The outbreak of Covid-19 has reshaped the outlook across advanced, emerging and developing economies. Beyond any doubt, the impact will reverberate across economies, irrespective of the level of fiscal stimulus or monetary policy adopted to cushion the impact of the associated slowdown in economic activities.
Particularly in Nigeria, the countries fragile fiscal and external positions have once again been exposed by the crash in crude oil prices, with the impact on the real sector requiring a material intervention which the fiscal and monetary authorities may struggle to provide.
The NOVA Merchant Bank H2 2020 Economic Outlook communicates our understanding of global and domestic developments. It also clearly delineates our expectations of development in the Global Crude Oil Market, Domestic Economic Growth, Balance of Payment, Currency and Foreign Exchange Flows, Consumer Prices, Monetary Policy, Fiscal Policy and the Fixed Income Market.
See below a summary of expectations:
Notwithstanding the recent slower rate of contraction in manufacturing and services PMI, the shock occasioned by Covid-19 is expected to depress economic activities for the rest of the year. GDP in Advanced economies is projected to contract 8.0% YoY in 2020 from 1.7% growth in 2019.
Compared to the 2009 financial crisis wherein emerging and developing economies showed resilience, the Covid-19 shock is expected to reverberate across most emerging and developing markets. GDP in emerging and developing economies are expected to contract 3.0% YoY from 3.7% growth in 2019.
While the global crude oil market is forecast to record an average deficit of 3.3mbpd in H2 compared to an average surplus of 6.7mbpd in H1, the high inventory build-up occasioned by the cumulative market surplus of 40.2mbpd over H1 2020 will keep crude oil prices range-bound over H2 at $41.5/barrel compared to the year to date average of $39.9/barrel and Q2 low of $29.3/barrel.
We expect the Nigerian economy to contract by 2.9% YoY over 2020 compared to 2.1% YoY growth in 2019. We believe compliance with the recent OPEC+ agreement has become necessary though not convenient.
Compared to the stipulated cut of 1.41mbpd, we estimate Nigeria average crude oil production of 1.57mbpd which combined with condensates should average 1.85mbpd compared to Q1 20 average of 2.07mbpd.
Even with our expectation of the complete opening of the economy at the end of July with strict rules on social distancing over the rest of the year, the return to full-fledged economic activities might remain slow as complete containment without major escalation of Covid-19 could extend until the end of Q3 2020.
Balance of Payment:
Over 2020, the depressed global crude oil prices amidst pressured demand pose major risks for export and the trade balance. Beyond CBN actions, the spread of Covid-19 across major economies will have a major impact on travel and related services for the rest of the year.
Also, given the expected lower return on investment and feedthrough of the global shock on individual income, we model lower-income deficit and workers’ remittances respectively. Overall, we forecast a current account deficit of $16.6 billion on our base case.
On the financial account, with the current risk-off across emerging markets amidst depressed yields in local short-term debt securities, we expect a further exodus of FPI with a negative financing of $3.4 billion and overall balance of negative $19.9 billion compared to 2019 overall negative balance of $5.5 billion.
Currency and Foreign Exchange Flows:
We believe there is a strong risk of further haemorrhaging in the gross external reserves over H2 2020.
Assuming resumption of CBN intervention sales at the IEW starting August with 25% repatriation of backlog and maturing offshore holdings between August and December, even with lower imports and services demand the gross reserve could close the year at $31.8 billion on our best-case scenario.
Our base scenario assumes that if 50% of the backlog and maturing offshore holdings are repatriated between August and December, the gross external reserves could end the year at $29.0 billion. With limited inflows and reduced avenues to control outflows, recent unification of rates will have limited impact on the reserves.
We believe an outright floating of the exchange rate with intermittent intervention to avoid unnecessary speculative attacks will have a more meaningful impact.
Based on our purchasing power parity model (PPP), the fundamental value of naira lies between N427/$ and $430/$ (~11% overvaluation from current NAFEX rate of N387.2/$ and an undervaluation from the current parallel market rate of N447/$).
The pressure on consumer prices over H2 will largely reflect the impact of the breakup in supply chains and volatility occasioned by the oscillating PMS price. While the impact of the border closure is expected to largely fade off in August, recent events have overtaken its impact.
The combined effect of Naira depreciation and expected volatility occasioned by the market reflective PMS price will further add to the pressure on the core index over the rest of the year. Adjusting our model for the above-mentioned pressures, we arrived at a base average inflation rate of 12.3% in 2020, compared to an average of 11.41% in 2019.
Beyond doubt, the LDR policy has proven to be more potent in driving real sector lending and at the same time moderating the cost of borrowing due to the increased competition for corporate names.
However, the distribution of loans continues to favour largely the prime sectors and lenders with limited transmission to the CBN’s preferred sectors. Going by feedback across the banking system, banks are concerned about liquidity and credit risk are given current conditions.
Due to the impact, unusual debits have had on system liquidity and overall interbank rates, we believe a gradual refund of excess CRR will have a more positive impact on rates in the interim, but actual lending by DMBs will require a fundamental change in the economic environment.
Over the second half of the year, we expect the CBN to focus on reflating the banking system and to adopt more efficient measures around the LDR to further support credit creation, especially to consumption stimulating sectors.
However, we see the possible transmission of any further cut of the MPR to CBN development programs and intervention initiatives.
Overlaying lower oil revenue (from lower prices and compliance to OPEC cut), we estimate total 2020 FGN revenue of N3.2 trillion (-22% YoY). We believe the implementation of the 2020 budget is largely doubtful with the scapegoat being the capital expenditure.
With our base case scenario assuming budget implementation of 80% (5-year average: 84.4%), we estimate budget deficit could range between N4.5 trillion and N5.5 trillion in 2020. While the IMF loan of $3.4 billion and the $150 million drawdowns from NSIA will unlock about N1.4 trillion for the federation, the 2020 budget will still have a financing gap of N3.2 trillion.
To fund the gap, our preferred scenario assumes FG secures the remaining external funding of $2.1 billion and no proceeds from privatization. It models financing half of the excess amount of N2.4 trillion partly by CBN and domestic borrowings.
Fixed Income and Strategy:
With the paucity of dollars for repatriation and limited avenue to attract FPI funds, the apex bank might not be aggressive in raising OMO rates from current levels and could be more inclined to lower it further.
On the part of the FGN, to meet up with the planned domestic borrowing, the FG will have to issue a total of N2.8 trillion between July and December, which compared to maturing NTB of N1.6 trillion and non-bank corporates estimated OMO maturity (between July and October) of N1.2 trillion suggest excess liquidity of N680 billion.
With PFAs and individuals largely dominating NTB and Bond auctions, we see the liquidity pressure further gravitating NTB and Bond stop rates lower from current levels of 2.5% and 10.4% on average respectively.
In all, we expect CBN to continue to pressure banks to drive OMO stop rates modestly lower, with 1-year stop rate likely to fall lower within the range of 6.5% – 7.5%. Bond rates could fall at the next auction due to demand pressure to 10% with a gradual convergence to OMO single-digit rates. NTB 1-year stop rate could gravitate between 2% – 3%.