ThursdayNovember 25, 2021 / 06:30 PM / by Afrinvest Research / Header ImageCredit:  Afrinvest Research

Global Macroeconomic Review & Outlook

Recovery Weakens amid Resurging COVID-19 Cases

TheInternational Monetary Fund (IMF) in its January 2020 World Economic Outlook(WEO) predicted that the global economic growth would strengthen to 3.3% in2020 from 2.9% in 2019. However, the unprecedented outbreak of the novelcoronavirus, COVID-19, devastated the global economy resulting in a tragicallylarge number of human lives lost. Consequently, countries implemented necessaryquarantines and social distance measures to contain the pandemic, putting theworld in a "Great Lockdown". The magnitude and speed of collapse in activitythat followed was unlike anything experienced and with that, the global economycontracted 3.1% in 2020, a downgrade of 6.0ppts from 2019.

Withthe development and approvals of vaccines and fiscal and monetary policies tosupport the recovery of economic activities, 2021 kicked off to a good start.The IMF in its January 2021 WEO projected global economy would grow by 5.5% and4.2% in 2021 and 2022 respectively. Nonetheless, global prospects remainedhighly uncertain given renewed waves and new variants of the virus.Furthermore, economic recoveries were diverging across countries and sectors,reflecting variation in pandemic-induced disruptions and the extent of policysupport.

TheIMF, in its October report downgraded global growth projection to 5.9% for 2021(down from 6.0% projected in the July 2021 WEO) while the forecast for 2022 wasmaintained at 4.9%. This was driven by a downgrade to Advanced Economies (AEs)and low-income developing countries, largely due to worsening pandemicdynamics. Across regions, some economies are expected to report downgradesrelative to July forecast. AEs are estimated to grow by 5.2%, down 0.4ppts. TheUS economy is expected to grow by 6.0%, down 1.0ppts due to large inventorydrawdowns in Q2, supply disruptions and softening consumption in Q3. InGermany, the expected growth is 3.1%, down 0.5ppts on account of shortages ofkey inputs weighing on manufacturing output while Japan was downgraded by0.4ppts, following the effect of the fourth State of Emergency from July toSeptember as infections hit a record level. Nonetheless, the Euro Area isexpected to grow by 5.0%, up 0.4ppts. Emerging Markets and Developing Economies(EMDEs) is estimated to grow 6.4%, reflecting a 0.1ppts markup from Julyforecast. The slight improvement reflects improved assessments for somecommodity exporters outweighing drags from pandemic developments, coupled withslow rollout of vaccines (Latin America and the Caribbean, Middle East andCentral Asia, sub-Saharan Africa).

Arguably,the outlook for the global economy shows that there is light at the end of thetunnel as it is projected to dust-off the effect of COVID-19 to grow modestlyby 4.9% in 2022. This will, however, be driven by more equitable access tovaccines by countries to curtail the potential for mutation and resurgence of anew variant, significant slowdown in the infection rate of COVID-19, additionalfiscal support to boost economic fundamentals, sustained accommodative monetarystance, and quicker reopening of economies.

Global Trade Recovery amid Price Pressures

Recently,the global trade front has been muddled with the ongoing COVID-19 pandemicwhich began in 2020. The economic and social disruptions brought by thepandemic on global trade was severe during the first half of 2020, as thevolume of world merchandise trade declined 15.0% y/y in Q2:2020 following theimposed lockdowns and travel restrictions. Thereafter, lockdown measures easedas infection rates reduced, leading to a recovery in Q3 & Q4:2020. Therecovery in H2:2020 was supported by major government policy interventionswhich boosted income levels and drove spending levels globally. Due toeffective management of the pandemic, global demand was propped up preventing alarger trade decline in 2020. Accordingly, world merchandise trade dipped 5.3%y/y as stated by the World Trade Organisation (WTO).

Thepositive trends recorded in H2:2020 grew stronger in early 2021. According toUnited Nations Conference on Trade and Development (UNCTAD), the value ofglobal trade in goods and services rose c.4.0% q/q and c.10.0% y/y in Q1:2021.More importantly, global trade in Q1:2021 was higher than pre-crisis levels,however, trade in services remained subdued. This rebound was majorly driven bystrong export performance of East Asian economies, especially China. Movingforward, data from WTO revealed that demand for traded goods will be drivenmostly by North America (11.4%), supported by large fiscal injections in the USwhich should stimulate other economies through the trade channel. Similarly, weexpect Europe and South America to record import growth of 8.4% and 8.1%respectively. On the export front, we expect East Asian economies to meet muchof global import demand especially Middle East and Asia whose exports areestimated at 12.4% and 8.4% respectively. Meanwhile, export in Europe and NorthAmerica is estimated to increase by 8.3% and 7.7% respectively. In Africa andthe Middle East, exports would grow by 8.1% and 12.4% respectively but would bedependent on travel expenditures picking up over the course of the year, whichwould strengthen demand for oil.

Thesignificant shrinkage recorded in the volume of global trade in 2020 (-8.3%IMF, - 5.3% WTO) is projected to reverse with a rebound of 9.7% (IMF)/8.0%(WTO) in 2021. This is expected to be driven by rise in consumer demandparticularly in economies that have recorded significant progress invaccination, despite the possibility of sustained supply-chain disruptions andcross-border travel constraints. Nonetheless, inflation rate is expected toremain elevated globally due to rise in food prices stemming from supplyshortages, increasing prices of commodities, supply-chain disruptions, and theimpact of currency depreciation pressures on imports.

Accommodative Monetary Policy Still in Play

Thusfar, the monetary policy direction has largely been accommodative since theCOVID-19 pandemic started in 2020, providing cheap capital to support economicgrowth. Although the global economy is staged for a post-recession recoveryfollowing significant progress in vaccine administration, the rebound isexpected to be uneven with AEs outpacing EMDEs. This reflects the former'searly access to vaccinations and better room to accommodate supportivemacroeconomic policies.

In AEs,the US retained all policy parameters after cutting its benchmark rate by150bps to a range of 0-0.25% in 2020. Previously, the US Fed envisioned thepossibility of a rate hike in 2023 but following the pace of economic growthand soaring inflation, there is at least one expected hike in 2022 and thepossibility of tapering its asset purchases in November 2021. In a similarfashion, the European Central Bank left its policy rate unchanged at 0.0% whileconducting net asset purchases under the Pandemic Emergency Purchase Programme(PEPP) with a total envelope of €1.9billion until at least the end of March2022. Going forward, the ECB indicated that decisions on policy rates would beguided by inflation outlook. Likewise, the Bank of England (BoE) retainedinterest rate at 0.1%, although, its current inflation rate stands at 2.5%,higher than its target of 2.0%.

In theBRICS region, majority of countries' monetary policy stance was unchanged fromlevels recorded in 2020. The decision to keep policies easy and interest rateslower is against the backdrop of improving economic growth and relativelycontained, albeit rising, price pressures. Accordingly, India, China and SouthAfrica held rates at 4.0%, 3.9% and 3.5% respectively. However, in Brazil andRussia, policy rate increased by 75bps and 50bps respectively to 4.3% and 5.5%in June to tame rising inflation levels. In MINT (Mexico, Indonesia, Nigeria,and Turkey) economies, Turkey's monetary policy actions was the highlight asthe monetary authority raised rate by 450bps to 19.0% in five months to tamethe high inflation and bring stability to the lira. However, this led to thedismissal of the third central bank's chief in two years by President TayyipErdogan.

