The National Bureau of Statistics (NBS) published the Q1:2018 Gross Domestic Product data earlier in the week announcing an expansion in real output of 1.95% Y-o-Y. This aligns with consensus expectations of a positive growth as the economy recorded the 4th consecutive quarterly increase since recovery from the economic recession in Q2:2017. This successive growth in output of 1.95% in Q1:2018 reflects a stronger increase of 2.87ppts relative to the first quarter of 2017 (-0.91%) but a slower growth when compared with the preceding quarter (2.11% in Q4:2017). Whilst the oil sector growth (14.77%) was much in line with our forecast, non-oil sector GDP growth (0.76%) disappointed relative to our forecast of 1.5%. Evidently, the major drag in Q1:2018 was traceable to the slowdown in activities of the service sector, the largest component of the non-oil with a contribution of 54.4% - which narrowly came out of recession in Q4:2017 but recorded another negative growth in the quarter - notwithstanding the modest expansion of 3.0% in agriculture and stronger growth momentum in industries (6.9%).
Oil sector GDP recorded a significant Y-o-Y growth in real terms of 14.8% from 10.7% in the corresponding quarter, indicating a 30.37ppts Y-o-Y increase following improved domestic oil production which rose 14.3% to average 2.0mbpd in Q1:2018 relative to 1.75mbpd in Q1:2017. Accordingly, oil contribution to GDP in Q1:2018 rose to 9.6% from 7.4% and 8.5% in Q4:2017 and Q1:2017 respectively. On the other hand, the non-oil sector performance was mixed, although below our expectation, as the sector grew 0.8% relative to 1.5% and 0.7% recorded in Q4:2017 and Q1:2017 respectively whilst the contribution to GDP weakened to 90.4% from 93.0% and 92.0% recorded in Q4:2017 and Q1:2017 respectively. Specifically, the growth in the non-oil sector was mainly propelled by Agriculture and Manufacturing sectors which expanded 3.0% and 6.9% Y-o-Y respectively whilst, yet another 0.5% decline in Services sector, dragged overall non-oil sector growth.
Furthermore, the manufacturing sector growth in Q1:2018 printed at 3.4% relative to 0.1% and 1.36% in Q4:2017 and Q1:2018 respectively, evidently reflecting the continuous improvements in the Purchasing Manager’s Index (PMI) for the manufacturing (56.9%) and non-manufacturing (57.5%) indices for the 13th and 12th consecutive months respectively in April 2018. Quarterly moderation in agricultural output growth to 3.0% in Q1:2018 from 3.4% in Q1:2017 and 4.2% in the preceding quarter (Q4:2017) largely reflected seasonal factors in crop production with the harvest peaking in Q3:2017 but suffered a setback in Q4:2017 on the back of a reduction in output following the start of the planting season in Feb-2018. However, Wholesale and Retail Trade Services sub-sector continues to suffer consistent decline in real activities since Q2:2016, save for Q4:2017, as output contracted 2.6% in Q1:2018 although an improvement from the deterioration of 3.1% recorded in Q1:2017.
Near Term Outlook Positive… 2018 Budget Implementation and Increased Fiscal Spending to Propel Real Sector Growth
Our analysis of the released GDP data suggests the economy is still largely driven by oil, though contributing less than 10.0% to the overall output. The underwhelming performance of Trade services GDP as well as sub-optimal Manufacturing and Agricultural output growth continues to call for concern with the economy struggling to regain the momentum of the pre-2016 recession growth trajectory. It is our view that, very bold long term structural reforms, in addition to ideologically entrenched market systems, will be required to continually spur growth, enhance structural vulnerabilities and attract patient Foreign Direct Investment to drive infrastructure development, create job opportunities and ultimately prop growth to the double digit territory.
Whilst we remain positive on economic outlook for the rest of 2018, we have revised downward our annual GDP growth forecast to 2.1% from initial projection of 2.6% as we believe stability in domestic oil production - forecast at an average of 2.1mbpd – as well as expectation of improved output towards H2:2018 with the coming on stream of the Total Egina Field Project - estimated to add an average of 0.2mbpd in the medium term – will support oil sector growth forecast to expand 7.0% and 9.8% for Q2 and FY respectively. Similarly, the sustained rally in global oil prices (currently averaging US$79.45/b and projected to stay above US$65.00/b for 2018), resulting from increased geo-political tensions between US and Iran, with the former threatening to impose powerful sanctions on the latter, is expected to bolster fiscal revenues and also support non-oil sector GDP growth as the capacity of government to fund 2018 Budget becomes strengthened. Likewise, we anticipate that an improved access to FX liquidity, especially at the I&E window, will further boost the manufacturing sub-sector of the larger industry and also support non-oil sector growth; Afrinvest estimates 1.1% and 1.4% expansion for Q2:2018 and FY:2018 respectively.
