Lukman Otunuga,
Senior Research Analyst at FXTM
Africa’s
largest economy entered the new quarter with a strong likelihood of following
the same old story, namely COVID-19 headwinds, recessionary trends and
widespread local and global market uncertainty.
What are the chances of a plot twist?
In a
year full of twists and turns, the Central
Bank of Nigeria (CBN) surprised investors with a 100 basis point interest
rate cut from 12.5 percent to 11.5 percent. The monetary policy signal is a
green light for more affordable lending which could stimulate economic growth
and temper recessionary pressures. However, the same green light could speed up
the inflationary pressures which weigh on the economy. The currency markets may
view the CBN’s rate cut as a sign that monetary policy no longer prioritises
foreign investors seeking high returns on deposits.
Until
now, the CBN’s hawkish monetary policy helped to maintain and grow the banking
system’s foreign currency reserves, providing the Naira with a cushion against
further weakness. The current weakening global and domestic economic outlook
does not support a high-interest rate environment in the short term. Faced with
a protracted recession or runaway inflation, the CBN appears to have chosen the
lesser of two evils. The central bank’s latest statement indicates that high
interest rates have not been successful in checking inflation, which the CBN
blames on structural factors like rising fuel and electricity prices.
This raises the question of why an Oil-producing country faces inflation in fuel and electricity prices when fossil fuels are locally produced and ought to be more affordable. The answer is the strange economic distortion created by COVID-19. In this case, Nigeria applied to borrow $3.4 Billion from the IMF in order to bail out the economy because of the COVID-19 pandemic. The money will have to be repaid - cue a hike in electricity tariffs to increase government revenues from utilities and bolster its repayment capacity. This would be credit-positive as the last thing Nigeria needs in such extraordinary times are doubts over its creditworthiness.
Weaker
global Oil prices make Nigeria’s creditworthiness even more of an important
factor because the state is hard-pressed to cover its budgetary needs in the
current climate of low demand for crude Oil. Now that the CBN has put checking
inflation lower down in its priorities, does this signal further rate cuts in
the near future?
The case for further pandemic-driven rate cuts appears to be strong. The COVID-19 outbreak shows no signs of abating. On the contrary, at the time of writing, the number of new cases in Nigeria is on the rise after lockdowns eased. Further monetary stimulus to the economy appears unavoidable. Of course, it all depends on what happens with inflation. If the inflation rate keeps rising in sectors like fuel, electricity and food it may drag on consumer spending, outstripping the economic benefits of lower interest rates. Medical costs have also risen because of COVID-19, according to the August inflation statistics.
The
pandemic comes at a time when Nigeria is exposed to external and domestic
risks. Locally, the drive to diversify the economy stayed stuck in first gear.
Border clashes between herders and farmers led to border closures, further dampening
economic activity. Externally, Oil prices remain in a slump, the US Dollar is
appreciating and global sentiment struggles with the COVID-19 circumstances. Further
elevating fears over a technical recession in Nigeria, the World Bank forecasts
an economic contraction of 3.2 percent for the full-year 2020, a five percent
drop from its previous projection.
Summing up, Nigeria’s outlook remains influenced by the same old themes. If Oil prices stay depressed, foreign currency reserves and government revenues will likely decline. Low Oil prices also impact the CBN’s capacity to defend the Naira. A falling Naira could accelerate inflation and further weigh on economic growth. Will the final quarter of 2020 see a continuation of these themes, or will the economy offer a positive surprise?
The
banking sector remains a bright spot in the cloudy outlook. Easier borrowing
terms might boost the banking sector’s income while encouraging economic
activity. Another bright spot is that growth in China has returned, promising
to hike demand in the Oil markets and further supporting Oil prices. After the
year we’ve had so far, one thing’s sure: surprises are only to be expected.
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