Covid-19, Crude Oil Price and their impacts on the Nigerian Economy
On the 28th of April 2020, I (Wilson Erumebor) was interviewed by Africa Business Radio and we discussed the effect of the crash in crude oil price and the outbreak of Covid-19 on the Nigerian Economy.
Below is the transcript of the interview.
Interviewer: This global pandemic has defined 2020 and Nigeria is no exception. What is your opinion on its impact on the economy so far?
It is unfortunate that the world is experiencing such pandemic right now, the Corona virus situation has affected many countries. Across several continents, many governments have had to shut down factories and cities as well as restricted movements and gathering of people. The situation has also created a strain on the health care system of many countries as there has been increasing number of cases in the United States, Europe and even here in Africa. Sadly, the number of death cases has also increased.
With respect to the Nigerian economy, there are several transmission mechanisms on how COVID-19 affects the economy. The transmission channels are as follows:
Transmission Channel 1: Crude oil channel
From January to April 2020, crude oil price has dropped by over 70% to about US$20 per barrel from US$70 per barrel at the beginning of the year. Lower demand for crude oil due to low industrial activities and movement restrictions arising from the lockdown of cities were largely responsible for the drop in price. In mid-April, the WTI futures even sold at negative price, which meant that crude sellers paid to sell their crude oil due to the supply glut in the market and limited storage facilities. For Brent crude, prices fell below $20 per barrel in April. In terms of crude production, Nigeria has struggled to get buyers for its crude due to the fact that the market is saturated with so much crude from different continents and countries. In addition is the price and market control tussle between Saudi Arabia and Russia. All of these imply that the outlook for the price of crude is bleak.
Let’s look at how this affects Nigeria.
It is no longer news that crude oil is a major determinant of how the Nigerian economy performs especially because of its significance in external reserve movement, performance of government revenue and also in movement of export earnings. So, a significant drop in crude oil price simply means a fall in government revenues. This implies that the Nigerian government will struggle to meet its financial obligations. Thus, payment of salaries, expenditures relating to keeping the government running, infrastructure, investment in education, health care spending will be severely affected as a result of the decline in crude oil price.
So, that is one major effect of the Corona virus pandemic on Nigeria.
Another implication of a fall in crude oil revenue and output is on economic growth. The recession in 2016 revealed how fragile the economy is and how even businesses rely on government finances to survive. In essence, once there is trouble with government finances, it directly affects the system, as the country struggles to meet its foreign exchange needs. At the moment, external reserves is approaching $34billion and it is declining significantly. This is even made worse by the fact that Nigeria does not have adequate savings or fiscal buffers. Countries whose revenues have been affected at this point would rely on their savings but right now, Nigeria does not have that luxury.
Given this, I must say that Nigeria is in a dire situation. Many macroeconomic projections have showed that a recession is inevitable. The question then is, how can we ensure that the economy does not fall into a depression, which is a recession that lasts for some years? What should the government do to ensure that the economy is resuscitated on time? An economic recession is not just a phrase. It affects lives and has a huge generational impact – many individuals will lose their jobs; prices will significantly increase; the poor will become poorer and many non-poor individuals will fall below the poverty line; there will be rationing of foreign exchange and a possible increase in social vices. So, these are some possible realities that we are likely to experience in the next few months.
Transmission Channel 2: International trade disruption
Due to the shutdown of factories and businesses, global supply chain is being disrupted. Importation of raw materials and essential goods that need to be used in the production of other goods will also be affected especially when many of the global economies are experiencing lockdown of economic activities. This will have an impact on trade and local production in Nigeria.
Transmission Channel 3: Local Economic Disruption
Due to the lockdown and movement restriction in some states in Nigeria for over one month, there has been a disruption of economic activities which will ultimately impact economic output and investments. Even though there is the production of essential items like food, drugs, etc., non-essentials are also very important. This disruption will manifest in GDP figures for the second quarter and result in significant decline in output. This is another direct hit on the economy.
Impact on some sectors
Manufacturing: The manufacturing sector will be one of the worst hit because the lockdown and restrictions affected key subsectors such as Cement, Textiles, Apparel and Footwear, among others. Back in 2019 even before the outbreak of Corona virus, the sector grew by just 0.8% from 2.1% in 2018. With such shock, it is expected that the sector will experience further decline in 2020.
Hospitality, Entertainment and Tourism Sectors: These sectors would be severely affected due to social and physical distancing policies as well as the ban on public gatherings.
Construction: This sector relies heavily on government finance. With the fall in crude oil price and the revision of oil price benchmark to US$20 per barrel in the 2020 budget, capital expenditures are expected to decline in 2020, thereby affecting key sectors such as construction and cement. From the private sector, lower investments and consumer spending will also affect the sector.
Transportation: The transportation sector is the second fastest growing sector in 2019 after ICT. Due to the restriction of movement, it is one of the first sectors that was affected. So, Nigeria would experience a decline in growth of the sector across all the different categories- air, road, sea and rail.
Social services sector: The education and health sectors are also key sectors that will be severely affected as a result of the lockdown. For education, the shutdown of schools means that the output from education will be significantly low even though some schools have explored online education.
Interviewer: It is evident that the current challenges may become the new normal. What are the scenarios that will confront us in the nearest future and how do you think this will impact the livelihood of Nigerians?
The scenarios will be based on the following:
1. Outlook for crude oil price going forward into the year
2. How long Nigeria can sustain this economic lockdown and most importantly,
3. Government intervention – policies and interventions in place to ensure that Nigeria limits the negative impact of COVID-19, fall in oil price and lockdown/movement restrictions on businesses, citizens and all the other economic agents.
