September 17, 2018/InvestmentOne Report
· Political risk has historically been the focus for domestic and foreign investors in the year preceding elections in Nigeria. It is often said to contribute to capital flight, instability of the local currency and a distraction from economic reforms. Systematic to most election cycles is some level of political instability amongst and between rival parties and in some cases violence, increased government spending skewed towards campaigning and winning the popular vote, often at the expense of capital expenditure and economic progression.
· However, what is unclear is whether these factors alone account for the volatilities in foreign currency and capital markets in the run up to elections or whether the movement in Brent oil prices, Monetary Policy decisions in developed economies and other exogenous factors play a role.
· To better understand the potential implications of electioneering and political risk on the economy as a whole we look at the last five elections (1999, 2003, 2007, 2011 and 2015), specifically the 12month period either side of the elections.
· In diagnosing political risk, we analyzed the political climate and how close the elections were in those years while scrutinizing changes in the nation’s foreign exchange reserves; capital importation (as a gauge of foreign investor participation); headline Inflation, benchmark interest; foreign exchange rate (both Inter-bank & Parallel market); yields in the fixed income market (91-day T-bill); and movement in the equities market. In addition to this, we incorporated movements in global Brent oil prices and the U.S. Federal Reserve rate over the same period, given the importance to the Nigerian economy and foreign investor participation.
· From our analysis of the last four presidential elections, there appears to be a slight correlation between political risk and capital flight. However, the extent of this is dependent on the intensity of the elections and conflicts within the country. It is also worthy to note that exogenous factors such as decline in oil prices tend to exaggerate the capital flight, decline in foreign currency reserves and the slowdown in economic activities.
· While the political tension has gradually been escalating in the run up to the 2019 elections, we expect this to intensify as parties step up their respective campaigns and spending, particularly as we approach and move past the primaries in October 2018. Although there is a chance for an accelerated budget implementation particularly short term projects and recurrent expenditure, we expect electioneering to detract from much needed economic reforms to spur growth while we should see headline inflation trend upwards.
· Furthermore, we are concerned about the escalating violence in the North between Farmers and Herdsmen, which could negatively impact food supply and inflation, as well as spreading to other parts of the nation. Although calm, the potential for a resurgence of unrest in the Niger Delta remains, which is key to oil production and revenues; and handling of Boko Haram insurgence could be even more delicate as electioneering intensifies.
· However, what is clear is that we are already seeing a level of capital flight but this has largely been systematic to most emerging market economies as a result of ‘risk off’ sentiment by foreign investors due to concerns on geopolitical tensions, U.S. Fed’s rate hikes and trade war. This contributed to the lacklustre performance in the domestic equities and fixed income markets in Q2 2018 and Q3 2018 despite Brent oil prices remaining high, oil production levels improving, although volatile, and the nation’s foreign exchange reserves remaining above US$45billion.
· Even though the outlook for key economic indicators appears positive, we could see further capital outflows in H2 2018, with an estimated US$9billion of local treasury bills held by foreign investors at the end of August 2018, due to uncertainty on the outcome of the elections. The level of outflows could be amplified by increased violence in the North as well as an escalation of trade tensions in the global space.
· Nonetheless, we expect that the accretion to reserves (+50% y/y) over the last 12months should aid the Central Bank of Nigeria in the defence and stability of the Naira amidst capital outflows as witnessed in recent months.