Understanding Africa’s largest economy

Author: | Published: 24 Apr 2015
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Seye Kosoko and Olafimihan Olayinka of Standard Chartered look at how Nigeria has achieved economic success in the face of adversity.

Nigeria has dominated the headlines in recent months, and not always for positive reasons. Boko Haram's atrocities have claimed thousands of lives and shocked the world. But if the jihadi threat has hampered investment into the country in a significant way, it has yet to show.

Nigeria recently overtook South Africa as the continent's largest economy. The UN listed it in 2013 as the 26th largest economy in the world by nominal GDP and the World Bank and EY both see encouraging signs for the country as a place to do business. Seye Kosoko and Olafimihan Olayinka of Standard Chartered explain how, despite the political instability that has rocked the country, and Nigeria's continued reliance on oil amid falling prices, there are plenty of reasons to be positive.

How did Nigeria come to overtake South Africa as Africa's largest economy?

With a GDP of $509.9 billion (NGN80.22 trillion) for 2013, Nigeria has formally overtaken South Africa to become Africa's largest economy. This was achieved as a result of the rebasing of the country's gross domestic product in 2014 – an exercise that hadn't taken place since 1990. The United Nations Statistical Commission recommends a statistical rebasing every five years, to account for inflation and changes in the patterns of a country's economic activity – consumption and production. By updating the base year from 1990 to 2010, the Nigerian economy had additionally made the necessary adjustment for the significant expansion of the services industry particularly the internet, telecommunications and entertainment industries.

Before the rebasing, the estimated GDP for the country was NGN42.3 trillion – nearly doubled by the rebased figures. The number of economic activities surveyed for the purposes of the calculation of GDP increased to NGN46 from NGN33 previously. Better coverage, including of the informal sector, the inclusion of new industries, and methodological improvements also led to significant increases in the contribution of the services sector, manufacturing, construction, and water and electricity. The services sector's contribution increased from 29% of GDP to 52%, with the telecommunications sector rising from 0.9% to 8.7%. The manufacturing sector is now estimated to contribute 6.8%, compared to just 1.9% previously, while the oil and gas sector's contribution has been revised down to 14.4% from 32.4% before rebasing.

The statistical data however also indicated that Nigeria's economy was $453 billion in 2012, instead of $264 billion as measured by the World Bank. In that year, South Africa's economy was at $384 billion in 2012, according to the World Bank. It therefore shows that Nigeria's economy in a real sense, had since overtaken that of South Africa even though this had not been reflected in the statistical figures.

With an improved ranking as 26th biggest economy in the world (from 33rd before the rebasing) and a reduction of its debt-to-GDP ratio to 11% for 2013, against 19% in 2012, the Nigerian government anticipates significant interest and increased foreign and domestic investment in the country, which will potentially result in a positive impact on the Nigerian economy and its people.

According to the country's Finance Minister Ngozi Okonjo-Iweala, an investment of $1.5 billion was envisaged in 2015 in the agricultural industry alone. There are however concerns among some analysts and Nigerians that though the recalculated GDP may raise Nigeria's profile internationally, the impact on the common Nigerian may not be commensurate considering unresolved issues poor infrastructure, corruption and insecurity, which the country currently faces.

How is the Nigerian economy coping with falling oil prices? Has greater diversification shielded it from the downturn?

Nigeria's economy is still largely dependent on oil, with over 90% of its foreign exchange earnings being derived from oil sale proceeds. The annual budget, which defines the direction of the country's economy, is based on crude oil price that was benchmarked in the 2014 budget at $78. Against this background, the falling price of oil – from $110 per barrel in January 2015 gradually to about $53 per barrel currently – therefore portends potential hard times for the country.

In response to this unanticipated state of affairs, the government immediately recognised the need to make adjustments with tighter fiscal and monetary policies as well as the need to build up economic buffers. In this light, the government has revised the benchmark oil price in the 2015 budget to $52.

Other measures taken or are in the pipeline include reducing the wastage of government funds through restrictions on foreign travel by civil servants; replacement of foreign training programmes with local trainings; and streamlining of the functions of the ministries, departments and agencies (MDAs) to eliminate duplication. Austerity measures have also been introduced. There are also plans to increase the VAT rate from 10% to 15%, not only to raise revenue but also to align with the VAT rates of other West African countries and make it easier to implement the Common External Tariffs.

To what extent has recent political instability, in particular the Boko Haram insurgency, hampered investment in Nigeria?

