory and weighing on investment spending. The Supreme Court ruled in favour of the old naira notes remaining legal tender until December 31, 2023, which prompted a return to normalcy in Q2’23.

In contrast to the decelerating inflation trend globally, headline inflation continued in its upward trajectory reaching a 17-year high of 22.79% in June 2023 from 21.3% in December 2022, fuelled by rising food prices and has been largely resistant to policy tightening measures by the Central Bank of Nigeria (CBN) since May 2022. The United Nations (UN) estimates that an additional four million Nigerians were plunged into poverty in the first five months of 2023 as purchasing power continues to be eroded by rising prices, particularly skyrocketing food prices.

Crude oil prices (brent) averaged $82 per barrel (pb) in H1’23, 26% lower than $111pb recorded in the corresponding period last year but still higher than the 10-year average of $70.47pb. Nigeria is still unable to benefit significantly as crude oil production of 1.2 million barrels per day (mbpd) in H1’23 remains 13% below the recently revised OPEC-sanctioned output quota of 1.38mbpd, constrained by oil theft, production shut-ins, ageing infrastructure and inadequate investments in oil fields. Lower-than-expected crude oil production in the face of rising FX demand in addition to the CBN’s efforts to manage demand via rationing led to severe distortions in the FX market, pushing the naira down to ₦800/$ in the parallel market and widening the premium to 63% in early May – one of the highest in the world. Nigeria also witnessed a steady depletion in its external reserves position as the gradual decline in crude oil prices and external debt finance needs pushed the reserves level down 7.9% ($2.96bn) to $34.12bn as at June 30 2023. Election-related uncertainty and FX illiquidity also limited capital importation to $1.13 billion in Q1’23 to its lowest levels in any first quarter since 2017.

Nonetheless, the first half of the year ended on a high note as the new government decided to bite the bullet and commence crucial market-based reforms, discontinuing petrol subsidies and liberalising the exchange rate regime – motivated by the need to counter the fiscal debt stress. The accelerated pace of reforms rattled markets, prompting rallies in the bond and equities markets, with the All Share Index (ASI) rallying by 15.1% in June alone to cross the 60,000 point threshold after a meagre 3.36% increase in the 5 months prior. The rapid fire approach also seems intent on signalling that Nigeria is ‘Open for Business’. Some argue that more was done in June 2023 to set Nigeria on a path to sustainable long-term economic growth than the preceding eight years. However, the trade-off is already evident in the spike in intra-city and last-mile logistics costs across the country spiralling through to the cost of goods and services, causing real incomes to shrink even further and necessitating belt-tightening measures.

H2 Outlook: Darker Before the Dawn

We estimate that GDP numbers for Q2’23 will reflect a further slowdown in growth to 2.2% as high inflation continued to constrain aggregate demand amid heightened political uncertainty and weak investment. However, the GDP growth forecast for the remainder of the year will depend significantly on the Federal Government of Nigeria’s ability to swiftly and efficiently capitalise on the current reform momentum and propel Nigeria towards an economic growth trajectory that is not only transformative and sustainable but also inclusive.

Figure 1: GDP growth in % (Q1 2022 – Q4 2023)

 

Source: National Bureau of Statistics and Agusto & Co. Research

In H2’23. the underlying impetus for GDP growth will come from the continued robust expansion in the services sector, particularly the telecommunications and financial services sectors. However, it is imperative to highlight that these sectors exhibit a certain degree of job inelasticity, thereby falling short of making a substantial impact in alleviating Nigeria’s unemployment levels, which currently stand at a staggering 40%. We anticipate a recovery in the trade sector, which was hampered by the cash crunch due to its largely informal structure, as most transactions in the informal sector are cash-based.

A substantial recovery in Nigeria’s crude oil output is anticipated by the end of 2023 to 1.5mbpd as reforms targeting the security of oil installations, as well as lives and property, are expected to be the government’s top priority. This will allow Nigeria to benefit from elevated crude oil prices, which we expect to average $75pb-$80pb in 2023. Enhancing security will play a pivotal role in mitigating banditry and conflicts within vital food-producing regions, which is positive for agricultural sector productivity. The end of the cash crunch, which constrained demand and impaired crop production in H1’23, will also bolster agricultural output. We expect high interest rates to continue having a stifling effect on borrowing and weigh on output growth in the near term even as high inflation erodes consumer purchasing power further.