InSub-Saharan Africa (SSA), Egypt retained all policy parameters after reducingpolicy rate four times by 400bps to 8.75% in response to the pandemic.Meanwhile, in Nigeria, the Central Bank of Nigeria (CBN) retained all policyparameters as well, after cutting policy rate twice and expanding liquidityavailable to non-bank financial institutions. This led to significant loweringof market yield of government securities in 2020. Going forward, we expectfiscal and monetary policies to be sustained, however, monetary authorities inAEs should provide clear guidelines on future scenarios for policy to preventfinancial disruption to emerging markets.

Oil Prices in 2020… OPEC+ to the Rescue

No oneenvisaged another oil price crash in the horizon since the incidence thathappened between 2014 and 2016, yet that was the case of 2020. In 2020, Brentcrude oil price averaged $41.96/bbl. and global oil demand fell 8.8mb/d due tothe prevalence of COVID-19 which necessitated severe economic lockdowns andrestrictions in movements across regions. Nonetheless, the global oil market,battered by COVID-19, opened the new year (2021) with a price rally gatheringpace. Brent crude oil rose by an average of $54.77/bbl. in January reflecting aboost in demand in cold regions of Europe & Asia, OPEC+ supply cuts thatlook set to keep the market in deficit, and resumption of economic activitiesowing to the vaccine roll-out. The continued uptrend in oil prices was furthersustained when oil supply fell 2.0mb/d in February to 91.6mb/d after a coldsnap shut in US production and Saudi Arabia made an extra cut of 1.0mb/d.Accordingly, Brent crude oil increased to $65.41/bbl., $73.16/bbl. and$74.03/bbl. in Q1, Q2 and Q3:2021 respectively.

In thelast OPEC+ meeting in July 2021, most delegates tentatively agreed to raiseoutput by around 400,000b/d per month from August till April 2022 to supportproduction outages caused by the Hurricane IDA. Nevertheless, in line withforecast by the Energy Information Administration (EIA), we expect Brent crudeoil prices to average above $70.00/bbl. in 2021. On the demand side, robustglobal economic growth, rising vaccination rates and easing social distancingmeasures would underpin stronger global oil demand for the remainder of theyear. Thus, we expect global oil demand to increase by 5.0mb/d in 2021 and3.6mb/d in 2022, although rising COVID cases remain a downside risk. On thesupply side, we expect global oil supply to rise by 2.0mb/d in 2021 and 5.3mb/din 2022.

Trends in the Global Banking Industry

Theadvent of blockchain technology led to the unlocking of highly sought-afterfinancial solutions and assets that were not envisaged a decade ago. This hasled to the swift adoption and rise to prominence of cryptocurrencies such asBitcoin and Stable coins. While the volatile nature of crypto assets hasattracted much criticism, the decentralised nature of the technology continuesto be a source of red flag to financial regulators and governments. Asindividual investors and entities continue to exploit the decentralisednetwork, monetary regulators have struggled to supervise its usage with mostrestricting access to financial services for entities dealing incryptocurrencies. Despite this, the use cases of blockchain continue toincrease, driving the rising trend of digital currencies adoption withinCentral Banks globally.

Unlikethe popular cryptocurrencies, the Central Bank Digital Currency (CBDC) isexpected to run on a centralised network which guarantees regulatory oversightand evaluation of transactions to ensure the stability of the financial system.According to data obtained from Atlantic Council, about 81 countries,representing over 90.0% of global GDP, are currently exploring CBDC option. Outof which, only five countries have fully launched their CBDCs, while the restare either in Pilot (14), Development (16), Research (32), Inactive (10), orOther (4) phases. Arguably, central banks around the world are looking to addthe CBDC to their currency gallery and the commercial banks are expected toserve as the primary distribution channels. As much as possible, the centralbanks hope to leverage the commercial banks' large customer base, existingdigital infrastructure, and APIs to reach substantial number of customers atlaunch.

Meanwhile,sustainable finance has attracted prominent interest within the global bankingsystem as developed nations continue to advance broader Environmental, Social& Governance (ESG) plans to secure the world's future. By lending toeconomic activities that boost sustainable development and rolling outincentive products targeted at addressing ESG opportunities and challenges,banks can take charge of the sustainable development drive. Furthermore, bankshave begun to reallocate funding to sectors and companies that are driving goodESG practices. For instance, Goldman Sachs is set to mobilise US$750.0bn acrossinvesting, financing, and advisory activities by 2030 focused on sustainablefinance subject matter such as climate change and inclusive growth. Regulatorsaround the world are quite focused on the unprecedented impact that risk ofclimate change may have on financial markets and stability, hence, many haveproposed new frameworks with a broader set of expectations.

Domestic Macroeconomic Review

Covid-19 Pandemic: Long Road to Attaining Herd Immunity

Morethan a year ago since Nigeria recorded her first confirmed case of COVID-19,the country has endured the economic hardship and disruption of livelihood thatfollowed. While the world had little hope in the resilience of the darkcontinent, Nigeria managed to keep her head above the COVID-19 waters in theface of the first and second waves of the virus. Through this, the increasedlevel of hardship resulted in social disorder and economic agitations which ledto the destruction of critical infrastructures (worth over US$800.0m) acrossthe country while the economy plunged into its second recession in 5 yearsbetween Q2 & Q3:2020. Although the Nigerian economy has clawed out of therecession (now with 3 successive quarters of growth), the populace remains atrisk of the stinging fangs of COVID-19 especially with the discovery of the newDelta variant.

Beforethe commencement of vaccination, the weekly count of COVID-19 cases in Nigeriapeaked at 11,659 cases as of January 18, 2021, during the second wave,surpassing the first wave peak by 152.0%. Thereafter, there was a progressivedecline in the weekly count to 96 cases on June 14, 2021, the lowest levelrecorded in more than a year. This decline is attributed to improved awarenesson the preventive measures. However, this was short-lived as compliance withnon-pharmaceutical preventive measures was weak. As vaccination rate gainedmomentum, a new variant of the virus emerged, fueling another round of concernswith the weekly case count on the rise since August 2021.

Interms of vaccine administration, Nigeria (as at the time of compiling thisreport) has administered about 3.8m doses equivalent to 0.7% of the populationfully vaccinated compared to Morocco's 33.3m doses (40.1% of the population)and South Africa's 15.3m doses (14.7% of the population) according to data fromAfrica CDC. The low level of vaccination can be traced to the inadequateresources to acquire sufficient vaccines, poor vaccine distribution, andsceptic hesitation of the populace. It is expected that the recent acquisitionof vaccines from COVAX and the United States would increase national supply toover 9.7m doses, however, this would only cover about 2.3% of the population. Nevertheless,the aftermath of the economic slowdown experienced in 2020 has made itimperative to combat the resurgence of COVID-19. This has brought to thelimelight several approaches that can be adopted to mitigate the effect of thevirus through herd immunity. Before proceeding further let’s pause to throwclarity on what we mean by "herd immunity".

