Nigeria’s rebound: Rising oil prices or structured growth?

Even recessions have a silver lining.

In Nigeria, an almost two-year recession brought on by disrupted oil output and a crash in commodity prices, led Africa’s largest economy into a period of intense self-analysis. The oil growth that Nigeria enjoyed between 2011 and 2015 was exposed as a poisoned chalice and diversification became a rallying cry.

Those leading the charge bemoaned the lack of development and depth in all other revenue-generating activities aside from oil. They said that Nigeria needed another way of making money and championed broad-based growth as a bulwark against future market shocks. Nigeria has now begun to grow at between 2.1% and 3.5% – depending on who you speak to – and some claim that these figures show the effects of structural reforms and steps taken to strengthen economic infrastructure.   

Those holding the opposing view would argue that growth is primarily piggybacking on rising crude prices and President Muhammadu Buhari has failed in his promise to reform a single-resource economy. While the government has introduced a number of key policies, 70% of government receipts still come from the oil and gas sector and Nigeria must be wary of resting on its laurels now that easy money has returned.

Financing the budget without oil?

Paradoxically, although oil revenue accounts for only 10% of GDP, it brings in over 90% of foreign exchange earnings. When militants in the restive Niger Delta region redoubled their attacks on oil infrastructure in 2016, dollars quite literally stopped flowing into the state coffers. 

With the central bank all but out of foreign currency, government projects gathered dust and the black market boomed as corporates scrambled for cash. Growth was derailed as revenue dried up and it was clear the country needed a more complex portfolio to back its spending.

At N9.12 trillion ($29.8bn), this year’s budget is Nigeria’s biggest ever. Its assumptions include a benchmark crude oil price at a modest $45 per barrel, output at 2.3m barrels per day and GDP growth at 3.5%.

The spending breakdown falls in line with the country’s Economic Recovery & Growth Plan (ERGP): a detailed document given to each ministry as a blueprint for growth. “The sectors that the ERGP promotes are agriculture, transport, power and gas and manufacturing and processing,” says Yewande Sadiku, CEO of the Nigerian Investment Promotion Commission.

These sectors – particularly agriculture and manufacturing – were championed by Buhari during his election campaign as key foreign exchange earners and engines of socioeconomic growth. Agricultural and manufactured goods processed in Nigeria and sold on the international market are certainly ways to bring dollars into the country.

Interestingly, the largest allocation of funds is to the Ministry of Power, Works and Housing at $1.5bn. The oil and gas sector has historically been chronically underfunded and unable to attract the capital it needs; hence the government support. The thinking in public office is to capitalise on rising oil prices and redeploy the capital into diversification projects. As Okechukwu Enelamah, the minister of industry, trade and investment, points out: “You need oil to get out of oil. If we combine reforms in the structural economy with rising oil prices; growth will come back.”

In this vein, much of the budget is funded by oil and oil projections as, for now, no other sector can provide the same level of revenue. However, if commodities were to drop once more, either through a slowdown in the Chinese economy as a result of a looming trade war or a ramp up in US shale, then Nigeria would face the same problems. It’s a risky strategy but Nigeria may have no other choice. Restructuring the entire economy to fund the budget another way would take far longer than two years.

“Government’s focus is to maximise the use of revenues from the oil sector and spend in the non-oil sector, to get the non-oil sector driving the economy,” Udoma Udoma, minister of budget and national planning, told reporters in a briefing on how the government intends to fund the budget.

One way to rebalance the funding of the budget would be to strengthen and expand fiscal policy. Tax has long been under-exploited as a source of government revenue in Nigeria. With a rapidly growing population currently estimated at around 184m, a broad tax base could be a real driving force behind Nigeria’s economy. Gains have been made but the instrument is slow to bring in the level of capital the country requires. Vincent Nwani, director of the Lagos Chamber of Commerce and Industry, argues the gains made are too few. “The issue is not tax rates, it’s about tax inclusiveness,” he says. According to Nwani only 10% of Nigerian citizens are tax-compliant and points to easily identifiable sectors like high-earning Nollywood stars as missed opportunities.