Nonetheless, we note that probable capital flow reversal in the build up to the 2019 General Elections poses a major downside risk to our 2018 growth forecast. Foreign Direct Investment (FDI) flow has been disproportionate relative to Foreign Portfolio Investment (FPI) – “hot money”. As at Q1:2018, cumulative FPI inflow since the launch of I&E in April 2017 summed up to US$11.6bn (average 65.7% of total flow) relative to FDI US$1.0bn (average 5.8% of total flow). Possible flight of FPI in H2:2018 presents likely depreciation/devaluation threat in the horizon which in turn is capable of inhibiting growth and fueling inflationary pressures. Other downside risks include the late passage of the 2018 Budget which could cause a drag to capital components of fiscal spending and unwittingly impede output expansion.
Post-MPC Reaction: Expansionary Fiscal Policy Fears Drive MPC’s Decision to Maintain Status Quo
The Monetary Policy Committee (MPC) held its second meeting for 2018 on the 21st and 22nd of May, 2018 amidst the rising global inflation, improving domestic macroeconomic conditions, fears of capital flow reversals and recent downward repricing of emerging and frontier market assets. The Committee by a vote of 8 to 1 and in line with Afrinvest’s and consensus expectation, decided to maintain status quo to:
- Retain the MPR at 14.0%,
- Retain the CRR at 22.5%,
- Retain the Liquidity ratio at 30.0%, and
- Retain the Asymmetric corridor around the MPR at +200 and -500 basis point
The MPC’s decision to hold was premised on key considerations of the development in the domestic macroeconomic environment. The Committee welcomed the positive domestic economic performance - 4th consecutive quarterly GDP growth (1.95%), improvement in the manufacturing and non-manufacturing sector PMIs, sustained inflation deceleration, foreign exchange rate stability and increased activities in the I & E FX window. However, it noted some upside inflation risk factors including supply chain disruptions in major food producing states amid security challenges as well as the impact of global inflation on domestic prices.
Also, the MPC was satisfied with progress in the Economic Recovery and Growth Plan (ERGP) implementation but highlighted the delayed passage of the 2018 Appropriation Bill as a limiting factor. In this light, the committee advised the government to sustain current efforts at growing the tax revenue base despite the uptick in global oil prices and the need to cautiously implement the 2018 budget in order not to counterbalance the achieved price stability. Furthermore, the Committee noted the improvements in the banking sector as indicated in the moderating non-performing loans and improved liquidity but also encouraged the CBN to ensure liquidity flows to the real sector in order to strengthen the economic recovery position as well as drive employment.
Lastly, the MPC noted the impact of the current capital flow reversals - following stronger dollar and rising treasury yields in the US - on financial market performance, especially in the Nigerian equities market which has been on a bearish run due to profit taking by investors. On the other hand, the committee was satisfied with improved domestic economic outlook such as downward inflationary trend (12.5%-April 2018), foreign exchange stability, favourable external reserves (US$47.8bn), upward pressures in global oil prices (US$79.45/b) and GDP growth (1.95%-Q1:2018) although further stimulus and reforms are needed.
Possible Implications for the Economy and Financial Market
The MPC’s decision to maintain rate may not be unexpected but the implications are far reaching on the economy and financial markets. We believe the Committee’s concern on the need to ensure quick passage of the 2018 Budget is apt as this will speed up the economic recovery process while also enhancing real sector output expansion especially in agriculture, manufacturing and trade. However, we opine that the MPC’s fears about bunched release of fiscal spending may be a bit exaggerated given that inflation in Nigeria has been studied to be largely cost-push. The 2017 Budget, for instance, was passed in June with release of funds for capital project bunched; yet, inflation trended downwards continuously throughout the year from 16.3% in May to 15.4% in December.
In the financial market, we expect the performance of fixed income securities to remain anchored on the activities of the CBN to keep system liquidity in check in order to sustain the recent gains accruing to the foreign exchange market and in also stabilizing domestic price levels. As has been the case since the start of the year, the CBN continues to guide market rates downwards, below the MPR, in its T-bills and OMO auctions in addition to market response to the shift in foreign investor appetite to money market securities. Additionally, the bonds market remains shaped by supply and demand conditions given the sustained bearish performance of equities. Our optimism is that the pace of market movement in the near term, across equity and fixed income asset classes, will be largely dictated by the on-going global monetary policy normalization, efforts at sustaining exchange rate stability by the CBN, improved corporate performances as the economy recoups from the encumbrances of the pre-oil crisis and the build up to the 2019 General Elections amongst others.