Highlights and Key Issues
* The drop in oil prices to around US$60 a barrel and continued production problems in the Niger Delta region will hamper GDP growth over the next year. Although the nonoil sector has remained fairly robust, growing 8.5% on the year in Q2, overall GDP growth was only a little over 6% in H1 this year, well short of official hopes of 9-11% by the end of the year, which were based on a recovery in oil output.
* Following the slowdown in H1 this year and with oil prices now forecast to remain around US$60-70 a barrel over the next year and output unlikely to rise significantly, we have lowered our 2008 GDP growth forecast to 6.5%, with a similar outturn expected in 2009.
* Despite concerns about inflation, which rose to 13% in September, and the strength of domestic demand and credit growth, the CBN started to ease monetary policy when it cut its MPR to 9.75% at an unscheduled monetary policy meeting in September.
* After their recent steep decline, oil prices are now forecast to average between US$60-70 a barrel in 2009 and 2010. As a result, we expect that the current account surplus will be around US$38bn this year, equal to 16% of GDP, before falling to only US$5bn in 2009. However, foreign reserves remain substantial, having risen to over US$63bn in mid-September, equal to over 16 months’ imports of goods and services.
Oil sector still a drag on growth…
* Coupled with ongoing security problems in the main oil-producing region, the halving of world oil prices since July is going to erode export earnings over the next year, making it even more difficult for the government to attain its budget and GDP growth forecasts. Latest figures from the Central Bank of Nigeria (CBN) confirm this prognosis, showing that year-on-year growth in Q2 was 6.7%, up from 5.5% in Q1 but yielding H1 growth of only slightly above 6%, well below the official hope of reaching 9-1 1 % by the end of the year. We have lowered our 2008 forecast to about 6.5%, which would be much the same as the 6.3% outturn posted in 2007.
* Because of the problems in the Niger Delta, where rebel activity has cut capacity by almost a third since early-2006, oil output fell 1 1 % in Q2 to 1 .82m b/d (on official data) and held back growth in the overall economy. And latest oil production figures suggest that the oil sector may remain weak in H2 – EIA figures indicate that output in Q3 was unchanged from Q2. But despite the drop in the oil price, to around US$60 a barrel currently from over US$1 45 at its peak, oil revenues remain high compared with a couple of years ago. As a result, the non-oil economy (some 82% of total GDP) still managed to grow 8.5% in Q2, albeit down from double-digit rates at the end of 2007, and should remain fairly buoyant heading into next year.
* Despite the slowdown seen in H 1 , our forecast that oil prices will hold around US$60-70 a barrel over the next year suggests that the economy should continue to perform reasonably well. But the growth forecast of 9.5% incorporated in the draft 2009 budget, which is based on a rebound in oil output, is very unlikely to be achieved and may have to be reworked in the light of the recent drop in oil prices. The IMF, which also assumes a recovery in oil output, has lowered its growth forecast to 8.1% for 2009, but we expect an outturn closer to this year at around 6.5%, with a further modest slowdown in 201 0.
…and the CBN cuts rates…
* Although the CBN raised interest rates in April and June this year in response to the threat from rising inflation and concern about high public spending, it then left rates unchanged in August in recognition of the worsening global backdrop and the less bullish prospects for the domestic economy.
* And at a special monetary policy meeting on 18 September, the central bank decided to cut rates, lowering its monetary policy rate by 50 basis points to 9.75%, while at the same times easing banks’ cash reserve requirements and adopting other measures to add liquidity. The CBN communiqué noted that while the economic fundamentals remained very strong and headline and food price inflation had been on the rise, it could not “afford to be unmindful of international financial developments”, although at the same time it believes that the impact of the turmoil will be limited. Yet it also noted that M2 money supply growth and private sector credit growth remained strong despite earlier rises in interest rates.
…despite inflation up to 13%
* The strength of domestic demand, buoyed by still high oil revenues, and rising inflation highlight the dilemma facing the CBN. Consumer prices rose 1 .1 % on the month in September, lifting the annual inflation rate to 1 3% from 1 2.4% in August. Food price inflation was even higher, at 17.1%, but this was down from 18.8% in August and could signal the start of a downward move in overall inflation in the months ahead. But a rapid drop seems unlikely, especially with domestic monetary conditions still loose – credit to the private sector was up by over 70% on the year in August. Our average 2008 inflation forecast has been raised to over 10%, up from 5.4% in 2007, but with a modest slowdown to around 8% seen for 2009.