The government is gradually looking to make amends. Under the direction of its state governor, Akinwunmi Ambode, Lagos has mobilised an online and centralised tax-paying platform called the Lagos Internal Revenue Service. The mega-city has come a long way in funding its own development. In 2017, the state raised N503.7bn ($1.4bn) in revenue to fund large infrastructure projects.

“There was far less infrastructure in Lagos 10 years ago,” confirms Kunle Elebute, national senior partner, KPMG Nigeria. “What you see now has been paid for by taxpayers’ money.” 

Yet at 6% Nigeria’s tax-to-GDP ratio is one of the lowest in the world. The government is aiming to bring this figure up to 15%. Domestic and international companies, high net worth individuals, the formally and the informally employed are all in the government’s crosshairs.

In order to bring a greater percentage of the population in line a tax amnesty called the Voluntary Assets and Income Declaration Scheme (VAIDS) was introduced in 2017 by the Federal Inland Revenue Service. The scheme allows taxpayers to declare their assets and income from all sources within and outside Nigeria for the preceding six years without being prosecuted. The deadline for the voluntary disclosures was 31 March and the government has since been pursuing those who did not comply. Abuja hopes to reclaim $1bn from these efforts.

Taxes on goods and services have also been lacking in the past. Nigeria’s VAT rate stands at just 5%, well below the global average of 15.79%. President Buhari has recently approved a hike in excise duties on tobacco and alcoholic beverages despite facing tough resistance from the industry. The new regime will raise the tax by as much as 20% – an increase challenged by the Manufacturers Association of Nigeria.

This highlights an important tension in the Nigerian economy: the difference between getting the most out of goods, services and corporates via tax and not inhibiting growth. While taxes should be increased, at times Nigeria’s tax system is overcomplicated and nebulous. Double taxation is often an unintended consequence and can frustrate growth objectives. Government, however, has recognised the problem and is looking for solutions. “We are working hard to create an enabling business environment which avoids unnecessary taxation,” affirms Enelamah. 

While the budget remains largely oil-dependant, Nigeria is moving in the right direction to secure a wider revenue base.

Better borrowing

Concerns have also been raised about Nigeria’s steadily accumulating debt. Nigeria’s total external and internal debt stands at around $70.92bn with the IMF concluding that the level was creating vulnerabilities. The argument, similar to the discourse surrounding the budget, is that Nigeria should find ways other than borrowing to embark on the ambitious recovery and growth plan.

Kemi Adeosun, minister of finance, argues that the debt-to-GDP ratio, which is at 21%, is “conservative, by global standards”. Compared to some other African countries she may have a point.

Importantly, however, the minister then argues the debt has been tied to specific infrastructure projects and will not be used simply to service costs and pay salaries. This is a key distinction to make as previous administrations – overendowed with oil money – have seen debt as a largely short-sighted exercise. Indeed, used in the right fashion debt is a crucial financier of much of the world’s large development projects. “We are not adverse to debt,” confirms Nwani. “It’s not bad for a government to finance its infrastructure by debt. But if you must borrow make sure you put it on something that will yield revenue; that will be able to pay back the debt.”

Some developments have been made in this area. Nigeria is beginning to borrow with better defined objectives and through a more diverse array of instruments. This signals a move away from less considered days and towards an era of smarter borrowing. Nigeria’s fifth and latest $2.5bn eurobond is a prime example. The sale was used to refinance domestic naira debt which had higher interest rates and shorter terms – the new eurobond offered maturity terms of between five to 30 years. This signals smart financial management with an appetite to get more from money by tying the extended maturity rates to long-burning infrastructure projects.

Babatunde Obaniyi, managing director of investment banking at United Capital, argues both corporates and governments are engaging in smarter borrowing. “What we used to see in the market was vanilla bonds,” he says. “You would simply use your balance sheet to raise money, but I think the market is getting sophisticated to the level where you can start engaging in project finance and infrastructure finance.”

