Coronanomics (1) - Understanding the Realities of an Impending Recession

Saturday, June 06, 2020 / 08:00AM / by Proshare Content/ Header Image Credit: EcoGraphics

Executive Summary

The connectedness of industries is positive in good times and a problem when times are difficult. - Professor Hamid Beladi

This report represents a deep dive into theemerging realities of a new world economic order that strips away pretenceabout the growingly outdated concept of globalization. The COVID-19 pandemichas shown that an integrated and tightly knit world could create lasting andcatastrophic problems and that nations may increasingly need to secure domesticsupply chains by strong backward domestic integration. The potent 'Asianisation' ofglobal supply chains has started to unravel as North America and Europe revisittheir production links to China, the s second-largest economy. Emergingmarkets such as Nigeria have also had to take a step back to see how they canprotect their economies from imported contagion of both a health and aneconomic variety.

The report makes a case for a new approach tofiscal and monetary policy management that it calls 'Fiscmon' whichrepresents an integrated approach that sees monetary and fiscal management tiedinto a forward plan of action to achieve clearly stated objectives within aspecified time frame. The report observes that this approach is becoming aglobal 'normal' as central banks become more assertive in intervening in thepush towards domestic economic growth and employment.

Nigeria's resource mindset has stayed trapped in apast that is fast becoming a burden. Within the dynamics of the new COVID-19inspired economy, fiscal policy is reduced to the task of bean-counting whilemonetary policy increasingly ascends to the status of the country's premiermacroeconomic policy driver. The recent ascendency of monetary authorities hasbecome a global event as new economic management frameworks adopted by nationsblur the once solid line between fiscal and monetary policy. As supply chainsget disrupted, and consumer spending power tails off, the trilemma of balancinggrowth, jobs and low inflation has become a Gordian knot.

The Central Bank of Nigeria (CBN) has since 2015(four years before the COVID-19 pandemic), taken on an increasingly aggressiverole towards determining the trajectory of economic growth by implementing aseries of intervention strategies designed to spur the growth of the realsector.

Monetary strategies have ranged from concessionaryagricultural loan schemes and insurance cover to aviation sector loans andspecial credit programmes for manufacturers. The outcomes of the variousinterventions have been stretched from being good to being weak. The mostsuccessful intervention of the CBN appears to be its agricultural sectorinterventions but the aviation and manufacturing initiatives have proved to bemore difficult to resolve.

The report looks at the traditional methods ofhandling macroeconomic disruptions and demonstrates why the old ways of doingthings no longer suffice. The new reality of economic management takes off froma set of revised frameworks that underly the ways new economies work. TheInvestment/Savings and Money supply/Money demand curves or the IS and LM curvesof old that have served so well for so long are currently being called toquestion.

The Hard Knocks of A Trilemma

Going forward, Nigeria will be smack in the middle ofa trilemma. The primary problems Nigerian fiscal and monetary policymakers willface in 2020/2021 are the following:

Negative gross domestic product (GDP) growth (Q1 2020growth was +1.87%)
Higher levels of domestic inflation rate (April 2020inflation rate was +12.34%)
Foreign exchange instability (N/US$ was N360/US$ inApril 2020)

The monetary authority (CBN) is caught betweeninflation dampening and economic growth. Keeping the Monetary Policy Rate (MPR)at 13.5% and Cash Reserve Ratio (CRR) at 27.5% the central bank has indicatedits desire to keep the inflation rate in check but by imposing a loan todeposit ratio (LDR) of 65% in Q3 2020, the Bank showed a preference foreconomic expansion through credit growth. The requirement of a high MPR and ahigh LDR appear inherently contradictory. To expand credit the CBN would needto grow money supply and reduce interest rates as well as bank's cash reserveratios, but in the last twelve quarters, the problem has appeared morepersistent. Beyond the obvious difficulty of balancing growth goals with thedesire to contain inflation another part of the policy puzzle has beenmaintaining external balance by keeping the naira strong in foreign exchangemarkets.

To keep the naira strong in FX markets, the domesticinterest rate needs to be high to give a 'riskpremium' that would afford foreign investors the opportunity to gainmargins higher than those in more mature economies. The premium would suggestthat domestic interest rates would need to stay high at a time the economy alsoneeds to grow. Usually, at this point, the fiscal authorities try to make upfor the growth slack by spending more money and creating new jobs.Unfortunately at a time of supply chain disruptions and a health pandemic, thetraditional model of growth and non-acceleratedinflationary rate of unemployment (NAIRU) breaks down.