Current account surplus set to fall
* The drop in oil prices means that the 2008 current account surplus is now forecast at about US$38bn (equal to 16% of GDP), rather lower than expected previously but still solid. However, the outlook for 2009 has deteriorated on the back of the slide in oil prices since mid-year and continuing production problems. We now forecast that the current account surplus will drop to only US$5bn next year (or only 2% of GDP), much weaker than previously envisaged, but this may be the trough if oil prices edge higher in 201 0 and oil output picks up.
* Unlike previous occasions of weakening balance of payments, however, foreign exchange reserves remain substantial, having risen to US$63bn in midSeptember. This was equal to over 16 months of imports of goods and services.
* Nigeria’s past has been turbulent, with the erratic economic performance since the early 1970s driven by fluctuations in oil prices and revenues and poor economic management, while politics were characterised by long periods of military rule until the return to democracy in 1999. Overall, GDP growth since the first oil boom has been very disappointing, with much of the vast oil revenues over the period either wasted on prestige projects or siphoned out of the country by corrupt military administrations. As a result, the vast majority of the population is still poor, the level of development is low and infrastructure is dilapidated, requiring substantial new investment. In addition, there has been a high level of social unrest and ethnic and religious violence, with considerable tensions between the mostly Muslim north of the country and the mostly Christian south.
* Since the elections in 1999 that saw the former military ruler Olusegun Obasanjo elected as president, there have been some significant improvements on both the political and economic fronts, albeit the progress has been slow. With Obasanjo unable to stand for president again in the April 2007 presidential election, ruling PDP candidate Umaru Yar’Adua won a massive victory over his nearest rival, the former failed military ruler Muhammadu Buhari, giving the PDP another four years in power. The elections were marred by widespread irregularities, with domestic and international observers declaring that the results were not credible, but a tribunal reviewing evidence about the alleged vote rigging and intimidation upheld the election result in February 2008.
* Obasanjo’s first four-year term was particularly undistinguished, being marked by sharp divisions between the executive and the ruling People’s Democratic Party (PDP). As a result, there was little progress on any of the key policy aspects, the result being continued economic decline and worsening social and religious unrest, particularly in the oil-producing Niger Delta where little of the oil wealth has been reinvested. In addition, the programme agreed with the IMF in 2000 was abandoned less than two years later, with the government reluctant to implement any of the policy prescriptions ahead of the 2003 elections.
* The main gains occurred in Obasanjo’s second term, with a coherent economic policy framework at last being put in place, the so-called National Economic Empowerment and Development Strategy (NEEDS), under the new finance minister Ngozi Okonjo-lweala. This was the long-awaited home-grown economic programme that the government had been promising since it broke off relations with the Fund in March 2002. The main thrust of NEEDS was initially on job reductions in government ministries, starting with the ministry of the Federal Capital Territory and then spreading into other ministries. Other measures on the agenda included privatisation of key sectors such as electricity and oil refining, reducing subsidies on fuel prices, tighter monetary and fiscal policy and fighting corruption. The IMF and the World Bank responded positively to the programme, the Fund describing it as “a clear break from past practices in economic policy formulation”, in stark contrast to its previous scarcely concealed criticism of Nigerian economic policy.
* GDP growth has picked up, to about 6% p.a. in 2005-07, and inflation has come down into single digits since the NEEDS programme began, with tougher fiscal and monetary policies being implemented under Okonjo-lweala. At the same time, higher oil prices have helped, increasing export and budget revenues in the last few years. As a result, the trade and current accounts have improved sharply, with the current account swinging from close to balance in 2002 to an estimated surplus of US$30bn in 2007, equal to around 20% of GDP, with an even higher outturn expected in 2008. As a result, foreign exchange reserves have risen strongly, standing at over US$63bn in mid-2008.
* A major breakthrough resulting from the improved policy stance was the agreement with the IMF in 2005 under the new policy support instrument, whereby the IMF monitors policy but there is no funding. This in turn paved the way for a massive US$1 8bn Paris Club debt write-off, with the government paying off some US$1 2bn in arrears out of its reserves, thereby eliminating much of the country’s external debt. External debt fell to just US$3bn (equal to 2.5% of GDP) in early 2007, following the completion of the buyback of the London Club debt of some US$2bn, compared with over US$37bn as at the end of 2004. As a result, Nigeria’s international creditworthiness has risen sharply, with credit rating agencies awarding a BB- rating despite ongoing political concerns and the poor record of economic management.
Copyright Oxford Economic Forecasting Nov 7, 2008
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