Accordingto WHO, herd immunity is the indirect protection from an infectious diseasethat happens when a population is immune either through vaccination or immunitydeveloped through previous infections. The foregoing highlighted the two commonmethods to achieve herd immunity - through vaccination or recovery fromprevious infections. The latter involves allowing the infection rate to surgewith the hope that a significant proportion of the population would respondpositively to treatment and ultimately recover. Those that recovered areexpected to have generated antibodies that can thrash the virus as such,protecting them and those around them from further infections. With thismethod, a country risks having an infection rate that spiralled out of controlthereby overwhelming the available health infrastructure. In contrast, thevaccination method protects vaccinated individuals and those around them withoutthe risk of an uncontrollable infection rate.

InNigeria's context, going the vaccination route to herd immunity is preferablegiven the inadequate health infrastructure and shortage of trained medicalprofessionals. To achieve this, a significant proportion of the population musthave been vaccinated such that their immunity against the virus reduces itsrate of infection. Although the government has continued to ramp up vaccinationcapacity, the nation remains on a long road to attaining herd immunity as only0.7% of its population has been fully vaccinated at the time of writing thisreport.

Economic Recovery: Still Below Inherent

PotentialFor over six years, Nigeria's economic managers have remained puzzled on theappropriate policy mix that would deliver strong and all-inclusive growth.Since 2014, Africa's biggest economy has continued to grapple with weak growth,sandwiched with recession in 2016 (GDP: -1.6%) and 2020 (GDP: -1.9%). Althoughthe latest recession was short-lived (lasted for only 2 quarters relative tothe 2016 episode of 5 quarters), the devastating impact was broad-based. Majoreconomic parameters - the GDP, inflation rate, unemployment rate, and foreignexchange (FX) rate witnessed sharp deteriorations, as the pandemic-induceddisruption further exposed Nigeria's years of economic mismanagement and weakcapacity to absorb shock. By the end of 2020, Nigeria's GDP contracted in realterm by 1.9% (highest since 1993 at -2.0%), while unemployment and povertyrates rose to historic high of 33.3% and 40.1% respectively.

Notwithstanding,the timely roll-out of fiscal and monetary stimulus packages in 2020 proved tobe the differentiating factor compared to the lengthy 2016 recession. ByQ4:2020, Nigeria clawed out of its second recession in 5 years with real GDPgrowth of 0.1%. However, the stimulus size was significantly low at c.3.0% ofGDP (Fiscal: 0.3%, Monetary: 2.5% CACOVID: 0.1%) compared to emerging marketpeers of South Africa (c.10.0% of GDP), Brazil (c.12.0% of GDP), Indonesia(c.3.8% of GDP), and Turkey (2020: 3.8%, 2021:2.2% of GDP) due to weak fiscalbuffer.

InQ1:2021, real GDP growth improved mildly to 0.5% (vs 0.1% in Q4:2020),supported largely by the non-oil sector with real growth of 0.8%. However, theoil sector contracted 2.2% in Q1:2021 (vs -19.8% in Q1:2020), extending thesector's recession spell to 4 consecutive quarters. In Q2:2021, the NationalBureau of Statistics (NBS) reported that the economy grew 5.0% y/y in realterm, supported mainly by the nonoil sector (up 6.7%). While this on thesurface appears a much stronger growth relative to the prior two quarters, thesize was not compelling enough to fully offset the effect of the sharp 6.1%contraction recorded in Q2:2020. Besides, the growth momentum was short ofinherent potential, estimated at 8.1% by the US Economic Intelligence Unit(EIU). Besides, a q/q analysis of the Q2:2021 real GDP number even revealed a0.8% tapering to N16.69tn, from N16.83tn inQ1:2021.

Despitethe GDP growth dynamics witnessed in H1:2021, we maintained our growthprojection of 2.5% for 2021. In H2:2021, we expect mixed performance across thecomponent segment of the non-oil GDP (Agriculture, Services, and Industries)due to the weak capacity of the fiscal and monetary authorities to stimulatethe economy, and the protracted impact of structural bottlenecks. For the oilsector GDP, we expect the gradual increase in Nigeria's oil production towardsthe new cap of 1.83mbpd (from 1.45mbpd) by the OPEC+ to boost the sectorperformance in H2:2021. Nonetheless, potential downside risk to thisexpectation includes overweighing impact of the Delta variant on global demand,reduced demand from Nigeria's major buyers - India and China - due to shift tocleaner energy sources, and resurgence of militant activities in theNiger-Delta.

Price Level: Structural Risks Pressure Inflation Higher

Thequest to rein in inflation have remained an uphill task for Nigerian policymakers in recent years. Since February 2016, when the headline inflation ratehit a double digit of 11.4% for the first time since 2012, price level hasremained elevated, taking immense toll on both individual purchasing power andbusiness capacity to flourish. This in turn have continued to impact on theeconomic performance, as business confidence index thread low (Dec. 2020: -15.2index points) due to elevated inflationary risk among others.

Beforethe emergence of the pandemic in 2020, structural bottlenecks such as weakinfrastructure, conflict in agrarian communities, weak manufacturing capacity,exchange rate volatility, and multiple taxation were the main drivers of theelevated price levels. These factors were reinforced in 2019 by FG's closure ofall land borders for 16 months (Sept. 2019 - Dec. 2020), with food pricesmostly impacted due to lack of domestic capacity to plug the gap. As thepandemic struck and crippled the already weak value-chain, the pressure on thegeneral price level intensified, racing to a three year high of 18.2% in March2021. Interestingly, the CBN has for many years, now set an inflation target of6.0% - 9.0% as one of the benchmarks to achieving its first objective - Monetaryand Price stability. Sadly, this goal has remained elusive in the last sixyears due to conflicting and counterproductive policy measures.

Althoughinflation rate eased in all the five months to August 2021 (to print at 17.0%)due to high base-year support, we believe the CBN's inflationary target willremain elusive in the near term, as structural bottlenecks remain in place. Inthe near term, we expect a reversal of the moderation in inflation due to thepass-through effect of the recent pressure on the exchange rate, the knock-oneffect of the rising cost of energy items (gas, diesel, and electricity) andthe planned complete removal of subsidy on PMS (by 2022). Consequently, werevised our 2021 average inflation rate projection from 14.1% to 15.8%.

External Sector: Worsens due to low Earning from Crude Oil

In2020, Nigeria booked a Current Account (CA) deficit of US$17.0bn, same as in2019. This translates to 4.2% of the 2020 nominal GDP of N154.0bn.By disaggregating the CA into component parts - Goods Trade, Services, Income,and Transfers Account - three recorded deficits, led by the Goods Trade accountwith a deficit of US$16.4bn (2019: US$2.2bn). The sharp jump in the Goods Tradeaccount deficit was driven by a 44.1% y/y decline in earnings from crude oilexports to US$26.8bn (2019: US$47.9bn), while refined oil imports remaineddisproportionately high at US$52.3bn, despite moderating 15.7% y/y. However,the deficit on the Services Trade and Income accounts moderated to US$15.8bnand US$5.8bn respectively, relative to US$33.8bn and US$12.5bn in 2019. Welinked the decline in Services Trade account deficit to the restriction ontrans-border travels in most part of 2020, while the tapering of Incomeaccounts deficit was driven by the aggressive management of FX by the CBN. Onthe other hand, the Current Transfers account emerged as the lone account witha surplus, albeit it recorded a 20.3% y/y moderation to US$21.0bn (2019:US$26.4bn).

