By Charlie Robertson
WED, MAY 17 2017-I am going to break the rule first rule of presentations by not starting with the most important thing. I am not starting with the most important thing because I don’t know the answer. But I am telling you what I don’t know first. What I don’t know is where dollar/Euro is going to go. And yet to answer a crucial question, if you are an investor in the Emerging market or the Frontier market, I have had clients in the last few weeks suggesting that the dollar is going to start to weaken. And if the dollar is going to weaken you are going to have to see more appetite for Emerging and perhaps then frontier assets.
The assumptions at the moment in the minds of investors is that they maybe a line of perhaps 12 months before Frontier gets the benefits that the Emerging markets have been having since the beginning of this year. What I know is that I can’t forecast for Euro.
I feel a little bit confident, or I probably shouldn’t about oil. But I will.
Oil prices in constant prices hit the level in 2008 that was seen in 1980. But the oil bill was just 4-5% of GDP, closer to the 1974 level. The world was able to afford oil at this level for a few years. But as in the 1970s (Siberia, Mexico, Alaska, North Sea) it encouraged new supply (shale gas).
Oil from 1985-2004 averaged about 2% of GDP – equivalent to $45/bbl today – give or take 10 dollars. I personally think that would last a decade.
That is not necessarily bad news for Nigeria in the long run. Because as I keep on pointing out, Nigeria produces so little oil per capita that actually makes it hard to call it an oil economy. There has never been that much money on the back of oil. But you also know that the budget depends or oil, that the FX reserves depends on oil. So let’s be more optimistic for a second to say I am wrong about oil and actually oil has been on the uptrend for the last 12 months or so consistent with the oil price going to 80 $/per barrel. It has dropped a outside that trend now. So let’s see what happens in the next few days. My view is that shale will keep it down. But there has been an argument that the Nigerian government might be supported in a couple of years by much high oil prices. Not my best case.
What I think is that the Giants of oil is China. When the China’s economy in GDP in dollars $ was booming, you had the oil prices shooting up. When Chinese GDP in $ stopped rising last year, the oil prices came down. There should be some recovery I would argue in the next few years.
But if there is one thing that worries me today, it is the Chinese new loans growth which is coming to a halt. -3% growth year-on-year is the 12 months increase in Chinese loans. I think that is why we are seeing this weakness we are witnessing in oil prices right now. It is not getting focus at the moment but I would say that’s the main risk.
Again, let’s talk about the Africa rising thesis. I hope you guys are not embarrassed by the Fastest Billion. I don’t think so, because I still think there is a story here which is working. And the story is, the last time oil prices fell in the 1980s, GDP in Nigeria fell over 10% and not just once but multiple times through the decade. By the 1990s when oil prices were low, actually Nigeria was not in recession at all in ‘98/99. And this time (given the latest figures) it is down to -1/1/2 from last year and that is a much better performance than the past.
When General Buhari took power in 1983 – GDP had shrunk for 3 years. In 1985 Nigeria saw the best growth in nearly a decade.
Then the oil price more than halved to the equivalent of $40/bbl. GDP per capita fell by over 10% for two years running. The falling oil price led to a four-fold NGN devaluation over two years and IMF support.
The next four-fold devaluation in 1999 did not cause negative GDP.
And as I explained before, our view about education, the human capital has changed not just in Nigeria but across Africa. The IMF forecast on GDP growth between 2016 and 2019 and you see probably a third of the countries or more are ranked between 5% and 9% a year. This is not a continent that the Africa Rising Thesis has disappeared.
And demographics play a role in that. You still have very nice demographics in Nigeria. The working age population is growing at 15% over 5 years. So you should get growth of 3% a year just from population. So actually, that minus one and half percent we had last year in Nigeria, the band is –four and half percent. That figure is bad as Russia when the oil prices fell and it is bad as Brazil when the oil prices fell.
So it is not a great story for Nigeria. We do know that basis is very negative. But one area my colleagues worked on last year is to look at what really drives equity performance and he says growth acceleration not necessarily the level of growth but the change in the rate of growth that matters. And if you look at the IMF forecast for 2017, in terms of the change of growth, it is Argentina, Morocco, Nigeria, Tunisia, Kazakhstan coming out as the great growth acceleration stories in 2017 as the top 5.