The state of insecurity in Nigeria heightened since the Boko Haram insurgency, that started in 2009, but has since steadily increased in severity and impact, leading to the loss of thousands of lives and property worth millions of dollars. Though the insurgency is linked to Islamic fanaticism, many have also attributed its root causes to factors such as political differences, economic inequalities, poor infrastructure, poverty, unemployment, lack of education, religious and ethnic distrust.

"Nigeria’s economy is still largely dependent on oil, with over 90% of its foreign exchange earnings being derived from oil sale proceeds"

The direct impact of the insurgency is most prominent in the northern eastern part of Nigeria, where the insurgency has remained prevalent. Amidst the risk of actual loss of life, destruction of property/investments and a general atmosphere of mistrust, fear and anxiety, the insurgency has led to massive exodus of citizens and businesses from the affected areas, while the few remaining businesses operate very skeletally. Clearly, this has led to a significant economic downturn and disinvestment in the North East – a state of affairs could remain for quite a while, as re-building the destroyed infrastructure and regaining investor confidence in the area cannot be immediate. In any event, the insurgency is currently still ongoing.

Notwithstanding this impact on the north east, the country's economy as a whole has not experienced a similar downturn as a direct result of the insurgency, despite the kidnap of over 200 school girls in 2014 which generated massive media and international attention. The Boko Haram violence does not extend to Lagos or the Niger Delta region where the economic activities and foreign investments are highest. As there is minimal foreign investment in the north east where the insurgency is prevalent, investors seem to have discounted the security situation. Even in the commercial cities of the north like Kano and Abuja where the insurgency surfaces from time to time, this has not resulted in a significant decline of investment in the country as a whole.

Some investors understand that political instability is not a new development in Nigeria, as the country has experienced religious, political and other crises at various times since its independence. While the insurgency may therefore be a source of concern to new investors, existing investors appear to have taken the view that it will not likely affect their businesses. GE, for example, has been in operation in Nigeria for over 40 years, employs about 250 people and operates offices in Lagos and Abuja, and still intends to invest about $10 billion in new power plants.

Nigeria has leapt five places in this year's Doing Business report from the World Bank. What is making Nigeria an increasingly attractive place to do business?

To corroborate this position, Ernst & Young ranked Nigeria third after South Africa and Kenya as the "most attractive investment destinations in sub-Saharan Africa", according to its recent Africa Attractiveness Report for 2014. Nigeria has been a major destination for foreign direct investments for a number of years now. In 2013, Nigeria received more than $21 billion of foreign direct investment being 28% higher than the year before.

Has pegging the naira to the dollar and devaluing it helped?

Because the country's revenue is largely dependent on oil exports, its currency is tied closely to the dollar. With the decline in oil prices and depletion of the foreign reserves, devaluation of the naira was inevitable, as has been considered by many as the appropriate step under the circumstance.

Devaluation of a country's currency is generally known to stimulate and encourage exports, because the prices of local products serve as an incentive for foreign buyers, whilst also discouraging importation for the same reason. However, because Nigeria is an import-dependent nation with low production of non-oil export commodities, increased cost of importation will lead to the increased cost of goods in the nation.

The expectation is also that government's revenue, in terms of naira value will increase, because of the wider exchange rate disparity between the dollar and the local currency. However, the effect of the continued fall in oil prices and decline in crude production by the country will limit the expected positive effect. Other happenings in the financial services industry such as the recent increase in interest rates on loans and adverse adjustment of the cash reserve ratio requirements for banks by the CBN will also increase the cost of lending and reduce liquidity in the country; thus limiting the anticipated benefit of the devaluation.

The Nigerian financial sector appears to be expanding at approximately twice the rate of GDP growth. What accounts for the industry's boom?

Since the mandatory recapitalisation of Nigerian banks in 2006, Nigerian banks have had an increasingly robust capital base with which to do businesses of larger volumes and returns.

Expansion of Nigerian banks to other countries; establishment of foreign banks in Nigeria; participation in multi-jurisdictional transactions and general globalisation of the financial activities have extended the scope and complexity of transactions in which Nigerian banks are involved, hence increasing their activities and returns.

Sanitisation of the industry by the CBN, closer monitoring, supervision and surveillance has increased local and foreign confidence in Nigerian banks.

Also, government policies on privatisation/PPPs on infrastructure development, oil and gas, energy etc has necessitated an increased involvement in banks for the provision of funding.

Eurobond issuance is expected to continue out of Nigeria in 2015. What risks does this bring?

The dollar's advance versus the Nigerian currency over the past nine months makes it costlier for Nigeria to pay interest and principal with the naira. That's being exacerbated for Nigeria, being an oil-producing country, which has seen dollar revenues tumble amid the 52% drop in crude prices since last year's peak in June. Nigeria's naira is the worst performer, falling 17%.