InH1:2021, Nigeria's Goods Trade account deficit plunged to N5.8tn(H1:2020: N2.3tn)mainly driven by a record high N3.9tn trade deficit in Q1:2021 (Q2:2021 deficit: N1.9tn).The Q1:2021 deficit was fueled by the impact of the 23.9% devaluation of thenaira on imports bills (to N379.00/US$1.00 vs Q1:2020 - N306.00/US$1.00)and weak domestic capacity to plug the demand gap. On the export leg, aggregateinflows (H1:2021) improved by 26.1% y/y to N8.0tn, aidedmainly by the 75.2% recovery in crude oil export earnings to N6.0tnas global demand and prices recovered to near pre-pandemic levels. However,this was not sufficient to offset the impact of the high import bills whichprinted at N13.8tnover the period. Although the stabilisation of crude oil prices aboveUS$60.00/bbl. may support improved earnings from exports in Q3 & Q4:2021,yet we see the huge importation bill (estimated at US$5.6bn/month) and weakportfolio flows to sustain the deficit gap in 2021. Hence, we project a CAdeficit of US$9.1bn in 2021.

Foreign Capital Flows... Investor Apathy Deepens on FX Illiquidity

In overhalf a decade to 2020, foreign capital flows through Direct Investments (FDI),Portfolio Investments (FPI), and Other Investment grades (mainly loans &claims) emerged as the third-largest source of FX flows into Nigeria behind oil& gas (+US$206bn) and diaspora remittances (+US$124bn). According to theNBS, Nigeria attracted a total sum of US$98.2bn between 2014 and 2020 fromforeign capital flows, with the highest inflow (US$23.9bn) in 2019. However,foreign capital flows contracted sharply by 59.2% y/y in 2020 to US$9.7bn. Thiswas driven largely by a 68.6% y/y decline in FPI to US$5.1bn, which over theobserved period, accounted for 68.0% of the total foreign capital inflows onaverage. The trend in 2020 was a "flight-to-safety" by foreign investors as thespill-over effect from the pandemic weakened Nigeria's macro-fundamentalsincluding the interest and exchange rates. Besides, the inability of portfolioinvestors to repatriate over US$2.0bn in Q2:2020 due to FX liquidity managementby the CBN played a part in the contraction, as investors developed apathy forthe Nigerian market.

Foreigninvestors' apathy towards Nigeria continued in H1:2021. Total foreign capitalflows stood at US$2.8bn, which translates to a 61.1% y/y decline compared toH1:2020 (US$7.1bn). Across the three investment flow channels - FDI, FPI, andOther Investments, we noticed synchronized moderation of 35.9%, 67.5%, and51.1% y/y respectively to US$232.7m, US$1.5bn, and US$1.0bn. Although recentimprovements in economic fundamentals and the yield environment have boostedgrowth outlook, yet we believe foreign investors may remain on the side-line inthe near term, given the lack of clarity on exchange rate policy.

Fiscal Policy: 2021/22 Budget Review & Analysis

Revenue Jinx Resurfaced Again

Theneed to stimulate aggregate demand for improved recovery underlines thematerial increase in the 2021 expenditure plan of the FG, themed "Budget ofEconomic Recovery & Resilience." At first, a total sum of N13.8tnwas signed into law for appropriation by the Executive, representing anincrease of 36.6% over the actual budget for 2020 (N10.1tn).However, the National Assembly (NASS) in July 2021 approved a supplementarybudget of N982.7bnto boost military operations and facilitate the procurement of COVID-19vaccine. With this, the total expenditure plan for the year jumped to N14.8tn,which translates to an increase of 46.5% over the actual budget for 2020. Onthe revenue leg, the FG projected N8.0tn (including revenue from Government-OwnedEnterprises - GOEs) to fund the N14.8tn expenditure plan. This created a deficit gap ofN6.8tn(old: N5.8tn),to be plugged by domestic and external borrowings. Based on our analysis of theH1:2021 budget implementation report by the MFBNP, the actual budgetperformance was underwhelming. Pro-rata revenue projection of N3.3tn(excluding GOEs) suffered a shortfall of 30.4% (actual:N2.3tn),dragged by the 44.4% gap in oil & gas revenue (actual: N618.2bn)and ultimately, a 61.7% shortfall in revenues from unsustainable sourcesincluding Signatory bonus/Renewals and Grants & Donor funding (actual: N356.9bn).Notwithstanding, non-oil revenue outperformed the pro-rated amount at 104.5%(actual: N778.2bn),aided by improved performance of the CIT and VAT which returned 116.5% (N379.0bn)and 108.2% (N129.0bn)respectively. On the other hand, actual expenditure for the period (excludingGOEs) printed at N5.8tn, marginally surpassing the pro-rated amount by0.7%. Nevertheless, the expenditure size was 51.2% higher than actual revenue - translating to an actual deficit of N3.5tn (budgeted: N2.4tn), whichwas plugged by debt issuance estimated at N1.3tn andCBN's Ways & Means credit of N2.4tn. For 2022, a sum N16.4tn havebeen proposed by the executive for passage by the NASS. This translates to a12.6% increase over the 2021 budget of N14.6tn.Likewise, budgeted revenue is estimated to increase 24.8% to N10.1tn(2021e: N8.0tn),comprising of revenue from oil & gas: N3.5tn (34.8%),non-oil: N2.1tn(21.0%), and independent & others sources: N4.5tn (44.1%).This is anchored on key macroeconomic assumptions including average daily crudeoil production of 1.88mbpd, oil price benchmark of US$57.0/bbl., exchange rateof N410.50/US$1.00,Inflation rate of 13.0%, and GDP growth of 4.2%. Based on our analysis of themacroeconomic assumptions and the major drivers of the projected revenue, weposit that the actual deficit for 2022 may top N10.0tn(budgeted: N6.2tn),due to some overly optimistic assumptions and the lack of clear fundamental todrive the realisation of the 44.1% (N4.5tn) share of the revenue from independent &other sources.

Prominent Legislation & Socio-Economic Update

Petroleum Industry Act 2021: Passed, but with Many Scars

OnAugust 16, 2021, the long-awaited Petroleum Industry Bill (PIB) was finallysigned into law by President Muhammadu Buhari (now Petroleum Industry Act - PIA), to end nearly two decades of political gymnastics on the bill. Forcontext, the PIB is omnibus legislation, aimed at repositioning the Nigerianoil & gas industry through far-reaching reforms in four (4) key areas ofGovernance, Administration, Host Communities Welfare, and Fiscal Provision.

