Mitigating the risks of collapse: Preparing for potentially unfortunate events in 2018 By Nonso Obikili

The story of the current state of the Nigeria economy is not news. After over a decade of relatively strong economy growth, the economy hit headwinds, triggered by the collapse in the price of crude oil. The result of the crash was a recession, the first in two decades, combined with deterioration in the macroeconomic environment. The consequences were there for all to see.
Indeed, the scenario of boom and bust is not new to the Nigerian economy and has been witnessed many times since independence. The boom and bust cycles result in key questions that policy makers must consider. Of course, the focus is always on promoting strong inclusive growth, as one would expect. However, strong growth followed by collapse is almost as bad as no growth at all. In many instances it is worse. A very important question therefore, is how to mitigate the risks of collapse.

The story of the last growth collapse brought the risks in the Nigerian economy to the fore. The economy was heavily exposed on two key fronts. First, a significant fraction of exports, and in turn foreign exchange earnings, were dominated by one commodity, crude oil. Second, government revenue was heavily reliant on crude oil, directly through royalties from crude oil sales, but also through the oversize effects of the petroleum sector on corporate income tax receipts and value added taxes. The collapse to oil prices, combined with disruptions in the oil sector, led to the unravelling of the Nigerian economy.

The Nigerian economy is still structurally identical to how it was prior to the last collapse. Crude oil and natural gas still account for a significant portion of exports and foreign exchange earnings. As at the third quarter of 2017, they accounted for 94 percent of all exports. The situation with government revenue is marginally better although still largely dependent on the petroleum sector. As at the third quarter of 2017, net oil receipts accounted for 43 percent of revenue. Note that 43 percent excludes corporate income taxes and value added taxes on the petroleum industry. For context, in the second half of 2014, when oil prices were still around $100 a barrel, net oil receipts accounted for about 65 percent of government revenue. Although debt, in absolute numbers and its share of government revenue, is significantly higher than it was in 2014.

On the macroeconomic front, inflation is currently higher than it was prior to the last crisis. It was
at eight percent before the last crisis while it hovers at just under 16 percent now. Interest rates are also higher than they were before the last crisis. The MPR was at 12 percent compared to 14 percent now, while the prime and maximum lending rates are two and four percentage points higher than they were in 2014 respectively. Despite the recent increase in foreign exchange reserves, it is at about the same level as it was at the start of 2014 before the crisis started.

Finally, growth is much lower than it was, especially non-oil growth. Growth was about 6 percent in the first half of 2014 while its stumbling at about 1 percent now. Non-oil growth was also above six percent in 2014 while it hovers around zero now. In summary, the structural risks to the Nigerian economy are still present, but the underlying conditions are worse. What this means is the consequences of another collapse could be worse than last time around.

So, what could kick off a crisis? A reversal in oil inflows either through a collapse in prices or a collapse in oil production could kick it off. Crude oil prices are increasingly volatile with crashes almost impossible to predict. It’s currently around $65 a barrel but it would not be unheard of if it dropped to $30 in three months. Crude oil output is also not without risks. Nigeria is going into an election cycle, and these cycles are typically associated with disruptions in oil production, as different groups try to reposition themselves.

The election cycle also carries other risks with it. Since the reintroduction of foreign exchange trading by the central bank, foreign portfolio funds have flowed into Nigeria. The election cycle could spook traders leading to a reversal of these flows with consequences for the foreign exchange market. There is also the risk that politicians might prey on the central bank, forcing it to implement policy that may look good in the short term, but will kick off another downward spiral.

How do we mitigate these risks? In the near term the central bank needs to demonstrate that it has learned the lesson from the last crisis and is ready to respond properly. This of course implies focussing on its mandate of price stability and allowing flexibility when required, specifically in the event of an exit by portfolio investors. The central bank also needs to show that it can withstand political risks, specifically pressure from politicians for short term boosts. Given that the central bank monetary policy committee currently cannot form a quorum to meet on policy then I don’t know. The executive and the senate need to resolve that as a matter of urgency. Although there is the problem of a lack of economists on the board of the central bank but that is a story for another day.

On the fiscal front, the federal government needs to follow its fiscal rule, saving any unexpected oil revenue windfall for the proverbial rainy day. Despite the fact the crude oil price is $20 above the budget benchmark, the excess crude account and the sovereign wealth fund have not seen significant increases in their balances. Perhaps the federal government is covering for the short-fall in its unrealistic non-oil revenue projections but it that may not prove to be wise. The federal government also needs to deal with current imbalances in the system, specifically with regards to energy prices. It’s always better to allow flexibility when you have the option to and not when you are forced to by hard times. A worst-case scenario strategy, especially with regards to the ever-increasing public debt, also needs to be developed in the unfortunate event that the worst happens. In the long term the diversification of export and tax revenue needs to be the focus. Although much has been done on the tax front over the last few years, the question of tax reform is still not on the table. With regards to export diversification, policy is almost non-existent.

We always hope that the unthinkable won’t happen, but it seems to happen over an over again. Perhaps we need to start to implement policy based on Murphy’s law, whatever can go wrong will go wrong. In general, we need to start to see that mitigating the risks of collapse is just as important as promoting growth, and make policies for the former as we do for the latter.