TheSearch for Liquidity

Higher local interest rates would also strengthen thenaira but discourage non-oil exports. The COVID-19 new normal of increasedeconomic nationalism and domestic supply chain strengthening could easily becompromised by a stronger naira exchange rate. The fiscal and monetaryauthorities would need to decide whether an external imbalance in the currentaccount would be a good gambit in the face of rising domestic cost of credit.Some economists, such as Dr. Ayo Teriba see opportunities within and beyond theCOVID-19 era to attract international liquidity to grow domestic infrastructureand local production linkages while other economists, such as Dr. AbiodunAdedipe believe that heavy reliance on foreign liquidity could createchallenges in the face of unexpected international shocks, thereby importingforeign financial contagion.

Teriba argues that the COVID-19 period could be usedfor a reset where Nigeria positions itself for growth by unlocking liquidityboth domestic and foreign. The economist has argued that liquidity locked innon-core physical assets should be liberated and directed to self-sustainingand self-financing projects. He, for example, argued that prisons built onprime land across the country should be relocated and the underlying value ofthe real estate should be realized and directed towards projects in whichmarginal social benefits exceed marginal social costs.

However, a few observers have differed from Teriba,arguing that such a strategy would result in further income inequality withwealthy Nigerians taking over what was previously collective social assets. Thepoint of uneven and worsening wealth distribution in Nigeria is becoming asevere problem that has been made worse by the COVID-19 pandemic. Nevertheless,Teriba's point about reducing the size of the countries domestic and foreignloan books without hurting growth is important and needs to be taken seriously.

In a recent special report on global debt at a time ofCOVID-19, the London-based, The Economist magazine's EconomicIntelligence Unit (EIU) in May 2020 observed that "Thecoronavirus pandemic is a game-changer for the global economy. The years 2020and 2021 will be lost years for growth. The Economist Intelligence Unit doesnot expect global GDP to recover to pre-coronavirus levels until 2022". Butmore precisely on the matter of debt, the report goes on to note that "For the most reliable sovereigns, the cost ofservicing higher levels of public debt will not be an immediate cause forconcern. However, governments will eventually have to confront debt pile-ups.To curb fiscal deficits, governments in most developed countries will not beable to pursue spending cuts".

The report goes further to point out that, "Austerity absorbs political capital, and theremight not be enough left to pursue such a plan, especially given that the lastperiod of belt-tightening was so recent for many countries".

In sub-Sahara African countries like Nigeria, thereport states that "the newest funding(albeit on concessional terms) will be added to the balance sheets of emergingeconomies. In addition, the debt-assistance package from the G20 is a delayrather than a write-off; debt repayments will remain outstanding and continueto accrue interest as time passes. Many countries will, therefore, emerge fromthe current virus-driven economic crisis even more indebted and financiallystressed than before. This will raise concerns about their ability to repayexternal debt in the absence of more comprehensive debt-relief plans. Sovereigndefaults might not take place this year, but they are likely among poorcountries in the medium-term".

The DebtBogey

In this report, the authors note that Nigeria'stotal debt stock as of December 2019 stood at N27trn. This included N21.7trnowed by the Federal Government and N5.6trn owed by the sub-national governments.

TheFederal Government's debts accounted for 79.59% of the country's total debt, whilethe states and the federal capital territory (FCT) debt accounted for theremaining 20.41%.
Foreigndebt account for 32.93% of the total debt at N9.02trn, with the FederalGovernment owing N7.53trn and the state governments owing N1.48trn.
Domesticdebts accounted for the remaining 67.07%. The Federal Government had a domesticdebt portfolio of N14.2trn, accounting for 52.09% of total debt stock, whilethe states owed N4.1trn, 14.99% of the total debt stock.