Nevertheless,we picked three major flaws in the PIA which may have far-reaching consequenceson the economy, going forward. First, the PIA provided that 30.0% of NNPC'sprofit, in addition to 10.0% from rents on petroleum prospecting licenses and miningleases, be committed to exploration in frontier basins. While we are notopposed to capacity expansion, we believe the focus of the Act should be toattract private investors to the frontier basins, given the government's thinresources. Besides, we believe the share of profit committed to this venture ismaterial and will result in a significant reduction in the flows to thefederation account in the immediate term. Secondly, the PIA did not reveal anyplans of the government to leverage existing hydrocarbon resources to build afuture of cleaner energy that could generate steady cash flow. Given the rapidshift of global attention to cleaner energy sources, we think the PIA has amajor vacuum that may become manifest over the next decade as major economiescut back on fossil fuels for cleaner sources. Lastly, the provision of the PIAdoes not restrict the President from doubling as the petroleum minister (justas we currently have). Hence, we are of the view that political interest maycontinue to play out in the operation of both the Upstream commission and theMidstream & Downstream authority, given that both managements report to thepetroleum minister, who also doubles as the President.

NPRGS - Recipe for Lifting 100m off Poverty... Another White ElephantProject in the Making?

SinceNigeria toppled India to become the "World's Poverty Capital" in 2018(according to Brookings Institute), forward-looking macroeconomic indicators inthe country continue to point to further deterioration in the poverty level. Asof 2019 when the NBS last published the Nigerian Living Standards Survey (NLSS)report, an estimated 40.1% (or over 80.0m) of the population were said to bepoor, living below the National Poverty Line (NPL) of N137,430 salaryper annum. We believe this number would have worsened by at least 1.5% in 2020,given the general economic downturn that accompanied the pandemic, and theattendant GDP contraction of -1.9%. Against this backdrop, the PresidentialEconomic Advisory Council (PEAC) set up in 2019 presented a National PovertyReduction with Growth Strategy (NPRGS) plan to the Federal Executive Council(FEC) in March 2021, to serve as the road map for the president's povertyreduction agenda.

Practically,we believe this strategic goal and the proposed funding structure are feasible,given the success story of India and Ethiopia both of which deployed similarmodels recently. However, we are not convinced about the political will of thepresent administration to drive this lofty objective, given its slow approachto critical matters. In addition, another area of concern is Nigeria's frequentpolicy somersault and lack of continuity of governance. This is evident withthe untimely ending of similar national strategies such as the National PovertyEradication Programme (NAPEP) in 2001; National Economic Empowerment &Development Strategy (NEEDS) in 2004; Subsidy Re-investment Programme (SURE-P)from 2012 - 2015, and the Vision 20:2020, to highlight a few.

Monetary Policy Review & Outlook

Monetary Policy Direction in Post-2020 Lockdown... Still in Search of theRight Mix?

Sincethe CBN Governor, Godwin Emefiele, assumed office in 2014, the dynamics ofmonetary policy tools have been steadily anchored on an unorthodox policymodel. Before the pandemic in 2020, the domestic monetary policy environmentwas utterly focused on exchange rate stability, while perspicuous rhetoric wason price stability and growth stimulation.

Meanwhilein 2021, major global central banks continued the accommodative monetary policymeasures put in place to mitigate the devastating effect of the pandemic andpropel their economies out of distress. Same way, the CBN sustained itsstimulus measures whilst keeping MPR steady at 11.5% despite the high inflationrate. In addition, other policy parameters - the asymmetric corridor at+100/-700 basis points, CRR at 27.5%, and LR at 30.0% were retained. Thispolicy direction was expected to sustain the gradual recovery of the economy,as policy tightening (to rein in inflation) will increase the cost of capital,and by extension weigh on the recovery drive. Amidst this dilemma, highinflation pressure shaped the CBN's position on the yield environment.Consequently, the average T-bill's rate rose from a record low of 3bps inDecember 2020 to 2.0% in January 2021, then rallied to 9.2% by the end ofH1:2021. Similarly, the 10-year government bond yield rose from 6.2% inDecember 2020 to 12.6% by the end of H1:2021. Despite this, real return remainedin the negative territory amidst the high inflation rate.

Meanwhile,the 60.7% y/y surge in import bills to N13.8tnrecorded in H1:2021 driven by the devaluation of the Naira and weak capacity tofill the demand gap mounted pressure on the FX reserve as demand for FXincreased. On the other hand, supply remains subdued because of low exportearnings and dwindling reserves, following the impact of COVID-19. As thedemand for imports accelerated, speculation on the Naira increased, with theCBN depleting the reserves to meet demand through the official channels. The FXreserves which opened the year at US$35.4bn declined by 5.9% to US$33.3bn bythe end of H1:2021. Accordingly, the CBN removed the official spot rate of N379.00/USUS$1.00from its website in May 2021 replacing it with the NAFEX rate of N410.50/USUS$1.00,effectively devaluing the currency.

Whilethis move temporarily brought the exchange rate unification closer by reducingthe spread between the parallel market and official rates to N91.25/US$1in June 2021 (from N116.00/USUS$1.00), we maintained our position thatthis was not sufficient to calm the pressure. Accordingly, the spread hascontinued to widen - increasing to N94.00/US$1 by the end of July 2021, despite therecovery in crude oil prices above the US$70.00bbl threshold. This increaseddivergence was further worsened by the CBN's stoppage of FX supply to Bureau DeChange (BDC) operators, as the spread crossed N130.00/US$1.00on September 10, 2021, and with no sign of a near-term improvement at sight.

A Resurgence of the Exchange Rate Conundrum… Some HistoricalPerspectives

Nodoubt, the exchange rate crisis in Nigeria pre-dates the tenure of Mr. GodwinEmefiele as the governor of the CBN. Although the CBN remains the onlyinstitution saddled with the primary responsibility of ensuring monetary andprice stability, the failure of the fiscal authorities to implementcomplementary policies has over the years contributed to Nigeria's exchangerate problems. Prior to 1958 when the CBN was established, Nigeria operates theShillings & Pence as a legal tender under the ruling of the Britishgovernment (1880 - 1912). This was replaced by banknotes and coins issued by theWest African Currency Board (WACB) between 1912 and 1959. By 1959 when the CBNissued Nigeria's first banknotes, the Naira value was pegged to the highestbetween the US dollar and the British pounds at a rate of N0.71 toUS$1.00/£1.00. This exchange rate regime was supported by Nigeria's position asa net exporter of primary commodities to the rest of the world and this trendsubsisted over the next two decades.

Between1973 and 1986, Nigeria's exchange rate policy changed four times, driven by thejoint impact of political and policy instability, widespread corruption,overbloated governance structure, and the neglect of labour-elastic sectorssuch as agriculture and manufacturing sector for "oil money". At this point,Nigeria had become a net importer from the rest of the world, notably,manufacturing and services products. By the end of 1986, the Naira had devaluedby more than 100.0% to N2.02/US$1.00. This trend became worse from 1987 whenNigeria began implementing the recommendations of the Structural AdjustmentProgramme (SAP) of the IMF and the World Bank as preconditions for assessingfresh borrowing. Aside from the inherent currency devaluation mechanism of theSAP on the beneficial countries, the gross impunity and high-handedness thatprevailed during the military administration from 1990 to 1999 furthercompounded the exchange rate crises, as the domestic supply of primary andsecondary products hit new lows. By 1999 when Nigeria returned to a democraticsystem of governance, the exchange rate had fallen to N108.00/US$1.00,while external borrowings under the SAP (which ended abruptly in 1993) andother facilities added US$6.9bn to external debt stock increasing it toUS$29.1bn.

