Global economies are now in a similar state as their public health services - on emergency, no thanks to Coronavirus.
Reports show the world is likely in a recession. Analysts at the UN say the world's $80 trillion economy will decline by $1 trillion to $2 trillion - a close to 3% contraction.
Nigeria, like most countries, will be hit on two fronts. Directly as a result of cases in the country, and indirectly, due to our closeness with - badly hit China, our number one infrastructure financier and trading partner, plus our reliance on global oil prices.
It is hard for one number to accurately capture the impact, but considering the uncertainties, such as how long the outbreak will last, the effectiveness of current policy measures, and how people and businesses will respond to these measures, there are certain impacts we should understand.
The price of oil hit its lowest level in 17 years, declining from $59 to $28 per barrel within a month as a result of lower demand and a lack of coordination between OPEC and Russia to reduce supply.
For Nigeria, where revenue from oil production is 31% of the 2020 budget revenue and oil accounts for 90% of foreign exchange - the effect of the sharp and persistent fall in oil price will lead to cuts in government spending and net exports, two critical components of economic output.
The Minister of Finance already announced that there will be cuts to non-critical capital expenditure. If oil prices don’t stabilize soon enough, critical expenditure like roads could also take a hit. On the private sector end, fewer dollars - normally earned from oil sales - will be available for Nigerians to import goods and services. This is particularly worrisome given the lack of foreign reserves to supply the system. Our dollar reserves at the Central Bank of Nigeria (CBN) have dropped from $45 billion last year summer to $35 billion today.
As a result of the shortage in foreign exchange earnings, the CBN has "devalued" the naira from an official rate of ₦307 to ₦360 per dollar. The dollar exchange rate for foreign investors was also changed from ₦360 to ₦380.
The devaluation, or as the CBN called it, realignment, has been praised by experts as it leads to the closer alignment between Nigeria's multiple exchange rates. It also allows the Nigerian government to earn more naira from its currently low dollar oil sales. One barrel of oil at $30 nows gives the government ₦10.8 billion, an increase from ₦9.2 billion at ₦306.
While this move will reduce the dollar required to meet foreign exchange demands, it also has negative effects on Nigeria’s equity and fixed income markets. With the naira losing value to the dollar, foreign investors are more reluctant to hold naira-denominated assets and as such, more inclined to sell off their naira assets.
The stock market has already taken a hit as a result of the virus. The Nigerian Stock Exchange (NSE) lost ₦2.3 trillion in the three weeks after Nigeria's first case - an 18% drop.
Uncertainty is a big factor for the shock in financial markets which has implications for the real economy. As investors lose money and businesses lose capital, spending by both individuals and firms decrease.
Another big hit to the economy and perhaps, the most direct hit will come from the restrictions on movement around the world and in Nigeria. The shutdown of offices and non-essential businesses will reduce productive effort and output. Take as examples, the closure of a Chinese fabric manufacturing company that produces input for a Nigerian fashion line or the shutdown of bars in Lagos. In both cases, Nigerian businesses will be required to slow down or halt production. Moreover, with stay-at-home policies and the uncertainty that comes with the pandemic, non-essential commodities will be less sought after.
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How have economic policymakers responded?
The CBN hopes to avert the economic impact of the pandemic by loaning money to the individuals, businesses and industries that are most affected and those that are in the front line of fighting the pandemic. The total stimulus package is ₦3.5 trillion. This includes 5% interest loans of up to ₦50 billion to households, airline service providers and hoteliers, ₦150 billion to the pharmaceutical and healthcare sector and ₦1 trillion for the manufacturing sector. It is also delaying repayments from SMEs under its many intervention funds.
The CBN hopes that the money can be used to keep vital sectors afloat. It particularly wants the manufacturing and pharmaceutical sectors to boost local production, reducing their reliance on foreign exchange for imports.
The Federal Government is yet to announce any major plans and there is a question of whether the CBN loans will be enough to stop the economy grinding to a halt and employees being laid off. Businesses are likely to need more grants. For some, taking up too many loans may be tricky, and if the crisis is prolonged the CBN might find that a lot of these loans end up being bailouts with no repayment.
Will COVID-19 lead to a recession?
A recession seems very likely.
Considering that the informal sector contributes about 41% of Nigeria’s economic output, how many people can stay at home and still be productive? Work-from-home policies would not apply to food vendors and artisans. Even within the formal economy, workers who are not skilled in working remotely like Nigeria’s civil servants and sectors without telework technology like manufacturing will be unable to work from home. A shutdown of movement will lead to a massive decline in economic output, income and consumer spending.
While most recessions are either caused by demand, supply or financial shocks, the COVID-19 pandemic promises to deliver all three in a single package. The shock to demand (restrictions to movement, and uncertainty causing consumers to reduce non-essential spending), to supply (shutdown of factories and service providers causing a reduction in goods and services produced) and the financial system (disruptions in the capital market) could be fatal. Nevertheless, the CBN is already making moves that it failed to make during the last crisis. Once the Federal Government comes into play, they might manage to minimise the damage.
But regardless of how our economy or economic policymakers react, the coronavirus is first a public health emergency. Without the population adhering to the World Health Organisation (WHO) guidelines and the government adopting preventive policies, the economy will continue to tumble.
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