Nigeria's mounting debt profile has become of concern to a growingnumber of economic analysts as the financial debt overhang threatens to raisedomestic interest rates and cut GDP growth in both 2020 and 2021. The unfolding debtthreat is despite the country havingabout $900bn worth of idle assets in properties and agricultural land.Nigeria's total debt has risen steadily but labour and capital productivitygrowth have declined. The implication may be that the Federal Government borrowingshave not been used for productive purposes. The nation's debt service, after awhile, may become a surging burden on the government and its fiscal balanceunless liquidity is found from the sale of non-essential public assets and theattraction of foreign direct investment (FDI) and foreign portfolio investment (FPI).

The NewNigerian 'Normal'

The post-COVID-19 'new normal' will mean differentthings to different people and organizations as humans cope with the reality ofCOVID-19, business and individual resets will be inevitable as companies andemployees make decisions to ensure sustainability. However, new normal willdiffer across countries and continents. The pre-existing realities of eachcountry and the fiscal headrooms of each government will determine what the newshape of economic and personal management would look like in months to come.While in Noth America, Europe and Asia, citizens would vote for greater digitalinteraction in Nigeria this would be difficult given the challenges ofacquiring computer hardware, the cost of internet access and the intenselycommunal nature of Nigerian lifestyles.

The report notes that the cost of acquisition oflaptop computers, desktop computers, internet modems and other communicationfacilitators such as a generator to power the business and personal hardwarewould make remote work and business interaction difficult in a society where85% of businesses are located in the informal sector of the economy.

Another problem with the concept of the new normal asapplies to Nigeria is that there are deep-rooted cultural mores that place apremium on interacting on a person-to-person basis; the village square is morethan just a place to congregate, it is a place for dispute resolution, communalplanning and an incubator for folklores and the passing of ancient knowledgeand wisdom across generations. No digital programme or contraption could substitutefor the folksy mystic of the village. Social distancing is a notion simplyalien to the realities of rural Nigeria.

Furthermore, social distancing in environments that are heavilydependent on daily -subsistence earnings is impossible. The hustle and bustleof commercial trading cycles from Lagos to Kano and from Portharcourt to Abujamake urban cities the hotbeds of social interaction as they fasten deepcommercial and financial bonds that tie everybody together. The large retailmarkets of Lagos, Kano, Portharcourt, Aba, Onitsha, Kaduna and Jos repelefforts at keeping safe distances. The reality of the market, like a cyclone,overwhelms the expediency of health rules no matter how well-intentioned.

For the Nigerian government to take full benefit of the digital age itmust gradually reduce the size of the informal sector and increase the breadthof the formal sector as it ramps up electricity generation and distribution,improves transport infrastructure and supports a significant reduction in thecost of access to the internet. Internet data costs need to fall as micro,small and medium-sized businesses (MSMEs) become more active in the emergingformal sector which will experience consumer spending shifts.

Of Banks and Sandboxes

Nigerian businesses will reinvent themselves but not rapidly. Banks, forexample, will trim down staff strength and scale-up technology applications asthey reduce brick-and-mortar engagement with customers and move a lot more oftheir services to digital online platforms. The tearaway success ofunstructured supplementary service data (USSD) or "Quick Codes" applicationsfor most tier1 banks in the country indicates the possibility of technologytaking away several previous back-office and front-office clerical jobs.

Artificial Intelligence (AI) would likely throw a further layer of aredesign of user experience (UX/UI) into the service delivery mix as banks likeAccess Bank Plc take advantage of their tech foundries and sandboxes. AccessBank's five-year corporate strategicplan that started in 2017 and isscheduled to end in 2022, was clear about the strategic imperatives ofincreased technology application and cost-trimming that would come from aslimming-down of staff strength and driving of product delivery efficiency byexpanding digital channels. UBA Plc also indicated this strategic push when it 'right-sized' its business at the beginningof the year in January 2020.

The new financial sector 'normal' would possibly lead to the recruitmentof a younger generation of employees with tech-savvy and the slow replacementof an older generation of staff with increasingly jaded skill sets. Admittedly,experience in credit appraisal (CAMs) and credit administration would likelyattract new job slots but even here, banks would prefer individuals who haveupgraded their skills in the use of big data applications (Python, R, Oracle Database, and MS BI) andinformatics. Also, bank marketing functions will be more about problem-solvingthan pretty faces and English prose. For rural transactions, agency bankingwill begin to gain ascendancy as banks shy away from impressive branchbuildings in communities where the likelihood of meeting breakeven margins, inthe short or medium-term, is either remote or non-existent. The era of 'competing showmanship' willlikely give way to one of 'scaling bottomlines'.

