2016. Nigeria, WYD?

The journey from there to here was a perfect storm in some ways and a comedy of errors in others. Two inevitable things happened along the way: oil prices took a hit (albeit at break-neck speed) and the political economy took over in a historic election year. With the dust having cleared, one doesn’t need too much sophistication to sense that we’re in much leaner times.

President Buhari’s government will struggle to deliver on its big ambitions with less oil rents to play with. Throw in a weak reserve position, and all those very good promises to invest in infrastructure and education, stimulate SME growth, make conditional cash transfers to the poor and frankly continue to subsidise manufacturing and trade with an artificially high Naira (but nobody likes to put it that way), while funding a counter-insurgency in the North-East, start to sound expensive.

Mr President was very clear during the ‘maiden’ Presidential Media Chat. Between capital projects, established commitments and supplying FX to parts of the economy, he put it quite bluntly: “we don’t have any hard currency now”. In short, there’s no room for sudden or false moves. What is in the pot is already spoken for.

So, now what?

We have tried ‘demand management’ and it has seen mixed results. At best. Look at the widening exchange rate spread between both tiers of the market and talk to businesspeople. It should also tell you a lot that MAN is starting to ask why exactly BDCs exist. Who wouldn’t want as much supply as they can get their hands on when the price of an asset is being subsidised by someone somewhere?

If we are serious about wanting to attract much-needed hard currency and investment capital (we may not like to admit it, but Nigeria actually needs foreign investors), then we will need to offer up the Naira at rates that look a lot more like fair value. And we all know what the black market is saying.

It’s perfectly rational that someone who is long foreign currency would hold off on bringing that money into Nigeria, rather than accept the very real probability of a 30–35% impairment on their capital before that money has done one day’s work. What kind of investment delivers enough returns to make me whole on a 35% loss and still deliver my required rate of return? The NSE is currently trading at a one year return of -17% and a two year average of -15%.

Devaluation is not the problem.

You wouldn’t be creating a problem by devaluing, you’d be facing up to an existing one. Our hydrocarbons are worth a lot less than they used to be and the outlook for an oil price rebound isn’t hopeful.

Exchange rates are not nearly as complex as they’re made out to be: the good in question is one dollar, pound, franc or deutschemark (if you know, you know). It has a price that the seller is willing to accept in exchange for what you have. No, you cannot set the price. You don’t have that kind of power in the market, there are too many other buyers. You either accept the market price or literally bring in your own supply in an attempt to flood the market with dollars in order to keep the price low and ‘defend the naira’. A strategy like that can only be time-bound when reserves are limited. And it’s quite a curious thing to do when what you desperately need is what you’re now spending time and effort flooding the market with.

I was amused that Mr. President eventually got impatient during the media chat when the devaluation question was asked I guess one too many times. He said “I need to be convinced”. I then sobered up quickly when he described a process whereby, until then, the CBN and the Ministry of Finance would identify productive businesses, and then “go and sit with them”, basically to negotiate their capital allocation decisions. That sounds like a recipe for disaster and an all-round waste of time. It also sounds like a great way for small businesses to be completely crowded out of official FX supply.

Setting aside the pesky detail that monetary policy really ought to have nothing to do with convincing Mr President, I reckon whoever has been talking to him about the FX policy so far is doing a shoddy job of explaining the implications of not devaluing, and of helping him understand that effectively taxing (in some cases effectively prohibiting) private consumption and constraining access to capital for business should really not be status quo for a forward thinking country that needs to grow.

So devaluation is, with any luck, a foregone conclusion by now. For me the more interesting question is: when will Mr. Emefiele bite the proverbial bullet? Soon I hope, but something tells me not soon enough.

Trying to increase domestic manufacturing capacity or to mine/farm our way out of the problem in anything less than ‘the medium term’ (how long is a piece of string? this government’s entire first term?) can only be a complementary strategy, not the primary one. Not while we are in the middle of a recession in the manufacturing sector (see page 6 of this NBS report) exacerbated by constraints to capital. We will end up killing existing businesses before the medium term materialises.