Despitethe external debt relief arrangement (worth US$30.0bn) in 2006, which wasfollowed by a strong accretion of the FX reserves in the seven years to 2013(averaging US$42.3bn), the exchange rate further moderately ebbed to N157.42/US$1.00by the end of 2013 from N108.00/US$1.00 in 1999. This was aided by pockets ofoil price shock in 2003/4 and the global financial crises cum oil price shockof 2008/9. Notwithstanding, the strategic management of both crises by theSoludo (2003-2009) and Sanusi (2009-2014) led administrations at the CBNthrough timely rate adjustment and the attraction of FPI's with market-friendlypolicies prevented the crises from escalating.

2015/17 Exchange Rate Crises... A Case of a Wrong Approach to GoodIntention?

The2015 - 2017 episode of the exchange rate crisis will go down in history as oneof the worst faced by Nigeria. Although the CBN could be absolved of the rootcause of the crises (like the case of previous episodes), its managementapproach to the crises led to a more devastating experience.

Forcontext, Nigeria faced a severe FX illiquidity situation at the beginning of2015 following the crash in global crude oil prices to below US$50.00/bbl. inQ4:2014 from US$114.6/bbl. as of H1:2014. The illiquidity situation worsened asoffshore investors began to pull out from the Nigerian market, following CBN'sreluctance to devalue the exchange rate. Resultantly, the CBN's resolved tocapital control measures, blacklisting 41 import items from accessing theofficial FX market. With the spillover of the demand from the ban hitting the parallelmarket, the crisis aggravated.

As thescarcity worsened, demand for FX ramped up in the parallel market, leading tothe wide margin between the official and parallel market rates of N61.30by December 2015 (from N4.22 in June 2014). In a surprise reaction to thisdevelopment, the CBN in January 2016 announced a ban on the sale of FX to BDCsover allegations of FX racketeering - a development that further worsened theFX crises until mid-2017 when the CBN set up the Investors & Exporters (I&E)window and also reached a truce with the BDC operators.

Reincarnation of the FX Crises in 2021... Same Ailment but Wrong Treatment

In our2020 BSR, we emphasized that "the Nigerian economy may be heading for anothercurrency crisis, just three years after it began recovery from the lastepisode. While the reverberating effect of the crash in global crude oil priceshas been the dominant trigger of many of the recent currency crises, wehighlighted that the CBN’s management strategy during the last episode was inadequate.We posited that the current management of the CBN takes a cue from measuresthat were adopted by the prior CBN governors (timely devaluation and otherproactive responses) to manage the 2003/4 and 2008/9 FX crises."

Basedon the reality that played out since FX illiquidity resurfaced in 2020, the CBNhas resolved to adopt most of its 2015/17 strategies. As the pandemic struckglobally, sending crude oil prices to the lowest level in four decades(US$17/bbl. in April 2020), the CBN yet again was swift to implement capitalcontrol measures but was reluctant to fully devalue the Naira to reflect theforces of demand and supply. Also, the dual pressure of reduced inflows fromcrude oil receipt and the unsustainable support provided to the Naira (by theCBN) eroded US$2.3bn from the foreign reserves in H1:2021, thereby raisingconcerns over FX sustainability.

As themargin between the official and parallel market rate widened to N86.74by the end of Q2:2020 (from N52.10 pre-pandemic), offshore investors moved torepatriate their investment to avoid imminent exchange rate loss. However, thisattempt was foiled by the CBN capital control measure as an estimated sum ofUS$2.0bn offshore holdings and c.US$5.0bn FX swap obligation was trapped due toFX illiquidity. We believe the credibility of the CBN has taken a big hit withthis development and it will take a much clearer exchange rate policy andattractive yield environment for Nigeria to attract sizeable foreign capital flowlast seen in 2019 (US$23.7bn).

Ban on FX Sales to BDCs: The Case of a Sacrificial Goat?

In asimilar fashion to the January 2016 episode, the CBN governor at the end of theJuly 2021 MPC meeting placed a ban on FX sales to BDC operators and suspended theissuance of new BDC licenses over allegations of FX racketeering. This wasfollowed by a directive to DMBs to set up an FX teller desk in all branches tocater to approved FX transactions.

Althoughthis development could help boost the FX and commission income of DMBs (due toincreased transactions), we are less optimistic on how it would restorecomplete sanity in the FX market given the huge FX needs that are met outsidethe official delineation. Besides, the import-substitution objective of the FGcum CBN which led to the blacklisting of 41 items from accessing FX at theofficial window in 2016 has not yielded any significant fruit that could helpreduce the demand for FX in the parallel market.

Recallthat, currency crisis worsened in the aftermath of the 2016 ban of FX sales toBDCs, despite the instruction to commercial banks to fill the void. This on onehand was driven by the insufficient FX supply to banks by the CBN, and on theother hand, customers' apathy to banks' cumbersome processes. Consequently,demand for FX at the parallel market remained elevated, aided by the largemarket already created by the CBN's ban on FX sales to importers of theblacklisted 41 import items. By extension, these fueled a steep rise in theinflation rate (Jan'16: 9.6% to Dec'16: 18.6%) and the deterioration ofoffshore investors' confidence which resulted in large capital flow reversal of67.2% y/y to US$1.8bn in 2016.

Interestingly,the CBN had in the last 20 months expanded its list of banned items to 45 items(Maize, Fertilizer, Milk, and Sugar being the new additions), while foreigncapital inflow declined 61.1% y/y in H1:2021 to N2.9tn. This isreminiscent of the 2016 trend, especially as the import-substitution objectiveof the FG has not yielded desired results.

Banking Sector Performance In 2020 And H1:2021

Industry Stays Strong in a Pandemic-induced Environment

Amidstthe tough macro and tight regulatory environment, banks remained resilient.This is evident in banks delivering a 15.6% and 6.8% y/y growth in total assetsand profit respectively in H1:2021 despite elevated CRR debits and compulsoryLDR levels. With the pandemic, the Nigerian Banking sector vulnerabilityheightened which required swift policy responses from the CBN. Consequently,the CBN rolled out stimulus packages to critical sectors with significant loanexposure, reduced interest rate on intervention facilities (from 9.0% to 5.0%)and granted banks the forbearance to restructure loan exposure. As a result,real GDP growth in the financial institutions sector grew by 13.3% y/y.

Nonetheless,the sector's earnings and profitability slowed in 2020, hurt by the stringentimplementation of the CRR policy (27.5%) which effectively sits at north of50.0% for some banks due to CBN's non-refund policy and the discretionaryexcess debits. In addition, the low interest rate environment in H2:2020 andH1:2021 drove weak yield on assets for the sector despite the drive to expandasset base. These factors coupled with deposits reduction in both consumer andbusiness segments, exposure to currency risk and increased credit default,affected Nigerian bank's profitability. Consequently, aggregate gross earningsfor the banks within Afrinvest's coverage (5 Tier-1 and 8 Tier-2 Banks)marginally grew by 2.8% in 2020 relative to 9.9% in 2019. Meanwhile, earningsweakened as the industry's PBT fell 2.3% from a growth of 13.2% in 2019 whilePAT slightly grew by 0.4% y/y compared to 13.1% in 2019.