And we are already half way through 2017, so maybe we should be focusing on next year and next year the top 5 growth acceleration stories are Kuwait, Oman, Nigeria again, Kazakhstan, Tunisia. So these are some of the markets that investors should be considering because of that growth acceleration story.
Nigeria ease of doing business right now ranked 169th in the world, I promise you that it is going to get considerably better in the next 12 months. Again, this government has actually started to perform. They have slashed the time to start a new business from 10 days to 2 days. They did that in February/March. So I you are going to start to see improvements. It has taken the government a while to get on its feet but it’s going to make a difference.
If you think of Nigeria’s ranking on the ease of doing (169) and corruption (140) both are not great but I think as you get the ease of doing business better, you should also see some improvements in corruption rankings soon. It is not going to rapidly get down to the Japanese type level, that is not realistic, but I think we are going to see improvements in these rankings. It is never going to traumatic. On the corruption score, Nigeria’s corruption score is about 28 over 100. That is exactly where you would expect it to be at it’s income level. But we do know that President Buhari have tried to make changes and it wouldn’t surprise me if Nigeria gains on that score too with the changes.
The World Justice Project does a study, the only study in the world of legal systems and it says Nigeria is one of the only countries which saw increase in the effectiveness of its legal system in the last 12 months. So there are some positives happening but they have all been clouded, of course by the foreign exchange system. However, we seen much improvements in ease of doing business, the legal system and corruption-this matters more.
Now when we look at Emerging markets currencies on average over 22 years or so, quite cheap when oil was low, more expensive when oil was high and just a little bit above their value now. In Frontier, you’ve got less history for Frontier. Frontier tends to be a little bit stronger and a little bit above its average over the last few years.
How Does Nigeria fit into this? If you take the inter-bank rates, of all the African countries we cover, these are the overvalued expensive currencies-Angola, Ethiopia and Central Africa Republic and a few others as well. Nigeria is reasonably expensive, about 15% stronger than its own average over 22 years. For the currencies we like, I am excited about Egypt, Tunisia, Ghana-three of the cheapest currencies in Africa right now. So will Nigeria need to be to be the cheapest currency in Africa and for us to say put your money into Nigeria? At N500/$ it will be cheaper than Egypt at N450/$ it will be around the Ghanaian levels, cheaper than South Africa. At N370/$ we are actually roughly at fair value. So Today, at the official rate the Naira is a bit expensive and it’s been a little bit expensive -18% of the time-in the 22 years. This is quite common. It is supper expensive 22% of the time, it is very cheap 28% of the time. So we see big variations in Nigeria’s currency over time and the reason for that is that currency hedge don’t work and they don’t seem to work in countries with low per capita income.
Oil rich exporting countries like Gabon in Africa do have currency regimes that most of the time stay at fair value. They are never too cheap and never too strong. Nigeria is either too weak or too strong and very rarely sits in the middle. We’ve seen the Naira strengthen in today’s money from our estimates maybe 600 20 years ago in today’s money, strengthening as oil prices come stronger, you will expect it to weaken as oil prices go weaker and at the parallel rates it’s not exactly that.
What has changed in the last few months? It is obviously the current account (CA). The current account has gotten better in Nigeria as oil production picked up, as oil prices picked up. Reserves have risen and that has given the Central Bank the money to put into this new rates, the Investors and Exporters’ (FX Window-I & E) rates. Of course the biggest risk for investors thinking about putting in money into Nigeria is if the Central Bank takes away that window or stop supplying liquidity to that window. Why would they do that-because the oil prices goes below 45/$ to 40/$ per barrel. I don’t think many people will be confident to think that Central Bank will continue to supply dollars in the I&E rate. And that makes it even harder for you to come in even when rate is at fair value.