Exchange Rate: No Quick Fixes

Following the effective liberalisation of the FX market and the steep slump in the value of the naira at the IEFX window in the immediate aftermath of the policy announcement, we expect the ensuing volatility and downward pressure on the naira to persist as the market continues in its quest for price discovery and given the significant demand backlog, estimated at circa $12 billion. The managed floating exchange rate regime implies some controls in place and therefore, we could see further depletion of the external reserves to $30 billion by year-end. When the dust settles, we forecast a rate of ₦750/$ – ₦800/$ by mid-2024 and anticipate a minimal differential of 5-10% between the IEFX and the parallel market, which should lower uncertainty, reduce the opportunity for round-tripping and enhance investor confidence. In addition, the currency restrictions on 43 items in place continue to send a negative signal and should be discarded in favour of fiscal tools (tariffs) to make domestic production relatively more competitive than imports.

Inflation: Near-Term Woes

We expect the removal of subsidies on petrol to have a singular, uniform impact on select prices, predominantly affecting expenditures on fuel for automobiles and generators, alongside transportation-related expenses and certain service charges. When we combine the aforementioned with the impact of FX reforms on the price of imports previously conducted at the erstwhile official exchange rate, we anticipate a short-term spike in headline inflation to above 30%, which we project should ease gradually in Q3’23 and average 26-27% for the year.

Figure 2: Headline Inflation (January 2022 – December 2023)

Source: National Bureau Statistics (NBS) and Agusto & Co Research

Monetary Policy: Futile Return to Orthodoxy?

We envisage that the CBN will maintain its hawkish stance by responding to higher inflation with further hikes in the policy rate. It will also consider the need to achieve positive real returns on investment and attract capital inflows and as a result we anticipate a rise in the monetary policy rate (MPR) to 20%–22% by year-end in spite of the President’s preference for lower interest rates. In spite of the CBN’s return to monetary policy orthodoxy – in alignment with its mandate of maintaining price stability – inflation has continued to trend upwards. Many have attributed this phenomenon partly to structural cost-push factors and partly to the monetisation of the deficit, which is allowing the FGN to borrow much less from the debt market. We also note that 364-day Treasury Bill (T/Bill) rates have failed to rise in tandem with the rise in the MPR and ended H1’23 at 6.23% from 7.3% at the first auction of the year.

Figure 3: Federal Government of Nigeria Local Currency Debt (₦’ trillion)

Source: the CBN, DMO and Agusto & Co. Research

 

We expect the current rally in the stock market to be sustained, and anticipate a strategic realignment of portfolios by investors, away from fixed-income investments and redirecting their focus towards equities to capitalise on the bullish market. This has the potential to significantly impact the demand for T/Bills, thereby exerting downward pressure on yields further.

Widening Fiscal Space

The removal of petrol subsidy and FX reforms will significantly improve revenue accruing to the federation account, which will allow the federal and sub-national governments to better balance their books. We estimate a rise in the FGN’s revenues to circa ₦7 trillion in 2023, with expenditure at ₦16.4 trillion giving rise to a deficit of ₦9 trillion, ₦4 trillion of which is expected in H2’23 – which we believe will be financed domestically.

Figure 4: Revenue & Expenditure of the FGN (₦‘ trillion)

Sources: Federal Ministry of Finance (FMF) and Agusto & Co. forecast

This would push the FGN’s local currency debt (including the CBN financing) to ₦52.9 trillion (798% of Revenue) in 2023 but lower fiscal sustainability risks as interest as a percentage of revenue is projected to decline to 77% from 100% in 2022.

Figure 5: LCY Debt as a % of FGN Revenue

Source: National Bureau of Statistics (NBS) and Agusto & Co. Research

We are also expecting a substantial increase in public sector wages, by circa 40%, as a cushion against the rise in prices. We expect that the significant borrowing from the CBN will continue until at least December 2023, after which we anticipate that budgetary reforms will be implemented to ensure that the FGN returns to the domestic debt market as its primary source of deficit financing rather than the CBN in 2024.

Figure 6: Interest Payment As % Of FGN Revenue

Source: CBN, DMO, Agusto & Co Research

Conclusion

The challenges confronting Nigeria are deep-seated and structural, and the economic policies adopted in the last few years, which have skewed towards protectionism, have further constrained the difficult business climate for foreign investors. Sustaining the current reform momentum and strategically sequencing the next set of reforms will greatly enhance the chances of eliminating the structural bottlenecks that constrain investment, production and export activities in the long term.