Nigeria in historic transition: Macro and market impacts – United Capital

Against all odds, the Nigerian elections have been concluded successfully albeit with pockets of skirmishes and logistic challenges in some parts of the country.

The historic win of the opposition, with 54 percent of total votes against 46 percent for the incumbent, is now seen by many as signalling a paradigm shift in the electoral system in Nigeria. What’s more, the incumbent’s congratulatory message to the winner, Muhammadu Buhari, has raised the hope of a calm transition, which is a sharp contrast to Nigeria’s history of post-election restiveness.

The market continues to react positively with an equally historic gain as the bulls staged an unprecedented comeback. We think the incoming government has a herculean task ahead as the macro picture remains gloomy amid high expectations of a positive change.

The morning after: Urgent need to push the frontiers of reforms

The president-elect comes with very little democratic credentials but he is widely believed to be disciplined, incorruptible, and bold in decision-making. One of the challenges perceived to have clogged Nigeria’s progress over the years has been the weak (or lack of) political will to push through reforms and curb rent-seeking behaviour across the political and economic landscape.

The outgoing government has initiated reforms in key sectors like oil and gas, power, agriculture and industry, among others. We expect the new government to consolidate on the gains achieved so far. More importantly, we expect to see a more fragile use of public resources and strengthening of institutions to ensure effective implementation of reform policies.

The Transparency International ranked Nigeria as the world’s most corrupt country in 2000. The country’s movement in the Corruption Perception Index has been rather flattish ever since with the latest ranking placing the country as 136 most corrupt country out of 174.

We believe the new government is primed to improve on the country’s corruption perception rating globally in the next few years, and we expect that to have a positive impact on FDI flows. This is arguably so given the rather untainted antecedents of the president-elect, which sharply contrast the historic negative pedigree of military dictatorship in Nigeria, at least from the perspective of accountability in public finance.

We note that a recurring theme in the All Progressives Congress (APC)’s campaign promises is the plan to block leakages in public expenditure. If this is successful, we believe the incoming government may just have succeeded in unlocking the growth potential of the Nigerian economy given that public expenditure has historically shown a very weak correlation to economic growth in Nigeria. A high level of unproductive spending have fuelled inflation and rendered monetary policy transmission weak. We would be looking to see these trends change in the new democratic dispensation.

The change agenda: Too costly to implement

A closer look at the APC manifesto reveals policies that require huge expenditure outlay and whose implementation may be severely constrained given current macroeconomic realities. Since June 2014, Nigeria fiscal revenue and export earnings are down by c.50.3 percent even as the possible diversification of government revenue remains at best a medium term strategy.

The need to hit the ground running given popular expectation may necessitate a drastic adjustment in fiscal policy with sizeable cuts in government expenditure across all levels. The 2015 budget spending plan is just 6.5 percent lower than 2014, but the benchmark is 31.6 percent lower though production level is expected to firm up with reduced leakages and theft.

It is left to be seen if the in-coming government’s resolve to channel government spending into more productive use and reduce fiscal excesses could free up enough resources to close current revenue gaps. It is important to note that both the incoming government’s “Change” Agenda as shown in the party’s manifesto and the incumbent’s “Transformation” Agenda bear noticeable similarities in broad social and macroeconomic policy framework, save for the latter’s emphasis on war against corruption.

By and large, the key economic challenges expected to face the new government include: Increasing pressure on government revenue with negative impact on both capital and recurrent expenditure; high public debt burden that may continue to put pressure on domestic interest rates and crowd out private investment; slowdown in economic growth as capital spending reduces significantly while monetary policy remains tight; the dilemma of a drastic cut in public wages versus the need to maintain a pro-people policy and avoid labour unrest.

The new dispensation: Impacts on markets

Markets will take comfort in political stability…

The Nigerian financial markets experienced a significant bout of volatility in the run-up to the just concluded elections. Expectation of a devaluation of the naira in Q4 2014 following persistent downward pressure on oil prices fuelled massive portfolio outflows which depressed the equities and fixed income markets. This was further compounded by the uncertainties around the outcome of the election seen as the most keenly contested in the history of the country.

Now that the dust has settled, we expect increased portfolio investment as foreign investor confidence returns to market in the wake of the peaceful conduct of the elections and a relatively calm post-election scenario.

… but underlying macro headwinds will persist

Given that oil prices are not likely to stage a sharp recovery in the short-term, we expect the pressure on FX to remain albeit at a moderated level. The clarity in political outlook should reduce the artificial demand for the greenback, leading to a faster gravitation to a more market determined exchange rate, following the recent scrapping of the official market window as well as the technical devaluation of the Naira in February 2015. We expect the depletion in reserves to slow for now, though continued lower oil prices will cap accretion.

Equities: Portfolio re-entry to drive market momentum

Nigerian equities have seen a bullish run in the last nine days (up 17.2%), as the market remained upbeat on election outcome contrary to our expectation of a wait and see pre election scenario. However, we estimate that the market still has a c. 20 percent upside before valuation catches up with Emerging and Frontier market peers (average11.9x P/E). That said, we think investors may be willing now to pay a premium for Nigerian equities given the expectation of a drastic improvement in economic and governance structure. We are positive on Nigerian equities in the medium term but we advise investors to trade with caution and play strictly on fundamentally viable names.

Fixed income: Tight monetary policy will moderate downward movement in yields

After running up significantly as political risks heightened pre-election, yields have recently begun to trend downwards, especially on short-dated maturities as bargain hunting on fixed income instruments increased. The long end of the curve has however sold off in recent times as market expectations continue to shift in the direction of the new macro realities in the market. We expect a continued softer yield environment in the medium term, driven mainly by reduced political risk.

However, the need for the CBN to maintain a tight monetary policy environment in the face of daunting macro-economic challenges will create a floor for yields in the 13 percent – 13.5 percent range for the rest of the year.