What is the benefit of the Central Bank FX policy? The benefit is that per capita GDP terms the decline in Nigeria was modest at first, relatively slow. IMF data shows that commodity exporters like Brazil and Russia-Russia the currency dropped so much so quickly that by 2015, per capita GDP was 40% down on 2013 levels. Nigeria was just down 10%. But Russia is already begun to rebound. Kazakhstan saw a drop of 50%, they have begun to rebound. They took the pain quickly, they’ve got the recovery. Nigeria has not yet got the recovery. So we reckon or the IMF reckons that by 2017 Nigeria’s per capita GDP would be down by more than 40% and by 2018, 45% and would have the slowest rebound in GDP.
In convergence terms, where countries were 60 years ago, relative the United States of America (USA) in 1960 and where it was in 2014. What we find is that Nigeria was about 20% of American wealth per capita in 1960 and today, it is about 9%. So, what we’ve seen for 60 years is de-convergence with America. America has gotten richer and Nigeria has slipped backwards. So historically, all countries that improved and done better like Taiwan, South Korea, Japan, Malaysia-they all got industrialized. You need to see industrialization to get that growth. You need to see investment to GDP, which at very low income level relative to America, usually it is about 17% to GDP and to catch up with America you’ve got to get it up to 30% to GDP.
And where is Nigeria today-14% of GDP? It is underperforming not just with most countries in this wealth level do; it is underperforming most of East Africa where a number of the investors have been more positive about in the last few years. So the government does need to lift up investment. But the budget has not allowed it. The budget have not allowed it because the currency policy is not realistic.
With investment, you will expect manufacturing to pick up. But in this regard, Nigeria is quite well blessed. According to the IMF/World Bank data we use, Nigeria has got 10% of GDP as manufacturing. Most countries is still at 4-8%, but you still need to see that increase dramatically to not just 20% but preferably to 30% of GDP to start catching up with America. And to do all of that, you’ve got to have electricity. And I think this is one of my biggest disappointments over the past 5 years-the slow progress on electricity. Sadly the electricity production numbers per head hasn’t changed much since 2012.
I will end on one positive. People are very critical of FX policies and that is understandable and for good reasons. But on the good side, when President Muhammadu Buhari came to power monthly deaths caused by Boko Haram was sitting at over 2000 a month. This was getting close to civil war proportions. But that has come down quite significantly in last 12. I think this is a very significant and positive change and despite the big educational divide in the country.
So my conclusions are these; We have not disowned our Fastest Billion thesis despite the slowdown in African growth in the past few years. In fact, we believe this reinforces our thesis. The collapse of commodity prices this decade has not resulted in the same economic pain as the collapse of commodity prices did in the 1980s. Instead of GDP shrinking by 10% at its worst point as happened in the 1980s, Nigeria’s GDP fell by a little over 1% at its worst point. Something dramatic has changed. We believe it is education, which has improved human capital, and has changed Nigeria’s, and Africa’s trajectory.
- Indeed, the IMF expects Nigeria to demonstrate the third best growth acceleration of any Frontier market in 2017, and then to repeat this improvement in 2018. Meanwhile countries like nearby Ghana are expected to show 9%+ growth in 2018 – among the highest in the world.
- We believe Nigeria, having already improved its legal system by more than any other Frontier market (according to the World Justice Project), will in 2017 also show sharp improvement in the Ease of Doing Business. So should Ghana, and perhaps Zambia too.
- But it is debateable whether foreign capital will help turbo-charge the recovery. The currency restrictions imposed on investors will likely mean that investors demand a premium to invest in Nigeria again. Zambia or Ghana or Egypt by contrast, which allowed currency flexibility, should find it easier to attract investors.
- Our 22-year REER model suggests the currency is fair value at around NGN375/$. Adjusting for oil, perhaps NGN400/$ is more appropriate. The C/A is supportive of the currency. Policy is getting more realistic. Providing the “investor and exporter” rate is allowed to adjust for inflation, Nigeria may yet prove attractive for investors once again.
Charlie Robertson is the Global Chief Economist at Renaissance Capital.
Charlie spoke at the RENAISSANCE CAPITAL ANNUAL PAN-AFRICA 1:1 INVESTOR CONFERENCE in Lagos last week. Recorded and Edited by theG&BJournal (Errors are our responsibility if any)