Otunuga: Nigeria’s Fortunes Remain Closely Tied to Crude Oil

Research Analyst at FXTM, Lukman Otunuga, in this interview stresses the need for the federal government to show more commitment towards the diversification of the Nigerian economy. Obinna Chima presents the excerpts:

What is your take on the ongoing trade tension between the United States and China?

At the start of the year, there was a strong sense of optimism over global growth and many central banks were moving forward with tight monetary policy and the outlook for global growth was robust. But things have changed considerably and global trade tensions between the US and China has sparked concerns over global growth declining. And that is true because a trade war between the two largest economies in the world represents a threat to global stability and global because there is always a contagion effect.

So, optimism for broader growth has declined in 2018 and naturally this will impact emerging and frontier markets, including Nigeria. There is not going to be any winner in the trade war. Look at the Turkish Lira, the currency was already vulnerable and what accelerated the decline was when the US doubled sanctions on steel and aluminum. And the reason why the Turkish Lira declined was because the market was fearful of the Turkish economy decelerating into a bad state and that has already impacted other emerging economies, except the naira.

We have seen the South African rand and many other currencies of other emerging markets, sharply depreciating. But the naira has remained stable. Why? The reason why the naira continues to remain stable is because of the Central Bank of Nigeria (CBN). The naira stability continues to highlight how the CBN has continued to repeatedly intervene to support the local currency.

We have seen predictions about the likelihood of two rate increases by the US Federal Reserve before year end. How much impact do you think that would have in terms of capital flow to Nigeria?

It will have a significant impact on the naira. Firstly, higher interest rate, especially the fact that the Fed is expected to raise interest rate in no distance time, naturally will spur capital outflows from emerging markets. Now, if the naira is still free-floating, this will be bad news for the naira. However, how things are right now, even if the Fed raises interest rate two more times this year, the naira will remain stable. Why? Because of crude oil prices. As long as oil prices remains at elevated levels, the CBN will have enough buffers to continue supporting the local currency.

Now, expanding that question and going to naira stability and the country’s benchmark interest rate, interest rate remains at 14 per cent in Nigeria. I remember the last time we spoke; the prediction was that the CBN would cut interest rate to about 12 per cent, to stimulate economic growth and support small businesses. But now the Fed is expected to raise interest rate, if the CBN cuts interest rate, wouldn’t this widen the monetary policy divergent between the Fed and CBN, ultimately accelerating capital outflows which would negatively affect Nigerians. So, what seemed to be an easy decision for the CBN has now become a very tough decision to take.

The stock market has not done well since February and that has been attributed to the apprehension towards 2019 elections. If you are to advise your clients, what will you be telling them about investing in the Nigerian stock market?

So, this is an interesting thing I was thinking about earlier. The trend, especially the Nigerian stock market is that before the elections, it goes down and after the elections, it jumps back up. And that has been the trend in the past 10 years. But then, if you look at it, you will notice that there have been many fundamental changes in Nigeria and outside the world. Ten years ago, was Nigeria in recession? Nigeria wasn’t in recession 10 years ago. Secondly, ten years ago, oil prices were trading at very low levels and 10 years ago, the Fed was very hesitant to raise interest rate. So, based on this, we can have a situation where investors remain hesitant or weary to hold stocks, even after the election.

So, what is your outlook for inflation?
So, my expectation is that inflation will continue to moderate to single digit if we didn’t have the presidential elections in February. But we are going to have a cost-push inflation and that is going to cause inflation to rebound. And the CBN has already stated that. That is why the CBN is in a very tough spot because, if it wasn’t for the 2019 elections in February, the CBN would have had an easy choice of cutting interest rate at the end of the year when inflation hits single digit. But now, they are working against the clock. That is because if inflation starts to rebound and we have a situation where a GDP growth for the second quarter disappoints, the CBN may miss the window to cut interest rate. Now, if the status quo remains and interest rate remains at 14 per cent, it is going to continue constraining businesses from borrowing and ultimately negatively impacting growth.

Also, what is your outlook for crude oil price and global economic growth?

So, looking at crude oil prices, I think last time we spoke, I was bearish on oil prices. I was bearish because I thought there was oversupply in the market then. But, I the past six to seven months, we have seen geopolitical risk factors in the form of sanction on Iran, previously there was a drop in output in Libya, but output has returned and also geopolitical tensions in the Middle East, all created oversupply in the market and pushed prices higher. So, it has to with the dynamics of supply and demand. But I remain bearish on oil prices.

The reason why I am bearish is because although the United States has imposed sanctions on Iran, Saudi Arabia and Russia may pump more oil and at the same time, the US oil production remains robust. And when you add these to the fact that global trade tensions have already negatively impacted growth and could result to less demand for oil, the only way for oil could be down. So, I am bearish on oil and I will continue to monitor as oil prices continues to trade around $70 per barrel. In terms of global growth projection, even though Nigeria continues to diversify, the country’s fortune remains tied to oil. If oil prices remain at the level at which they are, even with the uncertainty ahead of the 2019 elections, Nigeria still can reach the 2.1 per cent growth projection that was set by the International Monetary Fund (IMF).

But, if oil prices start to go down and inflation continues to rebound out of control and if uncertainty intensifies even more than expected from the elections, Nigeria could disappoint in 2018. So far, the Central Bank of Nigeria has done what it can in moderating inflation and has been careful in terms of monetary policy and to prevent any unexpected shocks. Even though we have said the CBN has continued to support the naira, they have supported the naira in a bid to promote stability.

So, moving forward, we can say the CBN has done what it can, but more need to be done by the government to diversify the economy. Yes, we have been talking about diversification, but it has gotten to a situation where the World Bank and IMF have expressed concern about the speed of economic diversification in Nigeria. Because oil prices have traded where they are, and it is not at an emergency level, it has given the government breathing room to continue to do what they were doing in the past to support the Nigerian economy.