Interms of asset creation, the banks under our coverage grew loan books by 16.3%y/y to N24.6tnfrom N21.2tnin 2019, as banks aimed to achieve the CBN's LDR target (65.0%). The growth wassupported by a surge in deposits of 28.4% y/y within the same period. Also,aggregate credit to private sector rose 21.7% in the first 12-months of thepolicy implementation to N30.2tn compared to an 11.1% increase in the preceding12-months, according to data obtained from the CBN website. Industrynonperforming loan (NPL) ratio in 2020 improved to 4.4% from 5.3% supported bythe CBN's regulatory forbearance to boost asset quality. However, Cost of Risk(CoR) weakened to 1.2% in 2020 from 0.9% as impairment charges surged 105.5% toN392.5bnfrom N191.0bnin 2019 given the increases in stage 3 loan classification. Industry CapitalAdequacy Ratio (CAR) improved to 19.4% in 2020 relative to 18.7% in 2019 (ex.Unity Bank), reflecting the banks resilient. This was higher than theprudential regulatory thresholds of 10.0%, 15.0% and 16.0% for national banks,international banks, and Domestic Systemically Important Banks (D-SIBs).

Basel III Adoption… Fostering Sound Financial Stability

Theimplementation of Basel III started globally since January 2013 and placesimportance on strong liquidity and capital for financial stability. TheNigerian banking sector after successfully implementing Basel II, is set tocommence the adoption of Basel III from November 2021 after a year-long delaydue to the pandemic. The phased implementation requires a parallel run of BaselII and III for six months with a possible three-month extension and atransition to full implementation if banks perform satisfactorily. Overall,this adoption would strengthen banks' stressed capital level, improve capitalquality (as risk levels are reduced with the exposure restriction) and maintainstrong liquidity position. However, this is no good news for banks below par ascapital raising to meet up could cause a dilution and affect dividend payout.Also, maintaining the revised liquidity position could hurt NIM as banks haveto paydown long-term assets with higher yield.

Ashighlighted by the CBN, adoption of Basel III requires Nigerian banks tostrengthen their current capital adequacy, liquidity, and leverage positions.Accordingly, banks are required to hold a capital conversation buffer of 1.0%in addition to the minimum CAR of 15.0% (international) and 10.0% (national)with an additional 1% of common equity capital for higher loss absorbency forDSIBs, in the form of common equity capital. Notably, additional tier 1 capitalwhich is typically hybrid instrument was introduced in the computation of totalTier 1 capital. Also, ceiling for banks' dividend payment would be based onCommon Equity Tier 1 (CET1) capital adequacy, NPL ratio, leverage ratio andcomposite risk rating (determined by the CBN) as against previously using NPLand CAR ratios.

Forliquidity measure, banks are to maintain liquidity coverage ratio (LCR- a stockof high-quality liquid assets (HQLA) that is at least equal to total net cashoutflows) of at least 100.0% on an on-going basis. Similarly, liquiditymonitoring tools were introduced and includes contractual maturity mismatch,concentration of funding, available unencumbered assets, LCR by significantcurrency and market-related monitoring tools. To lower excessive on andoff-balance sheet leverage by banks, the CBN requires that banks maintain aminimum leverage ratio of 4.0% and 5.0% for DSIBs (computed as tier 1 capitalover on and off-balance sheet, derivatives, and securitiesbacked transactionsexposures).

Fromour analysis using 2020 figures, all banks in the tier 1 and 2 categoriesoperating as a national, international and DSIB passed the stress testconducted to determine compliance with new CAR threshold. However, we note thatFBNH and FCMB failed this test at current levels (H1:2021- FBNH:15.7%;FCMB:15.9%) thus it is important for the bank to shore-up capital level eitherthrough retained earnings or additional tier1 capital issuance as the currentenvironment is not very supportive of common equity raise.

Tier-based Criteria… Upscaled to Reflect Changes in Economic &Business Landscape

In our2013 BSR, we initiated the concept of "tier-based classification" for bankswithin our coverage universe. This stratified our coverage banks into twobuckets - tier-1 and tier-2, based on performance of selected industryparameters that are scientifically testable in establishing an all-aroundefficacy. Key parameters considered were the size of total assets, capitaladequacy, asset quality (with a focus on NPL), and liquidity. The benchmarkadopted for each parameter are - minimum total assets of N1.0tn,a minimum CAR of 15.0% (CBN's benchmark), NPL cap of 5.0% (CBN's benchmark),and LR of 30.0% (CBN's benchmark). Lenders who meet up with all the benchmarkconditions for all the parameters are classified as tier-1 banks, while therest, are classified as tier-2 banks. Based on our evaluation using thesecriteria, only six of our coverage banks - Access, Guaranty (now GTCo), UBA,FBNH, Zenith, and ETI, met all the criteria for the tier-1 bucket.

Giventhe significant changes in the macroeconomics environment (especially, withinflation and exchange rates) and the banking industry landscape over the lasteight years, we have revised the qualification threshold and also introducednew parameters. Consequently, we raised the minimum threshold for total assetsto N5.0tn(to capture the c.108.6% Naira devaluation since 2013) and CAR to 16.0% in linewith the D-SIBs benchmark.

Due tothe lack of sufficient details on CBN's forbearance provision to some industryplayers (since 2015), we substitute the asset quality parameter in our previouscriteria with management efficiency - defined as 3-years average ROAE greater(tier-1) or less (tier-2) than 3-years average core inflation rate (2018 -2020) of 10.0%. Owing to CBN's strong enforcement of the 30.0% LR andinsufficient data on excess CRR, we have excluded liquidity from the selectioncriteria. The newly introduced parameters are share of business assetsdomesticated in Nigeria, CAR consistency, and Deposit size. To qualify for thetier-1 bucket, the share of business assets in Nigeria must be equal to orgreater than 50.0%, 3-years average CAR must be equal to or greater than 16.0%while, the last full year deposit base must be equal or greater than N2.5tn.Based on this revised criterion, only five lenders - ACCESS, FBN, GTCo, UBA,and ZENITH met all the criteria for the tier-1 bucket as at end of FY2020.

Market and Banking Stocks Performance

In2020, performance at the domestic equities market was a tale of two halves - agloomy first half and a booming half. Although 2020 kicked-off on a positivenote as investors switched interest to stocks due to unappealing fixed incomeyield, this mood was dampened by the outbreak of COVID-19. Nevertheless,reopening of economic activities, fiscal and monetary stimulus andbetter-than-expected corporate earnings drove positive sentiments, leading to a50.0% gain in the benchmark index.

Reflectingthe overall market mood, the banking index returned 10.1% in 2020. Theperformance was driven by investors' interest following impressive earnings andhigh dividend yield. FCMB (+80.0%), ZENITH (+33.3%), and FIDELITY (+22.9%) werethe best performing stocks in the sector while ACCESS (-15.5%), UBN (10.8%),ETI (- 7.7%), and WEMABANK (-6.8%) lagged.

