21 Jun 2023
Within his first month in office, newly elected President Bola Tinubu has moved swiftly to deal with the macroeconomic imbalances that built up over his predecessor’s term. Taking aim at the two biggest challenges – a fiscally unsustainable fuel subsidy and a dysfunctional exchange rate regime – Tinubu appears to be pursuing an orthodox policy path for this struggling yet high-potential economy.
As Africa’s largest oil producer, Nigeria really should have reaped the benefits from the high oil price seen through much of 2022. But an overly generous fuel subsidy coupled with a steady decline in production volumes over recent years more than offset this. The country’s fiscal position worsened in 2022, with the fiscal deficit widening to 6.2%. Furthermore, reserves fell by US$5 billion over the year, reflecting persistent financial account outflows, and constrained funding as (like many African debt markets) Nigeria saw a ‘sudden stop’ in foreign investment in 2022, forcing the central bank to finance a significant portion of the country’s deficit.
The day after his inauguration at the end of May, President Tinubu’s first move was to ditch the fuel subsidies. This is a vital first step in putting the country on a more sustainable fiscal path. And while protests have scuppered previous attempts to withdraw this long-standing financial support, the new government’s transparency around the issue and moves to increase the minimum wage appear to have reduced the risk of social unrest.
President Tinubu’s second move was to announce the unification of Nigeria’s multiple exchange-rate systems (as it was initially described). This was an equally urgent task: over recent months, uncontrolled inflation resulting from overly loose monetary policy has driven the black-market exchange rate to a c.70% premium to the spot rate. The central bank hiked rates to offset some of the pressure, but real rates have remained deeply negative.
To confirm his commitment to a more orthodox path, Tinubu suspended the central bank governor, Godwin Emefiele, with immediate effect on 9 June (appointing Folashodun Adebisi Shonubi as acting governor); Emefiele was seen as a roadblock to further liberalisation of the exchange rate. And while it’s still early days, there are initial signs that the government is allowing transactions to take place even above the black-market rate, suggesting a commitment to flexibility.
While much more needs to be done to reform an economy that has stagnated for the best part of a decade, we believe that some of the foundations are now being laid for a more prosperous future for Nigeria and its people.
Other essential areas of focus for Tinubu’s government include the need to improve Nigeria’s business environment and deal with high levels of corruption. The new administration also inherits some urgent social challenges. Until recently, Nigeria had the lowest possible score in our proprietary ESG scorecard, excluding it from our investable universe. Social policy and human capital in particular scores very poorly, stemming from unequal access to education (although improving), stagnation in literacy and a relatively low number of years of education on average. Access to basic education, sanitation or water services, electricity and quality transport infrastructure are also major issues.
However, positive momentum in environmental policy recently prompted us to upgrade Nigeria’s ESG score. This reflected support from key figures for mitigation actions and initiatives to improve on transparency of the country’s greenhouse-gas inventory system. Furthermore, with the Climate Change Act, Nigeria set into law a net-zero target, establishing a five-year and annual carbon budget process. This improves on the country’s near- and long-term planning and points to a more positive forward-looking trend.
Nigeria’s credit spreads have already rallied since Tinubu has taken office. While in the shorter term investors must carefully weigh risks associated with the market’s very high expectations and the significant reforms that still need to take place, we think that continued delivery on reforms could pave the way for eventual credit rating upgrades and underpin further spread compression.