Diversification to include a shock-resistant BoP

Most analysis of the balance of payments (BoP) covers the current account, and in this narrow sense Nigeria’s position is no longer dire. The oil price has now been soft for three years, leading to a current-account deficit for five successive quarters from Q4 2014. (There was briefly a deficit in Q2 2016 when the production losses/leakages from the Niger Delta were particularly high.) We are seeing a familiar lag: export earnings fell with the price of oil whereas import demand was initially sustained by the CBN’s reserves and banks’ indulgence. The BoP shows that the sharp fall in imports dates from Q4 2015. We all remember the backlog in repatriations for offshore investors and the reduced access to fx for manufacturers for raw materials.

The current account was comfortably in surplus in Q1 2017 (3.4% of GDP) and the oil price has settled in a range of US$45/b to US$55/b for many months. We should, however, be concerned because the outflows will pick up now that the economy is emerging slowly from recession and the CBN is making fx available in copious quantities. The policy aim should be to make the BoP sustainable, and not a reflection of the swings in the oil price. This is an element of the FGN’s broader strategy of economic diversification.

Imports should have started to pick up from Q2 as a result of the CBN’s fx interventions. The CBN’s sales to authorized dealers via the interbank market will come off a low of just US$370m in Q1 2017, compared with US$2.75bn one year earlier and closer to US$5bn two years previously.

On the services side the retail-driven outflows have crashed. For business travel they amounted to just US$61m in Q1 this year, compared with US$655m two years earlier. The story was similar for health and education expenditure. Now that the CBN is making fx available on a regular basis to the banks for onsale to the retail segment for invisibles, this will change.

On the goods side, there is plentiful anecdotal evidence that the CBN’s interventions have boosted imports of raw materials. In addition, our own manufacturing PMI has been in positive territory for four successive months (February through to June). The sub-indices for output and new orders provide a good narrative. Closer questioning of respondents by our partner, NOI Polls, reveals that firms have been able to raise production thanks to the greater access to raw materials. We should add that the CBN’s manufacturing PMI highlights a similar upward trend for three months in a row.  It is because of this expected build-up in imports that we see the current-account surplus narrowing from 3.1% of GDP this year to 1.2% in 2018.

Some BoP pressures will therefore build due to the fx interventions. These will develop without a strong recovery in oil revenues. Provided that the CBN is able to hold reserves at, or close to the current US$30bn, it will continue to make fx widely available through its various windows. In its ideal world, the investors’ and exporters’ window will attract inflows on a scale to reduce its drawings on reserves.

The challenge for the authorities is to diversify inflows and reduce wasteful outflows, and so create a more healthy and shock-resistant BoP. This is a well-worn journey but previous administrations have given up en route. Non-oil exports are one area to develop. They have disappointed. Nigeria has huge resources in terms of fertile agricultural land and a manufacturing sector which is larger and more diverse than any in the sub-region. Another area is remittances. These held up better than expected when fx was tight before the CBN’s stepped up interventions. They exceeded 5.0% of GDP for the past three quarters but we cannot help thinking that the FGN could offer more encouragement in the form of incentives.

Among wasteful outflows, we highlight imports of goods and services that Nigeria should be able to offer domestically. Here we can report some progress. Self-sufficiency in rice is on its way although officials disagree as to which year will provide the watershed. Then there is the Dangote Group’s refinery and petrochemicals complex in Lagos State. This game-changer is under construction, with media reports indicating that capacity of 325,000 b/d will be in place in 2019.

We are on less sure ground with the capital and financial account because of some pronounced flaws in the BoP data, notably in the size of the net errors and omissions. The CBN’s latest annual report shows deficits of US$15.44bn and US$1.03bn on the current and financial accounts in 2015, “financed” by net errors (positive) of US$16.47bn. This obvious flaw notwithstanding, the challenge is to improve the quality of the inflows.

Direct investment has been poor for an economy the size of Nigeria. Its best performance over the five years to 2015 was US$8.09bn (net of outflows) in 2011 or just 2.0% of GDP. Portfolio investment peaked in the period at US$10.4bn in 2013 (also 2.0%) when Nigeria’s debt markets enjoyed the endorsement of JP Morgan. The challenges are greater and more long-term on the financial than the current account. The most accessible wins in our view lie in import substitution. The return of the current account to surplus must not induce complacency. The authorities should persevere on the well-worn route to a healthier and more robust BoP.

Gregory Kronsten

Head, Macroeconomic & Fixed Income Research

FBNQuest