December 19, 2023/FSDH Research

GDP growth remains tepid while prices continue to trend upwards

Nigeria’s real Gross Domestic Product (GDP) grew by 2.54% (y/y) in the third quarter of 2023, the highest growth rate recorded so far in the year. As with previous quarters, the services sector, especially finance & insurance and information & communication, propelled GDP growth, buoyed by gains from FX revaluation and expanding the subscriber base in the telecoms sub-sector. Across the 18 main sectors, only two recorded negative growth – transportation and storage (-35.8%) and the oil sector, which continued its negative performance with a decline of 0.85% due to oil theft and low investment in the sector. Persistent headwinds such as power and infrastructure deficits, logistics bottlenecks, and more importantly, foreign exchange problems had huge negative impacts on manufacturing and agriculture, which exhibited lower growth of 0.5% and 1.3%, respectively, in 2023Q3. Furthermore, the removal of fuel subsidies and FX adjustment elevated the cost of doing business and weakened the purchasing power of consumers. As such, the inflation rate, which was 21.8% in January 2023, rose to 28.2% in November. The food inflation rate peaked at 32.8% in November, reflecting low agricultural productivity and high transport costs amidst insecurity challenges.

Figure 1: Real GDP Growth

Source: National Bureau of Statistics

In our macroeconomic forecast, we projected a GDP growth of 2.5% for 2023. So far, the average growth in the first three quarters was 2.45%, still in line with our projection. For 2024, we expect growth to be higher relative to 2023. We believe that growth will continue to be led by the services sector. However, the oil sector will achieve positive growth following anticipated improvements in oil output. Businesses and consumers will continue to adjust to the high-cost environment, which is occasioned by high prices of petrol and diesel and a weak exchange rate. We do not expect any major shift in the structure of the economy.

Monetary Policy Update – CBN to adopt conventional monetary policy approach with price stability as its core mandate

Prior to the current CBN leadership, Nigeria’s Central Bank has towed the path of unorthodox monetary policy in the last eight years. The bank implemented numerous development-focused interventions, including initiatives such as the Anchor Borrowers Programme, Tertiary Institutions Entrepreneurship Scheme, among many others, providing loans to farmers, young entrepreneurs, and households. As noted by the CBN governor at the CIBN Annual Dinner in November 2023, these quasi-fiscal activities resulted in the injection of over ₦10 trillion into the economy. While the CBN’s Monetary Policy Committee raised the benchmark policy rate since May 2022 to combat inflation, the continued injection of cash into the system, through unconventional approaches and Ways and Means, undermined the Central Bank’s objective of ensuring price stability.

To change this tide, the CBN Governor, Yemi Cardoso, announced that his administration would focus on price stability as its core mandate and discontinue the quasi-fiscal activities, in addition to addressing institutional deficiencies, restoring corporate governance, and strengthening regulations. Our view is that this renewed focus on price stability is positive and connotes the desire of the new administration to streamline the focus of the apex bank in line with its core functions, as stated in the CBN Act (2007). To achieve this, the CBN has said it will pursue an inflation target, which we believe will be in the range of 12%-15% in the medium term – the next five years. This suggests that monetary tightening will persist in 2024, until the inflation rate starts trending downward. While interest rate hikes and the issuance of monetary instruments to mop up liquidity are inevitable, we do not envisage excessive rate increases, as the apex bank will also consider the need to boost economic growth and curtail high borrowing costs for both businesses and the government.

Still on inflation, we expect to see more collaboration between the Central Bank and fiscal authorities, especially in dealing with the non-monetary triggers of inflation, otherwise the Bank’s efforts to squeeze liquidity will only yield negative outcomes. Challenges associated with agricultural productivity, logistics bottlenecks, infrastructure deficit and activities of non-state actors in imposing charges on businesses have implications for inflation in Nigeria, and efforts must be made to address them. The CBN must also be aware of its limits in taming inflation using monetary policy, especially given the peculiarities of the Nigerian economy – a large informal economy, a huge population of financially excluded individuals, etc. Therefore, constant dialogue with fiscal authorities is required, and we believe that the process of engaging with non-monetary authorities needs to be institutionalized to ensure proper coordination.

Beyond addressing inflation, the CBN has signaled the need for banks to raise capital to support the realization of a ₦1 trillion economy by 2030. The last banking recapitalization was executed in 2005 – banks were required to attain a minimum base of ₦25 billion (US$189 million). In dollar terms today, this amounts to US$28 million, an erosion of US$161 million in an 18-year period. When we consider inflation alone, ₦25 billion has a value of ₦2.7 billion today. Therefore, such a call for recapitalization is valid and Nigerian banks must be strengthened to support the economy. Going forward, we expect many more banks to issue ordinary shares to the public, which could also serve as an avenue to increase foreign participation in the NGX. In addition, we could witness a few mergers and acquisitions from 2024 in Nigeria’s banking industry.

In addition to recapitalization, it is crucial to prioritize commercial bank’s role in allocating credit to critical economic areas. Nigeria’s private sector credit to GDP at 21% in 2022 remains low relative to countries such as Brazil (72%), Mexico (36%) and Indonesia (35%). In an advisory capacity, the Central Bank must work with stakeholders to de-risk value chains and encourage long-term financing to stimulate production and productivity of the economy.