On crude oil price, with the supply glut in the international markets, estimates show that oil price will remain low for the most part of 2020. The government therefore will have to cope with the “new normal” situation. The sad news this time is that the economy will not only cope with low oil price but with movement restrictions, social distancing and the spread of the virus, which could put a strain on the health sector. The oil price crash in 2016 led Nigeria into a recession and its recovery brought Nigeria out of the recession. In 2016, Nigeria had a V shaped recession such that the economy fell into a recession in 2016 and recovered in 2017.
But this time, there are many factors that are against the economy. This suggests that the nature of the imminent recession will be U-shaped, which means the country would be in a recession much longer than in 2016. From the foregoing, the question is no longer about whether the country is headed for a recession, it is, how long are we going to stay in a recession and what does the Nigerian government need to do to ensure that we reduce the length of the recession? We can however, overcome this if government interventions are properly structured to reach key sectors, households and businesses in order to strengthen resilience of the economy.
Interviewer: The Nigerian economy is heavily reliant on the oil sector and despite several efforts we seem not to have fully diversified the economy; what policy directions would be effective at this time to drive economic expansion and on the long term?
Diversification is usually a long term process. No country diversifies its economy in a year. The Nigerian economy is currently in a dire situation simply because we have not done what we ought to have done in the past, which is to save for the rainy day. Nigeria’s problem goes beyond sole reliance on crude oil and there are several examples of countries (Saudi Arabia, Russia, Kuwait, and Qatar) that rely on oil but have adequate buffers (savings or external reserves) for rainy days such as these.
Saudi Arabia for instance has adequate Reserves in the form of Sovereign Wealth Fund of over US$1 trillion and as such, can adequately finance government activities during difficult times. Unfortunately, Nigeria does not have such luxury. Our Sovereign Wealth Fund has about US$1.5 billion while external reserves is below US$35 billion. Saudi Arabia produces close to 10 million barrels of crude oil per day with a population of 34 million people and Nigeria, with over 200 million people struggles to produce 2 million barrels per day. This shows that Nigeria is not really “oil rich”. It begs the question, why do we always think that oil is the problem?
Our attempt to save for the rainy day has been met with resistance by leaders across different levels of government who would rather the funds from crude are shared to the different tiers of government. So even if the economy is properly diversified and non-oil sectors such as manufacturing, services etc. account for 70% of government revenues as experienced in developed countries, with the economic shock occasioned by Corona virus, government revenues will fall significantly. The government will still need some savings/buffers to augment fiscal shortfalls. It therefore becomes important for Nigeria to inculcate the culture of saving for the rainy days.
In terms of the policy response, going forward, first of all, Nigeria needs to draw insights from the Keynesian economic ideology, which basically involves spending your way out of recession. In times like these, Nigeria needs to spend her way out. The government must ensure that it injects into the system sufficient and significant amount of money; however, such spending should effectively be directed to key aspects of the economy. Strategic sectors such as manufacturing, construction, agriculture, trade, education and health must be supported both financially and in terms of policies and regulations. Businesses, including small and informal businesses that are severely affected by the virus must be supported. In the U.K. for instance, business owners that can demonstrate that they have been affected by the virus and cannot pay salaries are encouraged to lodge such complaint on an online platform and will receive support. Such support structures are needed to sustain the economy, encourage production and reduce job losses.
Secondly, government at the federal and state level should ensure that the announced intervention reaches the poor, vulnerable and affected citizens across the country. Unfortunately, the recent crisis and lockdown of some states revealed that the country has a weak transmission channel in reaching the affected citizens across the country. For instance, the National Social Register captures about 2.6 million households i.e. about 11 million individuals. While the President announced that an additional 1 million households should be added to the register in April 2020, the total number of 3.6 million households is still far below the number of affected households in the country. With over 100 million people living in poverty, a significant number of households still need to be captured. To capture and reach the poor, Nigeria needs to develop a system such that each Nigerian has a social security number. With such in place, it will be easier for the government to reach each citizen and send palliatives to citizens that are affected by such crisis.
The third policy response is for us to think about homegrown solutions to whatever problem we have in this country. We must not always copy and paste solutions from other countries and apply it locally. Government policies, interventions and actions must be taken with due consideration given to our realities. Nigeria must focus on saving lives and saving the economy at the same time. We must think of gradually opening up certain areas of the economy as we increase investment in health care, testing facilities, isolation centers, etc. The fact remains that the government cannot sustain the lockdown for too long, especially given the weak social transmission channel in reaching out to citizens. About 60 – 62% of Nigerians earn daily income due to the informal nature of the economy. These persons definitely have been affected by the lockdown and in worst cases, some people cannot even afford basic meal. For instance, the survey done by the National Bureau of Statistics in 2019 showed that 32% of Nigeria households actually face food shortages in 12 months of the survey and this was even before the corona virus situation. Another 27% of households had to skip a meal because they did not have money; 21% were hungry and didn’t eat because of lack of money. So, the poverty situation is severe. We must intensify our efforts in reaching out to the poor.
Fourthly, in terms of sufficiency of government intervention to ameliorate the Corona virus situation, the size of announced interventions is 3.1% of GDP. This is minimal when compared with several countries, some of which spend close to 10% of their GDP. The government needs to consider the option of increasing the scale of interventions to prevent an economic depression. No doubt, government borrowing will have to increase due to a fall in revenue; unfortunately, this is the dilemma of the situation we are in as a country.
In conclusion, going forward, we must come together and think of homegrown solutions. Critical questions to be answered are, how can we invest in measures to prevent the spread of the virus? What areas of the economy can the government gradually re-open? How can we install washing hand pumps in public places? How can we increase testing? Should we consider movement restriction for the elderly, who are highly vulnerable? How can we effectively reach affected citizens and businesses? How can we encourage working from home?