In Dire Straits: H2 2020 Outlook

July 29, 2020/InvestmentOne Report

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  ·         We opine that, to see a lasting end to the menace of COVID-19, a cure or vaccine will have to be created. While a vaccine may be developed by 2021, we opine that this  pandemic will continue to have a lasting effects (positive and negative) on major “modus operandi” in human lives, businesses, industry development, global supply chain and perhaps, climate change.  

·         We have seen GDP numbers of major economies shrinking in Q1 2020. We expect further decline in economic growth. We opine that recovery is likely to be a “U” pattern, as economic activities are likely to pick up slowly. This is on the back of potential difficulties in recreating the jobs lost during the pandemic and fears of second wave. 

·         Various protests have broken out in different parts of the world, in the midst of increasing inequality. While markets are yet to respond emphatically, the world’s numerous hotspots have the potential to create macroeconomic instability for both emerging and advanced economies. 

·         Nigeria’s economy was on a thin ice prior to the advent of novel COVID-19 as the nation’s growth continued to lag behind population growth rate and its pre-2016 recession average of c5.0% (2011-2015). As such, the country’s GDP only grew by 1.87%, the lowest in six quarters, in Q1 2020 when the impacts of the current pandemic had not reflected in economic activities. We believe the weakness in the non-oil sector may be due to the long term challenges coming from weak infrastructures, insecurity and weak consumer demand despite the CBN’s effort to boost credit to the real sector. 

·         Going forward, we expect Oil sector to contract from Q2 2020, due to the nation’s compliance with the OPEC+ output cut agreement as well as high base effect (Oil output was around 2.01mbpd in 2019). Under the OPEC+ agreement, Nigeria’s oil output is capped at 1.41mbpd between May and June 2020, before increasing to 1.50mbpd between July and Dec 2020.  We expect oil output on the average to be around 1.8mbpd (including condensates) in 2020. 

·         Looking at the CBN’s PMI report for the months of May and June which showed contraction for Manufacturing at 42.4points and 41.1points respectively and Non-Manufacturing PMI at 25.3points and 35.7points respectively (50: Constant, <50: Contraction, >50: Expansion), we expect growth on the Non-oil sector to be negative in the next quarter. Overall, we believe Nigerian economy may enter a technical recession by Q3 2020 with recovery likely to be seen further into 2021. We highlight that Nigeria’s GDP is expected to record negative growth of -5.4% and -3.2% according to IMF and World Bank respectively in 2020. We expect GDP to fall by 3.6% in 2020. 

·         Going into H2 2020, we spotlight that policy decisions such as the long debated increase in electricity tariffs and a unification of the different FX rates, when implemented, could heighten inflationary pressures to the upside. Given the current economic climate and the boost output growth, we do not expect the CBN to take on a contractionary monetary stance in the near term to curb inflation. However, it is worthy to note that the current CRR and LDR mechanisms in place serve to mop up liquidity effectively. 

·         We maintain a view that Naira may remain under pressure in the near term as we expect more FX demand as international flights resume. However, we expect more items to be banned from the official FX market as CBN tries to reduce FX demand for imports. Looking at the current inflation differential between in Naira assets and dollar assets, we would expect about 10%      devaluation in the medium term. From historical point of view, CBN has always adjusted exchange rate in stages. 

·         We expect the budget to face implementation challenges on the back of weak oil price, crude production slashes. More particularly, we see capital expenditure continuing to bear the brunt of poor implementation. Additionally, revenues from non-oil sources such as taxes, customs revenue and stamp duties are set to decline with the real economy likely going to take a hit from the impacts of lockdown measures and business activities dwindle. 

·         Debt service already constitutes a large chunk of FG expenditure and has inhibited revenues from being directed towards growth enhancing investments.  We highlight that this could rise exponentially when principal payments need to be made, given the monumental pile of debt being raised this year and would inadvertently magnify the problem of poor levels of revenue generation. 

·         The general expectation of a recession in 2020 constitutes a significant downside for economic activities. This is expected to negatively impact performance of companies, consumer spending, savings and investment. For Nigeria, weak oil price means declining government revenue and slowing capital expenditure. We expect negative sentiments to flow into the equities market in the absence of strong fundamentals. However, we opine that this maybe one of the best periods to start picking some of the quality names with a medium to long-term investment horizon. 

·         With yields trending downwards, negative real return is likely to persist for investors in the FI space; consequently, we expect the search for positive real return to be an underlying motivation in keeping and attracting the interest of investors in the near term.

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