“The amount of private equity interest in Nigeria is extraordinary”
June 24, 2015 | 8:21 am| | | Start Conversation
Razia Khan is the internationally acclaimed Africa Chief Economist and Regional Head of Research at the Standard Chartered Bank.In this interview with BusinessDay’s Akin-Olusoji Akinyele (Senior Economist), on the sidelines of the recently concluded 2015 World Economic Forum on Africa in Cape Town, Razia Khan discusses the Africa growth story and Nigeria’s investment attractiveness in a post-election era.
Q: Perhaps a good place to start is the Africa growth story in 2015. Why is growth slowing down in Africa and what can be done?
Razia Khan: The oil exporting countries have been hit particularly hard, and those are the ones where growth has been particularly robust. Most of the oil importing countries are still holding on, but I think across the board, if you are going by assets, looking at a GDP weighted average, which is what we do, South Africa is slow, Nigeria is slowing – it is going to impact on average. There are some exceptions – if you look at Cote d’Ivoire, the growth rate looks good. The key is we don’t think this is going to be long lasting.
For Nigeria we have described 2015 as year of two halves, the first half of the year has slowed down because of the elections, the collapse in oil prices at the end of last year, uncertainty – no one is really doing anything with policy. Look at electricity, look at fuel. You don’t need to go into the reasons why. The lack of availability of foreign exchange is clearly as was the case before but I think that held back investment plans (to the extent that anyone was doing anything around the elections anyway).
But we see the second half as being supported. First of all, we have had a fairly constructive view about oil prices, our commodities research team has called it correctly so far and they think because what it is really happening is a supply squeeze in terms of exploration plans being put on hold, the market is going to start to factor that in and we will get prices squeezed higher, and we will look at 80 to 90 dollar per barrel a range overshooting by the end of this year.
If that is the case then that of course will come as considerable support to Nigeria, but more than that I think is just the expectation, how everyone has reacted to change, did anyone think that this is even possible and the fact that Nigeria got through those elections relatively peacefullywas also a big thing, and that gives rise to the expectation that there is going to be change, the anticipation that creates momentum of its own for the economy.
Now we are yet to see what kind of situation the new government inherit in terms of coming in, there is a lot they have got to look into, we got to have a sense of the public sector arrears, but we think that as soon as the interbank market opens up again and it is clear that there is two way trading for the Naira,we will see better conditions in place.
Q: In the first quarter of 2015, Nigeria posted perhaps the poorest growth numbers we have seen in many years, 3.9% growth.Are you saying we could see an inflection in the second half of the year?
Razia Khan: The second quarter is likely going to be very difficult as well,in terms of the oil contraction, I’m not sure if that changed dramatically, oil prices of course did improve. I think there would have been a lot more down days in terms of the retail and wholesale sector, simplybecause of the elections and that area and on the fuel shortages and what happened with electricity. But in the second half in Q3 and Q4, we think that is when the momentum is likely to build again for the Nigerian economy.
Q: Also in the second half of 2015, there is a near term outlook of US monetary policy changes. How would this impact Nigeria’s monetary policy?
Razia Khan: I don’t think that impacts Nigeria so much anymore, it was important when Nigeria saw a large amount of foreign portfolioinvestment, and what happened over the course of currency instability is a lot of investors even those that track the index, are underweight relative to the index. They had pulled out of Nigeria earlier on, so there is not really an argument that the Fed is going to tighten modestly and that is going to cause any outflow from Nigeria – quite the opposite.
I think if we do get any sort of unanticipated tightening in the market, if there is any element of volatility, it might slow the big returns of investors into Nigeria, but I don’t see it causing any risk in terms of investors comingout.
The other issuewith Nigeria is not just the portfolio investors.I think equity related investments might be a little bit more immune; bond flows will be more susceptible,they are more FX sensitive anyway. But the amount of private equity interest that we see lining up in Nigeria is just extraordinary.
The foreign direct investment – not so long ago we had the US Africa Summit, Power Africa and so on. I think we will see a return to momentum across all of that and so Fed’s tightening, especially if we are right in thinking it will be afairly modest adjustment, just isn’t going to change so much of that.
Q: Still on the US monetary policy changes, how do you think the Central Bank of Nigeria will react, given repeated cautions about this inmonetary policy communiqués?
Razia Khan: The very first thing that has got to happen is the re-opening of the foreign exchange market and I think only from that point on will we see where we go.The last CRR harmonisation, I mean different things were written about it – initially we thought it was a bit of easing but what we did not take into consideration is CRR is paid only on local currency, public sector deposits; therefore it was effectively a tightening which we now know.
There were debits from the system, so the central bank has tightened in a modest way, which we think in terms of policy direction, tightening is the right thing to do, simply because we think inflation in Nigeria is going to be rising faster.
When I was in Lagos I spoke to a whole bunch of FMCG companies, they said that look, the reason why you have not seen a pass through from the naira yet is that when you produce a packaged good, you can’t raise the price anytime you feel like, you can only raise the price N10 or N15 at a time and so you only do it once when you absolutely have to.
A lot of them were saying they have seen increase in cost, their margins have been squeezed, and they were going to be increasing prices that much more.When we look at our own consumer price tracker that Standard Chartered puts together,it is very clear that prices have been rising.
Q: So what is your target for the inflation rate towards the end of the year?
Razia Khan: We see inflation in low double digits at the end of the year, I know that some deputy governors want to shoot me on the spot when I say that but those are what my forecasts are saying. (laughs)
Q: Nigeria post-elections, everybody is commending Nigeria for giving Africa a shining moment but is that really what it is or are there challenges to growth ahead?
