Oil shock: Analysts paint gloomy picture of Nigerian economy as Afrinvest talks devaluation

Oil shock: Analysts paint gloomy future for the Nigerian economy as Afrinvest emphasises Naira devaluation

Analysts have painted a gloomy future for Nigeria’s economy due to the recent oil shock that is expected to curtail government capacity. Oil prices sharply moderated 46.8% year to date to $36.3 barrel per litre (bbl) today, the lowest level in over four years.

Analysts at Afrinvest noted that a price level below $60.0/bbl. would have a negative impact on Nigeria’s external and fiscal balance.

“Our worst fears have been confirmed at the current oil price, reflecting the double salvo of weak oil demand due to COVID-19 and expanding oil supply due to the collapse of OPEC+.

“The decision of OPEC+ to remove its support for prices by shunning the proposed 1.5mb/d and current 2.5mb/d cuts caused a sharp fall in oil price from $45.0/bbl. on Thursday to $36.0/bbl today”, Afrinvest remarked.

How will the FG Fund its Budget?

Afrinvest held the risk of poor implementation is now higher for the 2020 budget despite its pessimistic outlook earlier in the year.

It recalled that the FG plans to spend a record N10.6 trillion, with 76.7% financed through revenues and the balance from borrowing.

“Since 2015, the FG has lacked the earnings to support its spending profile and we captured this in our projected 43.9% underperformance for 2020.

“With oil price below budget assumption of $57.0/bbl., we estimate a revenue shortfall of 55.1%”, Afrinvest stated.

It reckoned that although the FG is expected to review the 2020 budget, analysts said they see little room for manoeuvre.

High non-discretionary spending – reflecting elevated debt service and payroll costs that account for 64.0% – and the absence of fiscal buffers means the FG would expand borrowings.

The Excess Crude Account (ECA) which should support the FG’s budget during episodes of oil shocks is almost empty at $71.8 million in February 2020 from $2.1 billion in 2015.

Afrinvest said that the budgeted fiscal deficit at 1.5% is below its projections of 2.7% at the beginning of the year.

But, analysts said they now review this upwards to 3.1%, above the threshold of 3.0%.

“We also revise our debt service to revenue projection higher to 66.6% from the initial 53.3%”, analysts remarked.

Can the CBN Hold Off on Currency Devaluation?

In our 2020 outlook, Afrinvest stated that it predicted 10% currency devaluation in the second half of 2020 given negative current account balances and weak capital flows.

“As Brent crude oil price currently trades below our threshold of $60.0/bbl. and could stay so in the near-term, we reiterate the need for a currency devaluation to support the economy”, analysts said.

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It held that the external reserves level of $36.2 billion is down 6.2% year to date but this still covers 6.2 months of goods imports, above the 3 months threshold recommended, from 11.2 months this period last year.

“We expect the CBN to sustain its peg by maintaining its FX demand management policies, tightening liquidity, and offering higher rates to foreign investors in its OMO auctions.

“There is a high chance that currency devaluation would be the measure of last resort to correct the external imbalance and support the economy”, analysts at Afrinvest remarked.

Analysts however noted that the CBN seems unlikely to relax its hold on the currency at external reserves level above $30.0 billion even though oil price now falls below the Bank’s $45.0/bbl. target.

“In our view, the worry is that history could repeat itself, with devastating impact to the economy like we saw during the 2016 recession.

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“We believe a gradual adjustment of the currency would better help the economy adjust to the current shocks and support government revenues.

“The 12-month forward rates suggest a currency value of N408.94/$ and using the long-term REER equilibrium of Nigeria, we forecast a similar 10.0%-15.0% adjustment”, Afrinvest stated.

Oil shock: Analysts paint gloomy future for the Nigerian economy as Afrinvest emphasises Naira devaluation