Suffice it to say, digging our heels in at N199/$ is starting to feel like masochism.

One price, one market?

I think discussions about a single-tier market are instructive but realistically not where the CBN/FG is headed anytime soon, and I can see why.

The fact is, a single tier floating exchange rate system is better. The market mechanism will always be quicker and better at allocating any resource. If you have 2 prices (or exchange rates), there will always be a spread and an arbitrage opportunity. Only one market-clearing price will eliminate that arbitrage game (aka ‘speculative demand’).

That said, a two-tier system can be a means to manage temporary fiscal pressures or to achieve specific policy objectives for industry. It’s clearly not a perfect system, but there you have it. Those are the kinds of arguments Nigeria would make for keeping it. (If you are interested, here is a quick primer.)

There are ways to make it harder for speculators to exploit it (for example by administering your subsidy via the tax system, which has other obvious advantages). So, the fact that we operate a two-tier market in itself isn’t really my issue.

My primary issue is that the current 35% spread is far from our ‘norm’, and is clearly so wide that it is disruptive to the economy. It will keep widening as long as supply is constrained because we insist on offering a few people FX at a rate that’s too good to be true, forcing the need for ‘demand management’, which ends up driving more people than usual to the parallel market.

This inflation of a thing.

Our obsession with exchange rates is really a mask for our fear of inflation and (understandably) long memories. Yes, very likely, higher inflation will follow devaluation. When prices rise, it is hard for everyone and when inputs cost more, you can usually expect to see job losses (mind you, a lot of that is already happening and some of it has to do with ‘demand management’).

First of all, the idea that inflation will spike out of control is not, so far, borne out in the data. Don’t forget, we already devalued by close to 30%, starting in November 2014 (the last action was almost year ago, in February 2015) and by a year later, inflation had risen less than 100 basis points (to 8.8%) according to the latest available data from the NBS.

The other thing to remember with inflation is that it really only matters when it starts to discourage economic activity. You shouldn’t spend too long thinking about inflation if the real GDP growth rate (nominal growth rate minus inflation rate) is expanding ‘fast enough’.

For example, if inflation increases by 100 basis points (say my raw material imports are now more expensive with a devalued naira) but power/infrastructural improvements help me to grow my profits by that same 100 basis points (I can deliver goods faster and therefore turnover more that year or I am able to apply my diesel savings to expanding production capacity), I am certainly not worse off. Things cost more, but I am able to afford them in the same way.

So, real growth is what we should be worried about for now (and tasking the government with), not inflation. And if the government’s investment and efficiency goals are achieved (think power, infrastructure, customs reform…), the economy should start to grow faster — costs will fall and the wheels of commerce will run more smoothly. As Mr President reminded us, “Fashola wasn’t made a superminister for nothing.”

The next logical question is, how fast is ‘fast enough’? I have a view on how fast it certainly isn’t, but there’s one more small point I want to make first.

Does government ever really know how to spend money?

One heavy criticism of the previous administration has been their imprudent management of oil wealth created during ‘the boom years’. The argument says that this money could have been invested in diversifying the economy further (don’t forget, for a while the narrative was it was quite diversified, but more on this later), and we would have been better insulated against oil price shocks.

On that, I found this study quite fascinating. Basically, it’s a recent piece of research published by the IMF that says a couple of things:

  1. There are no prizes for a rising tide that lifts all boats. It’s a no-brainer that when resource prices are high, GDP per capita grows in resource-led economies. (So we should really stop patting ourselves on the back for ‘over 7% per annum GDP growth’ from whenever to whenever).
  2. If you want to ask the tough questions, ask what happened to non-resource GDP per capita during the boom years. Then if you’re really sharp, ask if that growth rate was higher than what you would have expected to see, compared to some carefully selected control period before the boom began.

The study looked at 18 resource-led countries in the recent boom period up to 2011. These were all developing countries (the list is on page 36 if you’re interested): 4 or 5 are African countries. Crucially, they had all done the wise thing and invested in public infrastructure and education with their respective windfalls. Guess what? Not one recorded a significant change in non-resource GDP growth profile.

