Africa’s largest economy braces for big hit as oil prices plummet

With oil prices plunging amid concerns over a price war between Russia and Saudi Arabia, and the coronavirus outbreak obliterating stock markets, Africa’s largest economy is in a precarious position.

The International Monetary Fund (IMF) on Thursday said it will be working closely with the Nigerian authorities in the coming days to assess any vulnerabilities which may be exposed by the sharp decline in crude prices, as Nigerian and Angolan dollar bonds sank to record lows.

Nigerian stocks on Thursday headed for their fifth straight day of losses to a new four-year low, and a fall in oil prices to just over $30 per barrel, rising external debt and a depreciating currency pose a threat to economic stability in the country of more than 190 million people. Nigeria is Africa’s largest economy in terms of GDP (gross domestic product).

While markedly lower oil prices will undoubtedly have broad adverse consequences for the Nigerian economy, the country is not quite as dependent on oil exports as the likes of Angola, which analysts expect to suffer a substantial blow this year.

However, a prime concern for economists is Nigeria’s managed naira exchange rate, since even prior to the fallout from OPEC’s failure to reach an agreement with Russia on oil production cuts, the country’s foreign exchange reserves were in steady decline.

After the official exchange rate was devalued in 2016, foreign exchange reserves were approaching $25 billion, and the move failed to stop the slide of the parallel market exchange rate, which meant the Central Bank of Nigeria (CBN) was forced to act again the following year when the Nafex (Nigerian Autonomous Foreign Exchange Rate) was implemented. Reserves held just below $30 billion during this period.

“Extrapolating the trajectory observed thus far this year (the foreign exchange buffer shrunk by $2.3 billion during the first two months of 2020) suggests reserves could fall below the $30 billion mark by Q3 (the third quarter) and end the year just above $25 billion,” NKC African Economics Chief West Africa Economist Cobus de Hart said in a note earlier this week.

Capital Economics Senior Emerging Markets Economist John Ashbourne on Wednesday echoed this projection, suggesting that reserves will soon fall below the $30 billion mark, which Nigerian policymakers had identified as a key benchmark.

Ashbourne predicted that the naira will end the year down 8% to 400 NGN against the U.S. dollar. He added that in Nigeria’s case, a weaker currency will not provide a boost to competitiveness, since the country does not have significant non-oil exports or the “domestic manufacturing base needed to substitute for imported goods.”

Reuters reported Thursday afternoon that the naira was being quoted at 370 to the dollar on the over-the-counter spot market.

Parliament recently green lighted President Muhammadu Buhari’s request for $22.7 billion in foreign borrowing, but while external debt accumulation would usually be expected to support reserves, de Hart suggested that the sharp fall in global oil prices could potentially “more than offset” the boost.

“Firstly, should Brent crude oil prices average roughly $40pb (per barrel) for the remainder of the year, it would reduce Nigeria’s goods export receipts by roughly $14 billion (as opposed to our February baseline for oil prices to average $62.4 billion in 2020) — this may also be a conservative estimate, as it does not take into account any adverse impact on non-oil exports,” he said in the note Monday.

What’s more, Nigeria may have difficulty accumulating external debt following the fall in oil prices and its impact on the macroeconomic outlook, while the jittery investment environment raises the risk of a capital flight, de Hart highlighted.

Having previously backed the authorities to ride out the storm and maintain its foreign exchange rate at current levels in the immediate future, NKC analysts now believe that the naira’s prospects have “deteriorated markedly” and remains set for a “sharp fall” this year if current conditions persist.

The CBN will again be faced with the choice of whether to let the Nafex buckle or continue to artificially prop it up.

“We believe the CBN will continue to provide support in the near term, with a more drastic adjustment more likely in Q3,” de Hart projected.

“If the Nafex is not permitted to buckle, then the black-market rate should, and this might hold more severe adverse consequences for an economy that is now facing a gloomier outlook on multiple fronts.”