Obaniyi references the sale of a $100bn sukuk in 2017 which was oversubscribed and tied to a number of specific projects including the construction of the Kano Western bypass, of the Loko Oweto Bridge in North Central and the rehabilitation of the Enugu-Port Harcourt road in the South East. A total of 15 projects were earmarked to benefit from sukuk proceeds. This is also true of the private sector.

Obaniyi explains that in the past the majority of issuers on the capital markets were banks. “If you look at the structure of the Nigerian economy the financial sector is less than 20% of GDP but prior to 2014 banks raised more than 90% of the capital on the local markets,” he says.

For Obaniyi this represents a mismatch and means that corporates were neglecting a key capital-generating instrument. “For any developed economy in the world you need a strong debt capital market where you can get long term financing,” he says. “In the past few years the markets have seen an increase in breadth and depth and new players from the power, hospitality and real estate sectors have come to the markets to raise funds.” 

Nigeria’s public and private sectors are therefore beginning to borrow better post-recession, ensuring sustainable development and less reliance on oil to fund large projects.

Import-dollar glut

A large portion of Nigeria’s income is spent on importing commodities that are found in abundance throughout the country. Nigeria’s two comparative advantages are oil and agriculture and yet the country wastes millions of dollars each year importing both. Nigeria annually spends $1.2bn on petroleum imports and $22bn on food imports. The raw materials – crude and agricultural foodstuffs – are plentiful in Nigeria. The solution, therefore, is strengthened domestic processing capacity yet Nigeria has traditionally struggled to put this theory into practice. “Nigeria has talked for a long time about the importance of local production, local refining and value added products,” admits Enelamah.

The good news is there are some slow developments. The refinery debate in Nigeria exposes the ever-shifting balance between Nigeria’s public and private sectors. In the past Nigeria’s oil and gas sector was replete with beleaguered parastatals guzzling money and with very little to show for it. “I don’t believe in government run refineries,” says Dada Thomas, CEO, Frontier Oil Limited and president of the Nigeria Gas Association. “We have seen the impact of government run refineries in Nigeria. We have three or four refineries that have been gulping billions of dollars and achieved nothing for it.”

Thomas gives Eleme petrochemicals complex in Port Harcourt, Rivers State as a case study. The complex was state-run for a long time and was functioning at a fraction of capacity. In 2006 it was sold to Thailand-based Indorama Group for $224m and has since become a poster boy for privatisation by ramping up output and becoming profitable. “The private sector has turned black hole companies into profit-making machines which are expanding,” says Thomas.

Along these lines Nigerians are eagerly awaiting Aliko Dangote’s Lagos refinery at Lekki Free Trade Zone, just outside of Lagos. At $11bn the refinery is expected to come fully online in 2019 at a 650,000 barrels per day capacity: enough to meet Nigeria’s domestic needs and even export to other West African countries.

On the agriculture side a perennial problem to processing plants in Nigeria is power and basic infrastructure. Companies like Olam, Notore and BUA Group are setting up processing plants but cite poor infrastructure as a major obstacle. Often a company will have to power its own plants, unable to use the grid system, and will be forced to invest in roads and transport links to get the goods to market.

“The government really needs to think about providing power and infrastructure for agri-business,” says Akintunde Sawyer, executive secretary of the Agricultural Fresh Produce Growers and Exporters Association of Nigeria. “Government should look at providing incentives for those who want to build infrastructure that enhances the preservation of food, whether that’s warehouses or silos or preservation units.”

The catch is that with so much money spent on imports the government is already strapped for cash and may struggle to provide the infrastructure necessary. The public and private sectors must therefore work together to reduce Nigeria’s import bill and free up money for projects giving long-term growth.

Weakening the grip of oil

To sum up, Nigeria has made some key advances in strengthening the country’s economic infrastructure. These advances, however, will take some time to weaken the stubborn grip of oil on the structure of the economy. If Nigeria can continue the gains made during the recession and see its current policies weather the storm of the upcoming 2019 elections then Africa’s largest economy will be better adapted to withstand any future commodities crash.

Tom Collins