Comparison of Nigerian Banks with BRICS and SSA Banks

UsingCAMEL (Capital adequacy, Asset quality, Operational Efficiency, Profitabilityand Market Valuation) analysis, we modeled tier-1 Nigerian banks compared totheir SSA and BRICS peers. From the analysis, the following can be inferred:

Capital Adequacy: CAR ofselected SSA (19.2%) and BRICS (17.2%) banks recorded was above the 8.0% globalregulatory minimum under the BASEL III, reflecting effective risk managementduring the pandemic. However, African peers such as Egypt (21.7%), Ghana(20.2%) and South Africa (19.8%) were better capitalized than the Nigerianbanks (19.7%). In the BRICS region, the Nigerian banks fared better than itspeers save South Africa.

Asset Quality: The negativeimpact from COVID-19 on risk assets weighed on SSA and BRICS banks leading to asubstantial rise in impairment charges. The average CoR of selected SSA andBRICS bank stood at 2.6% and 2.4% respectively. Kenya banks (3.6%) reported thehighest average CoR among the banks in the SSA region, trailed by South Africa(3.5%). Equally, across the BRICS region, the Brazilian banks (3.9%) remainedthe worst performer reflecting the higher business risk environment. TheNigerian tier-1 banks (1.8%) performed relative better than its peers saveEgypt (1.7%), Morocco (1.7%), Russia (1.4%) and China (1.0%).

Operational Efficiency: Across theSSA and BRICS region, the average cost to income (CIR) for most banks is quitehigh. In the SSA region, the Nigerian banks (58.0%) were the worst performersgiven the rise in operating expenses and moderation in operation income.Nevertheless, Egypt (35.8%) maintained the top spot, trailed by Ghana (51.5%)and Kenya (52.7%). Across the BRICS region, Chinese banks remained the mostefficient with an average CIR of 34.8% while Brazilian banks (77.3%) came in atthe bottom.

Profitability: Surprisingly,across both SSA and BRICS regions, Ghanaian banks reported the best ROE and ROAof 23.1% and 3.5% respectively due to better-thanexpected operationalefficiency within the period. Despite the heightened macroeconomicvulnerabilities to operate business, Nigerian banks emerged the best among itsBRICS peers with an average ROA and ROE of 15.9% and 1.8% respectively.

Market Valuation: ThePrice-to-Earnings (P/E) and Price-to-book value (P/BV) ratios for the selectedNigerian banks settled at 5.4x and 0.5x respectively relative to SSA (18.6x and1.5x) and BRICS (11.7x and 1.6x) averages. This implied that Nigerian banks arestill relatively undervalued, even as the Nigerian Exchange Limited recorded astrong performance in 2020.

FY:2021 Crystal Ball

Broadlyspeaking, is safe to conclude that the Nigerian banking sector remainedresilient in the face of COVID-19 and several regulatory headwinds.Nevertheless, banks' earnings and asset quality have taken a beating whilebeing under pressure from competition. Also, the pandemic has provided learningpoints for players in the sector to reshape and reimagine theirproduct/services offerings for longterm growth and sustainability. As thebroader economy recovers, regulators are expected to relax the support given tothe financial system which might affect some segments of the bank's business.The banking sector faces a continuous period of uncertainty, and the resilienceof the sector would depend on players' response to new developments. To thisend, we highlight key outlook for FY:2021.

1. EarningsPerformance to Remain Fragile: Despite the rising Naira interest rate trendso far in 2021 (against 2020 when it crashed), we do not expect a significantimprovement in banks' operating terrain. While the banks have shownhistorically that they can defend NIMs through different interest rate cycles,we expect the CBN's continued cash sterilisation via CRR debits and punitivemeasures for 65% LDR non-compliance to tame the prospect for strong growth inthe short term.

2. LoanBook Growth Amid Expectation of Asset Quality Deterioration: We expect a15.0% growth in industry loans and advances as the economic recoverystrengthens and banks can drive growth in deposits. Compliance with the CBN'sLDR directive will not be a big driver for loan growth in our view as banksplace a higher premium on quality risk asset creation over the punitive measurefor non-compliance. With the improvement in macroeconomic conditions, we expecta lesser deterioration in asset quality based on the ECL model. We note thatthe CBN has extended its regulatory forbearance for loan restructuring.However, the viability of most of the restructured loans is still questionable.

3. IncreasedDigitalization: With the pandemic, the adoption of digital banking channelsrecorded a significant increase. Even with the relaxed restriction, this trendhas continued as observed from our 2021 banking survey. We expect this growthto be sustained in 2021 and beyond as increased internet and mobile penetrationwould result in higher transaction volumes resulting in higher income fromdigital channel. This would also drive operational efficiency and lower thecost of operating a branch system. However, to capture the full benefits ofdigitization, banks have to make continued investments in infrastructureresulting in higher costs of maintenance which we expect would mute the savingsfrom operational expenses. Also, tussle with Fintech players in terms ofinnovation and volume hinder banks' earnings potential through this medium.

4. BASELIII Implementation to Elevate Capital and Liquidity Levels: Theimplementation of the BASEL III guidelines in November 2021 is expected to haveimplications for banks in terms of a tradeoff between having solid capital baseand dividend payouts, high liquidity and strong margins and loan growth. It isour view that the guideline would help in controlling liquidity, make banksstronger and more resilient during period of stress given that it addressesissues on minimum liquidity coverage ratio (LCR), capital adequacy and systemrisk. For banks to comply with the LCR criteria, bank would have to hold higherliquid assets while decreasing proportion of long-term debts. This will hinderbanks' ability to create higher margins over the long-term. The implementationof Basel III requires a stronger and higher Tier-1 capital to absorbunanticipated shocks. To this end, we expect banks with weaker Teir-1 capitallevels to increase retained earnings as current environment is not very supportiveof equity raise combined with the already elevated issued share capital of mostbanks.

5. Need for Regulatory Collaboration: We have noticed the increasing diversification of banks into new andadjacent financial services segments by leveraging on HoldCo structure. On theback of this, we recommend a more inclusive collaboration on the part of keyregulators in the banking, insurance, pension, capital market and governmentsectors. This is necessary to mitigate regulatory restrictions and enable exposureto a wider spectrum of financial services to further deepen the financialsystem and improve financial inclusion.

Related News

1. Nigerian Banks: H1 2021 Scorecard
2. Banks in H1 2020: Imagining Beyond COVID-19
3. Banks' H1 2019 Numbers: Top Line Growth, Bottom Line Uncertainty
4. Nigerian Banks’ Performance - H1 2018
5. Global Financial Stability Report October 2021: COVID-19, Crypto, and Climate
6. Climate Risk Will Be Visible in New Structured Finance Deals in Coming Decade
7. European Banks Face Weaker Revenue Outlook
8. Nigerian Banks' Near-Term Credit Risks Ease
9. Nigerian Banking Sector Recovery Still Hampered By Bad Loans
10. Nigerian Banks' IFRS 9 Shows Asset Quality Is Still Weak
11. Nigerian Banks' Rising Local Currency Issuance Is Credit Positive - Fitch
12. Nigerian Banks' Eurobond Buybacks Show Better FC Liquidity - Fitch
13. IFRS 9 No Threat to Nigeria Banks'' Regulatory Capital - Fitch
14. Asset Quality Replacing Foreign Currency Liquidity as Main Risk for Nigerian Banks - Fitch
15. Afrinvest Banking Sector Report Sets Agenda for New Government
16. Afrinvest Special Report on Nigerian Banking Sector - July 2013