July 5, 2023/Cordros Report
Domestic economic activities were in a lull in Q1-23, primarily driven by the impact of the CBN’s naira redesign drive amid existing challenges, such as increased production costs exacerbated by high energy prices and elevated borrowing costs. However, the transition phase ushered in by the general elections brought about cautious optimism on medium-term economic prospects, especially as the new administration set the ground running with long-awaited reforms. Notably, President Tinubu signed a new Electricity Act, authorising states, companies, and individuals to generate, transmit and distribute electricity, thus repealing the Electric Power Sector Reform Act (EPSRA) of 2005. Following the PMS scarcity associated with the President’s announcement in his inaugural address, the NNPCL announced new PMS prices from 31 May, effectively removing PMS subsidies. Simultaneously, the CBN announced the abolishment of its multiple FX windows on 14 June, collapsing all the official FX segments into the Investors & Exporters Window (IEW).
We expect the policy reforms from PMS subsidy and FX liberalisation to be painful for households and businesses in the short term based on an anticipated squeeze in consumer wallets and increased production costs. Besides, looking at the GDP by output approach, we estimate the domestic economy to grow by 2.92% y/y in 2023FY relative to the 3.10% y/y growth recorded in 2022FY, supported by the oil sector returning to growth and the telecommunications and finance sub-sectors supporting the non-oil sector’s growth.
While the lingering factors stoking domestic prices remain intact, the recent fuel and FX reforms constitute new triggers to push prices upwards in H2-23. Notably, PMS prices have adjusted upwards by c. 175.0%, with further increases in sight as FX liberalisation induced the exchange rate to trade between NGN660.00 – NGN750.00/USD. Consequently, consumers have no respite in sight as increased price pressures are expected to squeeze consumer wallets further, potentially reducing consumption. Overall, we project the headline inflation to average 25.11% y/y over 2023FY (2022FY: 18.77% y/y) and 29.23% y/y by year-end (December 2022: 21.34% y/y) based on our base case.
On the currency, while we view the CBN’s FX liberalisation as positive in boosting foreign investor’s confidence, we think they may adopt a wait-and-see approach, for now, looking for signals on the CBN’s plans for clearing the FX backlogs and boosting FX supply to support the market in the near term. Besides, we suspect that due to the previous lessons learnt from the damaging currency controls of the prior administration, investors will be on the lookout for signs that there are no counter policies to prevent them from leaving at any point in the near term before returning to the market in their droves.
Given that the end of rate hikes by systemic global central banks is in sight amid sticky domestic inflation, we think the MPC will tread cautiously at subsequent policy meetings. Thus, we suspect the dilemma will remain whether to keep hiking policy rates less aggressively or keep the policy parameters constant. However, at this stage, continuous increases in the MPR at a time when supply-side factors are the dominant upside risk to near-term price pressures will undermine economic growth. On a balance of factors, while our baseline view is for the MPC to adopt a HOLD stance at subsequent meetings over H2-23, we do not rule out a 25bps – 50bps hike at the July policy meeting.
Government reforms and policies are expected to reap benefits in the medium-to-long term if they are maintained. However, we see limited upsides for oil revenue in the short term, and the public debt profile is likely to balloon in 2023FY on the impact of naira depreciation on external debt outstanding. Nonetheless, while we expect revenue to increase in 2023FY relative to 2022FY levels, we anticipate a corresponding increase in aggregate expenditure. Accordingly, we expect the fiscal deficit to remain high, to be funded majorly from domestic sources and CBN’s Ways & Means advances, as we do not expect the government to access the Eurobond market given the elevated global interest rates.