Not a single one.

Basically, their ability to meaningfully invest the excess capital was, to use an euphemism, not great. They probably didn’t hurt growth, but whatever growth was achieved was to be expected for that higher level of investment.

Think about it this way: if a country invests more, it will grow faster. The smart money is in achieving a higher growth rate by investing each dollar smarter.

An almost 20-year old study (which had the benefit of more time after the boom) found the same thing:

‘Previous research on the major commodity booms of the 1970s found little positive effect on economic growth through 1981, when measured against what benchmark models would have predicted, in spite of the fact that much of the resource windfalls were invested in the domestic economy.’

Even worse:

‘Furthermore, slow per-capita growth in the oil-rich Gulf states since the 1970’s makes it clear that the passage of additional time has only served to underline this earlier conclusion.’

In other words, these people made investments in education and infrastructure that didn’t create any more value than one might have expected no matter how much time you allowed for the investments to ‘mature’.

Economists talk about growth curves and total factor productivity. These guys didn’t make any investments that drove TFP and lifted those countries on to better growth curves. That’s not to say they didn’t have good intentions — they were investing. They were just not especially innovative about it.

I am still trying to decide how much better I think this is, compared to just looting the money. It’s clearly better, my question is by how much?

But Nigeria is different.

Nigeria was not included in the study (I suspect due to the rebasing a couple of years ago, which basically means that until the NBS completes an ongoing exercise, any data before 2010 — the new GDP base year — is unreliable as a comparative set), but of course it got me thinking about the implications for us.

The most dangerous and most self-sustaining myth in our public discourse on the economy is that Nigeria is ‘different’, and if that’s the starting point, I suppose it’s not surprising that often, if you persist with such conversations, you will eventually end up in ‘Nigeria knows best’ territory. It is the single most frustrating narrative I have ever come across and one that I will continue to dedicate myself to fighting.

Someone somewhere will say we are not a resource economy. I remember as recently as early last year when Nigeria was “not an oil economy”. GDP was rebased and I kept hearing this from smart Nigerians. They pointed out that oil-related GDP growth was negative (that was true until about Q4–14, but the numbers are still quite low), and that only 10% of GDP comes from the oil sector. Until oil prices hit $40 a barrel and somehow manufacturing is in recession, banks are taking impairments/writing off loans and telcos are shedding staff. I haven’t heard it said since.

The transmission mechanism from oil prices to the so-called non-oil sector (90% of the economy) in Nigeria is strong and working well. If that’s not an oil-based economy, I don’t know what is. Some of it has to do with fiscal policy and the banking system of course, but I reckon a lot has to do with the informal economy and exciting things like money laundering and ill-gotten gains. But that’s a whole other post.

So what does that mean for us?

Diversifying the economy to the point where our fate is significantly de-linked from the oil price is a tall order. And those kinds of orders aren’t fulfilled overnight.

At a time when resources are scarce (we no longer even have the cover these other countries had of claiming to invest ‘excess’ resource gains), we could very easily pump scarce resources into education and infrastructure and make little incremental impact on the growth trajectory of the economy. It’s one thing to grow faster because you have more money to throw at the problem, it’s quite another to do so because you’ve worked out how to use each dollar you invest better than the next guy.

I literally yearn for private sector-led solutions (and one of my biggest frustrations with this government is its socialist tendencies). Governments are notoriously bad at allocating capital (one of the reasons I am terrified when Mr. President says things like CBN and MoF will go and sit with businesses to determine their capital needs), so it worries me when I hear things like the federal government is recruiting teachers and training artisans.

While I am thankful on the one hand that our significant physical capital needs will be funded in the main by the private sector (these things tend to force better discipline and greater focus on value-creation through innovation), of course I am worried on the other hand that the implication is the pace of infrastructural development is not directly in our hands.

I also don’t see us treating foreign capital like we actually need it urgently yet. That would be really nice.