The Retail Makeover

The retail sector will likely migrate slowly from a physical consumerinterface to more digitally-inspired consumer interaction. Business-to-Business (B2B) and Business-to-Consumer(B2C) transactions will ride on the shoulders of increased internetdata penetration and a fall in the cost of data which could arise as a resultof a major reduction in the right-of-way (R0W) costs of laying digital cablesacross states, the Ekiti State government recently reduced the cost fromN4,500.00 per metre to N145.00 per metre. If reductions of this magnitude occuracross all states, data costs could come down and improve data access by microand small-scale businesses.

With increased digital penetration and consumer sensitivity, the retailmarket will likely see faster expansion in spending, greater product andservice choices and superior user experience and interaction.

Lower consumer sensitivity, especially in Nigeria's large informalsector, and low or non-existent digital involvement would keep the economyrunning along the same old rail track and would perhaps bring the country to apoint of repeating the same worn responses to future pandemics with littlelessons learned and nothing gained in terms of socioeconomic repositioning.

The realities of the COVID-19 pandemic indicates that societies thatwill grow stronger from the pandemic experience are those that migrate fromnon-digital existences with low consumer sensitivity to those with higherdigital engagements with increased consumer participation in influencingproduct or service design, quality and delivery.

The medical and pharmaceutical sectors will need to raise their deliverystandards as equipment, research and development and personnel training willall have to be ramped up over a very short time. Indeed medical laboratorytechnicians will have to be vastly improved with more professionals schooled inthe science of lab technology as vengeful viruses remain an ever-presentpotential global threat. Healthcare insurance will, therefore, also have to beleveraged to achieve wider coverage and more efficient pricing. Life insurancewould equally need to be made easier to buy and faster to process as more microand small scale entrepreneurs are brought into a micro-insurance coveragescheme. Medical science and its various supply chain interfaces will need togrow into a state of unending preparedness.

The traditional concept of the market place may take time to transitionto a new normal, but Nigeria's young national demography (over 60% of theNigerian population is between the ages of 1 and 35) with growing digitalcapabilities will result in a gradual reduction in the importance of physicalretail platforms. Digital market places will slowly become the go-to platformsfor fast-moving consumer goods (FMCGs) and other more durable purchases. Howfast the transition occurs depends on the pace of digital infrastructuralgrowth and development.

So are we talking about drones as 'delivery boys'? The concept may nottake quickly but over the next half-decade logistics would be more abouttechnology than brawn as human intervention in the E-commerce distribution (or 'fulfilment') value chain would be more about programming than lifting,driving and counting.

Section 2 ofthe Coronanomics report takes a birdseye view of global economic responses tothe coronavirus (COVID-19) pandemic and does a comparison of differentapproaches to both healthcare interventions and economic policy. The sectionlooks at the impact of the virus on equities, commodities and global fixedincome markets.

Section 3 ofthe report delves into the impact of COVID-19 on large and small-sized Africaneconomies. It takes a look at Africa's trade with the world and its tradeamongst member nations. The section addresses issues of protectionism and thecurrency impact of the COVID-19 pandemic and its potential to disrupt worldtrade and depress African economic growth.

Section 4 breaksdown the Nigerian economy in the face of COVID-19 and looks at how the economyhas responded to the pandemic and identifies key opportunities beyond thethreats. The section deconstructs the economy and takes a look at the country'ssub nationals (states) and the opportunities (as well as challenges) open tothe subnational entities across the federation with case studies of two stateswithin each of the six geopolitical zones.

Further analysis is done on the differential impact of COVID-19 onNigeria's business sectors. The sectoral analysis isolates the so-called 'winners' and 'losers'. Amongst the winners are the Agricultural sector (which begins toflourish as the country attempts to build stronger local agricultural valuechains), the Fintech sector (which jumps as Programming, Big Data, ArtificialIntelligence(AI), and Informatics become core skills that drive commerce andmanufacturing), Healthcare sector (which expands as the country re-scales andretools its health sector to cope with present and future shocks), Digitalentertainment (which becomes fashionable as consumers get used to socialdistancing and prefer to receive entertainment content in the privacy andrelative safety of their homes), Digital web-based online content (whichincreases as consumers/readers spend more time on the web than in the past), E-commerce(which grows as e-shops become staples of consumers searching for bargain buys)and Digital online Education (which would likely grow at the speed of thought,will become a blended framework with physical classes).