Fiscal Policy – President Tinubu’s Budget of Renewed Hope

In November 2023, Nigeria’s President presented a proposed FGN budget of ₦27.5 trillion for 2024 to the National Assembly. Christened the “Budget of Renewed Hope”, the budget expenditure is 10.9% higher than the total budget for 2023 (₦24.8 trillion). The budget is driven by key assumptions such as a crude oil price of US$77.96 per barrel, an exchange rate of ₦750 per US$ and a GDP growth of 3.76%. We note that while oil price is expected to remain high following the persistent war between Russia and Ukraine, among other factors, the assumption of exchange rate and GDP growth appears to be unrealistic.

Specifically for the exchange rate, we expect the pressure in the official market to continue given the limited FX inflows via the trade and investment channels and huge FX demand for imports of goods and services. A lower exchange rate assumption in the budget implies that actual revenue will underperform, leading to more borrowing to finance a wider-than-anticipated fiscal deficit. This has been the situation for years, and we do not foresee any change in 2024. More importantly, a major risk that the fiscal and monetary authorities will have to deal with is the likely return of Ways and Means above the statutory limit, especially when revenues will likely underperform. The CBN Governor has clarified the need to restore corporate governance and confidence in the apex bank. This time, the Governor must “walk the talk” to ensure compliance with relevant laws and guidelines in dealing with fiscal authorities.

The budget deficit is projected to be ₦9.18 trillion in 2024, which is about 50% of revenue and 4% of GDP. New borrowing in the budget is ₦7.83 trillion, the majority (77%) of which are domestic borrowing. Insights from a historical review of previous budgets indicate that actual deficits and borrowings will surpass initial projections, mainly due to weak revenue performances. Therefore, public debt is expected to exceed ₦100 trillion in 2024.

Figure 2: Breakdown of the 2024 FGN Budget

Source: Budget Office of the Federation

In terms of spending allocations, 41% of the budget will be spent on non-debt recurrent items, 31% will be used to service debt, and 28% will be spent on capital projects. Lower-than-expected revenue tends to affect the capital component of the budget the most negatively and results in a low implementation rate. For example, only 11.6% of the actual budget expenditure was spent on capital projects from January to September 2023, despite a provision of 32% for the full year 2023. Therefore, we expect a low capital budget implementation rate until key issues such as low revenue and delays in the budget process are addressed. Finally, budget reforms are urgently required to reallocate funds to priority areas with maximum impact on economic growth as well as to improve spending efficiency and transparency.

Analyst View

Going forward, we expect the following:

• GDP growth will be in the range of 2.8% to 3.2% in 2024. We do not anticipate any major change in growth drivers in 2024. These drivers include the services sector (finance, information & communication) and factors such as government spending and consumer demand. Prices will continue to trend upward in the early part of 2024. However, we expect the inflation rate to decline from Q2 2024 as CBN’s tight monetary stance takes effect. Fiscal authorities will also need to play their role in addressing the structural drivers of inflation.
• Foreign exchange pressure will continue in 2024 as demand for foreign currency will continue to increase. There are very limited efforts to improve the productivity of the local economy, especially considering the huge infrastructure deficit and the weak manufacturing base. However, we expect the government to intensify efforts in curbing crude oil theft by destroying illegal bunkering and engaging local communities. This will improve oil production volumes in 2024 but at a moderate level. We expect some reforms geared at incentivising domiciliary account holders in Nigeria to sell their foreign currency in the official FX market.
• CBN will raise key interest rates and issue instruments to mop up liquidity, all in a bid to address inflationary pressure in the medium term. Foreign Portfolio Investment will respond positively to the interest rate hike; however, lack of transparency on the true state of Nigeria’s External Reserves may hold back major investors. The CBN will need to publish the true state of the reserves and outline clear actions that will be implemented to ensure reserves accretion. There will be an improvement in FPI inflows relative to 2023, but FPI inflows will still be below the pre-COVID level.  
• Dangote refinery will likely come onstream and supply petroleum products to the local markets. The share of petroleum products in total imports, which was ~34% in 2023Q3, should reduce. However, lower oil exports could offset the reduction in imports if oil production volumes remain the same. A lot depends on the terms and arrangements between the Dangote Refinery and the Nigerian government. Key questions include whether crude oil will be sold in US dollars, terms of payment, the role of NNPC in the downstream sector, etc. 
• We do not expect any major budget reforms owing to competing interests among different stakeholders – MDAs, National Assembly, contractors etc. High borrowing costs and rising public debt are major fiscal risks to contend with in 2024. The government will make efforts to review and harmonise taxes to improve non-oil revenue and simplify tax payments for businesses.  
• Policy coordination will remain a challenge in the medium term, mainly due to the weak institutional structures. In addition, some deliverables across MDAs are unclear, and there are unbalanced power relations between and within some MDAs (for example, NNPC/Customs vs Ministry of Finance). The Special Adviser to the President on Policy and Coordination faces a herculean task to address these problems. A more effective approach is for the President to directly lead the coordination efforts as experienced by many of the East Asian countries in the 1980s and 1990s during their period of transformation.