Razia Khan: In terms of growth, I mean there are challenges to growth, but I think what people are really saying is: “Hey, something hugely significant is happening in Africa’s biggest country, for the first time since 1999 you saw an opposition party winning the election and the government conceding and (wow!) this is big.”
Because let’s consider the counter-factual – if we had seen things go wrong in Nigeria, that could easily have stopped the whole Africa rising narrative.Nigeria is so important and pivotal to region. Without Nigeria there, without investors being super enthusiastic about the political direction and the political maturity that we had seen in Nigeria, it would look like a very different African story.
So yes it is big and it needs to be celebrated and it is absolutely Africa’s shiningmoment but none of that meansthere are no deep-seated economic challenges, which there are.
Q:Just after the election victory, we saw some sort of a “Buhari bounce” in the stock market and then it fizzled out, what exactly are investors looking for?
Razia Khan: Certainly any amount of optimism might be eroded after an election victory, if you have 27 states behind in salary payments; official grid generationfalling toabout 1,300 megawatts; queues everywhere because of the lack of fuel; banks announcing that they have to close early because they can’t get to find diesel for their generators; that has started to impact even the services sector in Nigeria.
So all of these things happening, plus the non-availability of foreign exchange, you know things were not as easy as they had been in the past.
For foreign investors the key is that there is a working foreign exchange market and that they are able to see how demand and supply interact. Nobody is going to put money into Nigeria, if they think there is a chance of a big devaluation. So a lot of them are waiting on the sidelines, and you won’t see the big foreign portfolio flows coming in until we see that adjustment in the currency.
Q: Do you see a chance of another big devaluation coming up?
Razia Khan: Our forecastsat Standard Chartered see a gradual opening up of the market, so our end Q2 Dollar – Naira forecast is N207, and our end Q3 forecast is N220. And then maybe just a very modest move beyond that. I think the market is going to clear, if the amount of outstanding demand for foreign exchange isgoing to be met, then we will have to see that.
Q: Still on Nigeria in terms of the challenges what solutions are there, towards ramping up revenue across the federal and state governments?
Razia Khan: VAT [Value Added Tax].When I spoke to the budget office in April, they said if the state government finances were troubled, 85% of any VAT increasewould go to state governments. So there’s long been talk of a potential increase in VAT from 5% – 10%. Nigeria has a low rate of non-oil revenue mobilization;it’s got a globally low rate of VAT, and so it seems like a no-brainer that this is something that might have to change.
The problem for the government is if we think inflation is already rising as we see the pass through effects of the Naira weakness,let alone what may come, inflation is already onan upward trend.
And then at the same time the government will think about some sort of fuel price deregulation.Something has to change with the subsidy because it is unlikely that it can stay in its current format and that is a one off shock and that is still inflationary
And then they increase VAT at the same time, it is another one off shock and that is still inflationary,it is going to be very tough to push through that package of measures altogether.
Unfortunately it is very difficult to see what choice Nigeria has. Nigeria has to start raising revenues in a more meaningful way and this is a reform that is important for the medium term.
In the near term of course it can always borrow more … an external Eurobond, I think markets will be open to that, but they would want to get visibility on Nigeria’s foreign exchange reserves; they would want to know that they are not threatened anyway by the FX regime that central bank has in place; and if that is the case they would want to see how the FX market works to safeguard central bank reserves.
But I think Nigeria is still seen as a very favourable credit and markets are open for Nigeria to issue again, and investors will like to get Nigeria debts at the kind of yields that the debthas been trading off recently.
Nigeria’s debt ratios are fairly low, so long as investors are convinced that some kind of export diversification was possible, I think they will be okay with Nigeria borrowing.
Q: Where do you see the debt to GDP ratio rising to, from 11% currently?
Razia Khan: I think a lot depends of course on Nigeria’s debt service capacity. Even if at 20% debt to GDP ratio, so long as debt service capacity does not look difficult, we would still be seen as relatively modest and better than a lot of peer countries.
Q: So if you were to weigh both in terms of a near term action,would you take borrowing?
Razia Khan: They’ve got to do the VAT move at some point and better that a new government does it at the outset,before it starts to impact on the popularity of that government.It is something that is critically necessary for Nigeria, even if oil prices come back to 200 dollars per barrel.
Nigeria has to make this move. It’s got to look at balancing out the oil revenue with the non-oil revenue or there is no way that can grow sustainably.
That said, we know this would be a difficult time for Nigeria from an inflation perspective,the sooner these measures are taken, better for the country,and I think Nigeria could still come to the markets later this year.
Of course it will not be ideal to come to the markets just at the very point when the Fed is tightening or when that anticipation is building up because that will impact the price of the Eurobond.
Q: What are the key sectors to watch in Nigeria especially with the coming of a new government.
Razia Khan: The consumer sector in Nigeria is still a no brainer for the long-term play. Nigeria income and consumption is going to be rising, it is about finding the right opportunities.
The oil and gas sector,because of the priority that will be given to passing the PIB,probably not as one super piece legislation, but it is very ambitious and it tries to do everything in the upstream and downstream but more piece meal and I think that will be very significant.
Then the power sector, because this is still where Nigeria needs the investment.This will still show the country’s ability to make progress and do more.
The rail sector – existing projects that will likely continue, Nigeria needsan upgrade in infrastructure across the board – roads,rail,air,and ports.
The question right now is how it is going to be funded, and Nigeria has spoken of selling off some state assets,we would have to see what assets it has in mind and what can be done to fund all of that.
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