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Low oil price and currency controls hit Nigeria hard

Returning to work after prolonged sick leave is never easy. For Muhammadu Buhari, the president of Nigeria, heading back to the office after 50 days of medical treatment in London has been particularly challenging. Days before he flew home on March 10, data showed the country’s economy had contracted for the first time in 25 years, dropping 1.5 per cent in 2016 after growing 2.8 per cent in 2015. For investors, the question is a simple one: can Mr Buhari fix Africa’s biggest economy?

The figures are not encouraging. Over 2016, the oil sector — the source of more than two-thirds of state revenue and 90 per cent of its export earnings — shrank nearly 14 per cent.

This was largely because of militant attacks on pipelines in the oil-producing Niger Delta, reducing state revenues that were already hit by the recent oil price collapse. Compounding the bad news is a severe currency shortage in the non-oil sector, with manufacturers unable to get dollars for imports and forced to lay off workers.

Worse still for the returning president, many business leaders and analysts blame him for the severity of the economic crisis. Since he came to office in 2015 he has insisted on maintaining an artificially high value for the currency, the naira, out of fears of a spike in inflation — a policy at least one investor condemned as “old fashioned”.

Analysts are united in saying that the currency controls are holding the economy back. “[Foreign exchange] liberalisation is the key that is needed to unlock improved momentum elsewhere in the economy,” says Razia Khan, chief economist for Africa at Standard Chartered Bank. “Without it, we are looking at a still-constrained environment.”

The question for investors is whether the president will shift his policy now that he has returned, and what the outlook will be in the meantime.

Nigeria’s grim economic picture is far removed from its situation only three years ago, when the country was set to become a continental economic powerhouse. In April 2014 it became Africa’s biggest economy overnight thanks to a statistical revision. With strong oil prices and a young population of 187m, growth seemed assured.

By the time Mr Buhari took office a year later, global oil prices had collapsed and endemic corruption meant there was little left in the coffers with which to ride out the crisis. But sentiment remained positive. “Market participants were very excited that he would tackle corruption and institute reforms,” says Dominic Bokor-Ingram, portfolio adviser at Charlemagne Capital, a frontier markets-focused investment company.

This may have made the disappointment more acute as it became clear that the new president was insisting on maintaining a strong naira, even as the currency weakened. When a parallel exchange rate emerged last year on the black market, Charlemagne, which had 5 per cent of its $400m frontier fund portfolio invested in Nigeria, withdrew its money from the country.

“Whenever we see a parallel exchange rate emerging, we sell,” says Mr Bokor-Ingram. “We won’t invest anywhere we cannot get our money back.”

Other investors are more sanguine. Michael Levy, co-head of emerging and frontier equities at Barings, the UK asset manager, says Nigeria’s finance sector offers good medium- to long-term investment opportunities, even if the foreign exchange issue is a constraint for short-term investors.

“A lot of bad news has been priced into the market and is reflected in market positioning,” he says. “What is exciting is that there are very good companies, particularly in the banking sector.”

Mr Levy is among a number of fund managers who say there are tentative signs of a turnround in Nigeria. Oil output has stabilised thanks to better security in the Niger Delta after visits to the region by the vice-president, Yemi Osinbajo, over the past two months.

Also positive is the release in March of a long-delayed economic reform plan, which is important for getting loans from international lenders. The plan includes pledges to revamp domestic oil refining, improve the power supply and invest in agriculture and industry. It also proposes a market-determined exchange rate.

Although there is scepticism that intentions will be matched by action, Paul Clark, Africa equities specialist at Ashburton, the investment manager, says: “The government’s focus on diversifying the economy, improving infrastructure and reducing wastage and corruption will put the economy on a much more sustainable path.”

Simon Hopkins, a director of Novare Fund Manager, the private equity firm, is more sceptical. Mauritius-based NFM manages $500m of assets and builds and manages shopping malls in sub-Saharan Africa.

He says turnover of NFM’s first fund in Nigeria, which closed in 2011, has been “pretty resilient” and a second fund has continued to invest there. “Property is always a safe bet, as the assets are tangible,” he says.

But he adds that the government’s “inertia” on the economy has prompted NFM to diversify away from the country and it is now backing projects in other sub-Saharan African countries, including Zambia and Mozambique.

Until it is clear that this policy “inertia” has shifted, many other investors are staying away, or keeping their exposure to a minimum.

George Birch Reynardson, a portfolio manager at Somerset Capital, the emerging markets-focused investment company, says his frontier fund is “slowly becoming cautiously more interested” in Nigeria, particularly in stocks of high-quality Nigerian consumer companies.

But he adds that “complications such as the foreign exchange regime keep us on the sidelines at the moment”.

Analysts say currency sales, such as one that made dollars available at 20 per cent above the official rate and which was held during Mr Buhari’s absence in February, may be a sign that currency liberalisation is finally on its way.

“Stepped up [foreign exchange] sales aimed at clearing the backlog of accumulated demand still represent the possibility that the Nigerian authorities are working towards an eventual, more meaningful, FX liberalisation,” says Ms Khan.

But time is running out for Mr Buhari’s administration, even if Mr Osinbajo has been praised for being proactive in his boss’s absence.

Not only is the president ill, but by the end of 2017 Nigeria will start preparing for 2019 elections.

“Effectively, they only have, if we are being generous, 12 months to try to make things work,” says Manji Cheto, senior vice-president of Teneo Intelligence, the advisory firm.

“Given the gravity of the situation, I don’t see [the government] being able to achieve as much as people would expect. People need to temper their expectations about what is realistic in the short term.”