Yields on Nigeria's $500 million of Eurobonds due July 2023 have soared 199 basis points since the end of May, more than similar-maturity Russian dollar debt according to data compiled by Bloomberg. There is growing concern about the capacity to pay the interest, not only the nominal amount. Investors are going to become far more punishing of the sovereign for any type of fundamental weaknesses.

The currency's woes have raised some fear about the impact on the balance sheets of companies and banks and have been reflected in some of Nigeria's top banks' Eurobonds. Nigerian banks' total foreign currency exposure tallied up to as much as $11 billion when adding syndicated loans and currency swaps to the $3.6 billion total outstanding in Eurobonds. Inflationary pressures from the devaluation are already taking its toll on consumer disposable income and banks' retail loans. One thing is for sure in 2015: abundant Nigerian Eurobond issuance is unlikely to continue in the same volume as before. The recent tighter restrictions on banks' foreign currency borrowing by the CBN is an indicator.

How are minority shareholding rights shifting in Nigeria and how will this affect the M&A market?

In Nigeria, protection of the minority shareholder has a strong statutory backing and the corporate law spells out the peculiar rights and remedies available to this group of shareholders beyond the general rights of every shareholder. This includes the right to information, right to voice an opinion on the affairs of the company, right to seek redress for wrongful acts of the majority and the right to receive distribution of the company's property after liabilities have been settled. Most of these rights are limited or could be extended by the shareholders' agreement or other company contracts like the articles of association.

Despite the protection provided for the minority shareholder, there are certain factors that have hindered the minority shareholders from exercising their rights in Nigeria. One of these is lack of awareness or interest on the part of the shareholders. A majority of shareholders are usually more interested in the returns they can get for their investment rather than how the company is being administered or whether or not the company under goes a scheme of arrangement (merger or acquisition). However, as there is a direct link between the quality of administration of a company and the returns the company makes for its shareholders, there is need for shareholders, particularly the minority to be more actively involved in the affairs of the company they have invested in.

Minority shareholders constitute a check on the excesses of the majority in the administration of the company and they must seek to enforce their rights and seek redress where such rights have been infringed by the majority in order to get the best value for their investment.

Provision for shareholders' safeguards in corporate governance in Nigeria is articulated in two broad frameworks. These are: provisions within the Company Law; and provisions within the Securities and Exchange Commission Act. The need for safeguards for the rights of shareholders in corporate governance reveals two broad levels of protection. These are: safeguards between the shareholders in general meeting and the board of directors; and safeguards between the minority shareholders and majority shareholders and the management (for minority protection).

The SEC Code expressly provides that the company or the board should not discourage shareholder activism whether by institutional shareholders or by organised shareholders' groups. The code envisages that the general meeting should be a forum for shareholder participation in the governance of the company. Regarding the composition of the board of directors, the code provides that shareholders with less than 20% or more shareholding should have a seat on the board. It further provides that a director representing the interest of minority shareholders should be given a seat on the board. The code further provides for more regular briefings of shareholders, going beyond the half year and yearly reports.

About the contributor

Seye Kosoko
Head, legal and company secretary, Standard Chartered

Lagos, Nigeria
T: +234 1 236 8365
E: Seye.Kosoko@sc.com
W: www.standardchartered.com

About the contributor

Olayinka Olafimihan
Senior counsel, Standard Chartered

T: +234 1 2778006
E: olayinka.olafimihan@sc.com
W: www.standardchartered.com

Olayinka Olafimihan is a senior counsel in the legal & compliance Africa team supporting corporates and institutional clients of Standard Chartered Bank across the African continent, with special focus on the West Africa sub region. He is responsible for the delivery of world class legal support to the CIC business in the West Africa sub-region as part of the Africa region CIC legal support team.

He is a highly experienced product specialist with over 30 years post call experience in legal practice, banking and telecommunications. His experience spans diverse industry segments where he occupied many senior positions and played diverse roles over the years within his native Nigeria and the entire West Africa sub-region.

A Fellow of the Chartered Institute of Secretaries & Administrators (FCIS) (UK & Nigeria) he also holds an MBA from the University of Ilorin Nigeria and a Master of Laws (LL.M) degree from the London School of Economics and Political Science (LSE) where he specialised in Corporate Commercial and Taxation laws.

He was a member of the Nigeria Communications Commission (NCC) committee that developed the corporate governance policy for the Nigerian telecommunications industry. He is married with a daughter and two sons.