The losers would likely include Airlines (which would see disrupted cashflows, higher breakeven margins and bumped-up ticket fares leading to lowerpassenger patronage), Hotels (which could face lower revenues as tourismfalls-off and large events move from physical spaces to digital screens), Mallsand Restaurants (these places of recreation and high impact social gatheringswill wane as the social-distancing culture settles in and people opt for the 'to-go' option for fast food purchases and favour the digital order alternativefor groceries and other food items), Cinemas (more people will buy theirmake-believe entertainment in the form of movies from online platforms ratherthan go to crowded cinema halls), Sports (sporting events without the gutsy noiseof crowds and popcorn may currently appear odd and feel uncomfortable, but theinevitability of smaller attendance at games will cut into revenues andpotentially thin down profitability but as people get used to watching matchesat home on television sets or computers or even their phones, advertisingrevenues may begin to pick up well enough to keep games such as football,Tennis, Boxing, Wrestling etc. commercially viable), and Places of worship(religious gatherings will be smaller in numbers as social distancing protocolsimpose limits on the number of people permitted in confined spaces,nevertheless Tithes, Offerings, Zakat and Sadaqah can be paid electronically justas sermons can be delivered in digital messages) .

The section explains the organizational changes in strategy and planningthat would be needed to address the fluidity in consumer experiences andexpectations. Corporations will need to evolve business plans that try to mapfuture consumer needs and not their past preferences. The import of this isthat companies would be required to construct several scenario models withattendant probabilities to determine the most likely outcomes.

The Investment Bridge Post

The section briefly looks at both the local private equity and fixed incomesecurities market and highlights the gradual growth in private equities despitethe general modest growth outlook for the Nigerian economy in the short-term.In its recent Monetary Policy Committee (MPC) Meeting Communique for May 2020,the Central Bank of Nigeria (CBN) acknowledged that it was pleasantlysurprised by the Q1 2020 growth rate of +1.87% published by the National Bureau ofStatistics (NBS) and was optimistic that the economy would not contract asseverely as earlier expected by the International Monetary Fund (IMF) whichexpected the economy to contract by -3.4% at the end of 2020.

While the economy may see slower growth in Q2 and Q3 2020, analysts aremore enthusiastic about a crawling growth of above +1.00% in the two quarters and a full-yeargrowth of between +1.5 and +2.00% for the full year, which would be lessthan 2019's growth rate of +2.55%. Because several mature economies will witnessnegative growth in 2020, the slow-motion growth rate of the Nigerian economymay still seem attractive if oil prices hold up at between US$35 per barrel andUS$40 per barrel for the better part of 2020. The expectation is that if pricessteady at least US$35 per barrel and output averages 1.7mbp the fiscal deficitwould still be manageable and debt servicing less punishing than at a lowerinternational oil price.

A bright oil price outlook in 2020/2021 should see larger quantities ofcapital importation into Nigeria as private equity managers search for bargainopportunities before a full-scale economic rebound. The report equallynotes that Nigeria's debt ratings would likely rise as oil markets strengthenand the international cost of sovereign borrowings would possibly fall.Domestic cost of local Treasury Bills and Bonds would equally fall as Bill andBond prices rise on the back of the government's stronger fiscal position. Inother words, as oil price rises the coupon yields on local Nigerian bonds maybegin to fall.

Monetary and Fiscal Policy; The NewHeterodoxy

Monetary and fiscal policies were in the past Siamese twins, eachworking to support efforts of the other and managed by separate authorities,but those were the days before the previous global economic crisis in 2008/2009caused by the collapse of subprime real estate-linked credit in the UnitedStates of America. Since the crisis of 2016/2017 fuelled by a rapid decline in internationaloil prices, global central banks have been more assertive and taken on broaderbriefs than merely keeping domestic inflation rates in check.

Since the coronavirus pandemic started to affect major (and minor)global supply chains and disrupt consumer and producer demand in Q1 2020,central banks around the world have attempted to prevent economies fromslipping into recessions by expanding the money supply, cutting interest ratesand providing easy credit targeted at vulnerable industries such as airlines,automobiles, hotels, restaurants and logistics.