Here’s where my head’s at in 2016.

Here’s how I relate everything I’ve said to my thoughts on Nigeria this year (and they are many, so this list is by no means exhaustive; besides which, I reserve the right to change my mind):

  1. We are an oil-based economy and are at the mercy of the oil price. The best GDP growth rate we can achieve with the current structure of our economy won’t have much to do with anything other than what happens to oil prices. The government is hoping we can deliver 4.4% in 2016 based on $38 oil (and thinks that will be enough to generate 3 million jobs, but more on that below). The IMF thinks we will come out at 4.3%. I’m taking bets in the 3.5% to 4% range.
  2. There are many things we could do to self-sabotage and messing around with FX policy is one. It is still too early for full year data on 2015, but the IMF’s growth forecast (revised downwards during the course of last year) was 4%. I don’t see it — the NBS had us tracking at 2.8% year on year in Q3–2015, we didn’t achieve 4% in either of the previous quarters and we all know how the last quarter ‘felt’. I think we will end up in the mid to high 3’s. Aside from obvious culprits like the ‘wait and see’ game on account of the elections, and the unjustifiable timeframe it took Mr. President to appoint ministers, a major drag on business last year was ‘demand management’.
  3. Three million jobs is a pipe dream, for 2016 at least. Per quarter, on average 750K people (net) are joining the labour force (700K are just people becoming old enough to work and the other 50K are basically people changing their minds about not looking for work). So really the goal is just to match labour force growth, and not to do anything spectacular like reduce unemployment (currently 10%). But in Q3–2015, the economy only created roughly 475K jobs, over 90% of them in the informal sector (and over 70% of those by subsistence farming). The formal private sector did less than 42K jobs. I want to believe that subsistence farming isn’t what the government has in mind when it talks about job creation. 1 million people will be employed directly by the public sector (500K as teachers and 500K as trainee artisans, which sounds to me like a stopgap to the informal sector), so the private sector would need to create 2 million jobs next year — that’s 500K a quarter and over 10X the number it seems to be able to do now. To complicate matters, the 42K jobs are less than a third of what they were a year ago, the difference of course being the economy isn’t growing at over 6% a quarter like it used to. If 2.8% growth generated 42K new jobs in Q3–15, where are the other 450K jobs going to come from even at 4.4%? If that’s too confusing, look at it another way: in the last three years, aggregate job creation totalled 4.2 million, again mostly driven by the informal sector. That’s 1.4 million jobs a year in a period when GDP grew in excess of the current 4.4% target for this year. The maths isn’t linear and I am sure I don’t know the correct econometric model to use, but it’s pretty clear there’s a missing piece somewhere. The NBS data is all here.
  4. 4.4% GDP growth is not it, and I won’t be taking my eyes off Okey Enelamah or BRF this year. The wheels of business need to run a lot smoother than they are doing now if we are to drive activity and have any hope of being less at the mercy of oil prices. Infrastructure/power is obviously key to doing that and to also freeing up capital for investment. Export and investment promotion should be hot topics and foreign investors need to be brought back into the economy. We should be pushing them into sectors like infrastructure and manufacturing. That means we need to understand that the market is not domestic (it really doesn’t matter if your toothpick is made in Nigeria or in China, but that you can afford to buy it at a good price), and we should be doing everything we can to convince the outside world to buy Nigerian, recognising of course that the market is global and our tendency to cut corners won’t fly. All of that requires discipline and better competitiveness. We also need to make foreign investors feel good about bringing their capital into the country (my key issue with the current FX policy). All the enabling processes and institutions to achieve these things (including those that ‘enable’ by adding cost, time and complexity) should be priorities for improvement.
  5. I don’t expect 2016 to be a standout year for this government from an economic perspective. We won’t get there in one year but I’d like to start to see some deliberate and coherent moves that would give me better confidence that we are headed in the right direction, starting with an end to this FX debacle. I’m not seeing much that resembles good progress yet but I suppose it’s just January 3rd.

We wait.



Originally published on medium on January 3, 2016.

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