Nigeria's CBN in Q1 2020 has been confronted with a double whammy of alarge fiscal deficit and a slowing GDP growth rate. The policy choices havebeen for the CBN to increase the money supply to spur production as interestrates fall (a choice it has felt uncomfortable pursuing) or cut policy rate andallow the money supply to find its level (a choice it has equally seen asundesirable). With conventional monetary tools seen as inadequate andunfit-for-purpose, the CBN has adopted a new heterodoxy, by urging banks toincrease their loan-to-deposit ratios (LDRs), keeping monetary policy ratesbetween the lower and middle double digits (between 14% and 13.5% in 2019 andrecently 12.5% in May 2020), regularly intervening in the foreign exchangemarket to keep the N/US$ exchange rate within a narrow band, previously aroundN307/US$ and more recently N360/US$. The 'dirty float' intervention stance ofthe CBN in the FX market has earned the regulator some criticisms, especiallyfrom local and international economists who believe that the monetary authorityshould allow for a wider float and an in-built correction stabilizer to thecurrent account (CA) of the country's balance of payment.

Concerned about the wider inflationary consequence of a free float ofthe domestic currency, the country's monetary authority has refused to benudged towards higher exchange rates, preferring to adopt the unconventionalframework of a managed float with multiple-windows, combined with directintervention in respect of concessionary lending to select economic sectors.The Bank has supported this with microeconomic interventions in the localcredit market by adjusting bank loan-to-deposit ratios (LDRs) first to 60% by September2019 and then to 65% by December 2019. The banking sector regulator hasrecently reduced the rates on concessionary interventionfund loans from 9% in 2019 to 5% in Q1 2020 for one year effectiveMarch 2020. The Central Bank has tried to propel growth in sectors such asagriculture, aviation, entertainment and manufacturing but so far theintervention efforts have seemingly yet to yield a sustainable outcome tosupport near-term aspirations of GDP growth rates above the national populationgrowth of +2.7%.

Before the advent of COVID-19, the CBN's heterodoxy appeared to havebeen working like a charm with the N/US$ exchange rate remaining stable andinflation rate trending downwards as GDP grew at over +2.5% in 2019 (notably +2.3% in Q4 2019 as against +1.8% in Q4 2018). But since the emergence ofthe pandemic the resilience of the regulator's approach to macroeconomicmanagement is tearing at the seams with pressure on foreign reserves, risingdomestic interest rates and a widening gap in the country's fiscal balance.

Orthodoxy may have had its limits but heterodoxy is not without itsbaggage, or so it seems.

How Fareth The Household?

Households under the COVID-19 new normal have not fared well. The totaland partial lockdowns of the economy have taken their toll on families as morecompanies lay off workers as supply chains become difficult to fix in theshort-term. The disruption to production raw material, industrial replacementsupplies and the stalling of logistics has meant that many companies have foundit difficult to sustain operations with a pre-COVID-19 level of staffing. Evenfinancial institutions such as banks have had to trim down operations as somebranches have had to close to abide by the protocols set for social distancing.

Households have also seen costs double and in some cases quadruplemaking nonsense of the recent 2019 upward adjustment in the national minimum wagefrom N18,000 per month to N30,000 per month, spiralling retail prices havedecimated households real take-home incomes. As bad as this may seem, manyhouseholds simply do not have take-home pays anymore as company's go under andjobs get lost as lockdowns either persist or are mildly modified.

Section 5 ofthe report reflects the closing thoughts of the writers concerning how thecoronavirus and declining oil prices will affect both the Nigerian and globaleconomy between 2020 and 2021. The various scenarios range from the obscure anddark to the simple and bright. The most likely path seems somewhere in-between.

Section 6 providesa treasure trove of references and additional reading material to build arobust body of knowledge on the impact of COVID-19 and oil price declines in2020 on global and local economies. The section enables the user of the reportto explore related material that adds context to issues that could not be dealtwith in detail by the report as a result of the constraint of space and time.The references enable the reader to go to Proshare's marketplace page and unearth nuggets of actionable business and financial marketintelligence data.

Section 7 advisesreaders on how the report could be used for strategic personal and businessdecision-making without violating relevant and applicable copyright guidelines.