A number of people have reached out to me about the recent global economic situation - the mixture of Covid-19, global oil price crash, concerns about currency devaluation & general economic impact. Here is a bit of explanation on what’s going on. This may be long. Grab popcorn.
First, COVID-19. Global pandemic has destablised global supply of goods & services. China, most affected by the outbreak, is the 2nd largest economy in the world contributing almost 10% of global GDP (abt 9.3%) + the factory of the world & a large source of foreign investment.
Due to travel restrictions & bans, supplies for many industries that rely on Chinese factories have slowed leading to business disruptions. It has been estimated that the global aviation industry may lost almost $113 billion this year alone to the COVID-19 travel restrictions.
Things aren’t looking good. People can’t travel freely. Companies are losing revenue. Flights are being restricted. OECD has revised global rate down from 2.9% to 2.4% (slowest since 2009).
Companies also can’t easily sell to China’s large consumer market. This affects the global stock market as companies have to revise growth & revenue targets. Stocks in almost every major stock market has plunged downward since the beginning of Covid-19. So pot of beans really.
Now, Global Oil Price Crash. So global price for oil is determined by a number of things - extent of demand for oil, level of supply of oil in the market & agreement among OPEC countries & non-OPEC countries to control supply levels.
OPEC members (led by Saudi Arabia) have artificially propped up the price of oil by controlling how much each member supplies (oil production cuts) + agreements with non-OPEC countries, so that there is a controlled amount of oil in global circulation & oil price stays up.
The US in recent years has stepped up exploration of shale oil. Shale oil is profitable at $50 per barrel. Due to agreements btw OPEC & non- OPEC countries (led by Russia) on production volumes, oil prices towards end of 2019 hovered btw $59 - $62 per barrel ( $67 in Dec 2019).
China is second largest oil consumer globally, so Covid-19 means a major reduction in oil demand. To maintain oil prices, Saudi Arabia pushed for oil production cut of 1m barrel a day for OPEC members & 0.5m barrel a day for non-OPEC members. Russia refused this deal last Friday.
Since the deal didn’t work, Saudi Arabia decided to jettison oil production cuts and also cut price it sells oil to Asia. Meaning everyone can pump as much oil as they want. Too much supply of oil means oil price will fall. And it did, falling 30% on Sunday to as low as $35 p.b.
Today it’s about $30 per barrel and most estimates are that it will fall to about $20 per barrel. Now that is not good, and all is not well.
The oil price crash has also affected the stock market, as most investors are dumping stocks and buying government bonds instead, and yields on bonds also dropped due to high demands. Yesterday, Stocks fell more than 7%, making it the worst trading day in Dow since 2008.
Now, Nigeria & Other Oil-dependent countries. Countries, like people, plan their budget around estimated revenue. Meaning for determining yearly budget estimates for income and expenses, countries make estimates of what they will earn.
For oil-producing countries, that estimate includes what they will earn from oil based on how much they estimate oil prices will be. Nigeria used $57 per barrel, Bahrain & Oman used $80 - $90 per barrel. Any drop below this number will mean a reduction in expected revenue.
Now in Nigeria, oil revenue constitutes about 65% of Government revenue and 90% of foreign export earnings.
Also, present Dollar exchange rate (i.e the price at which you buy dollar) which businesses depend on for global import and export is artificially maintained by the CBN who uses its foreign reserves to supply dollar to the economy at a CBN rate.
Falling oil prices = oil revenue for the Government = less revenue to share between Federal and State governments = less revenue for Government’s expenditure plans = strain on reserves to maintain the present Naira to Dollar exchange rate = less dollar that businesses can access
Most countries look to their Excess Crude Account (ECA), which is mostly excess funds stashed away when oil prices are high, as a buffer for when oil prices are low. In Feb 2020, Nigerian Accountant General said that Nigeria’s ECA stood at $71.81 million. Not much of a buffer.
The CBN governor has hinted that if oil prices fall below $45 per barrel for a sustained period, the present Naira-Dollar exchange rate cannot be sustained.
Over last 2 years, The CBN’s reserves have decreased by 20% to lowest since November 2017, and the oil price crash may push the reserves towards the $30 billion threshold set by the CBN governor for Nigeria to consider a devaluation.
Now, Global economic implications. Drop in oil prices means a lot of oil companies will review production plans. Most oil companies, like BP and Royal Shell need $50 per barrel to break even. Also US shale producer need $50 per barrel to break even. So tight times.
Most countries, especially oil producing ones, will reduce expenditure & review government plans for the year. Less money, means less ambitious plans. Some governments is to turn to borrowing or private sector partnerships to augment revenue for important projects.
Companies will also have to review expansion plans and supply logistics. Many businesses that depend on global imports, especially China will have to turn to other or local alternatives. Airlines are already cutting prices to encourage people to fly.
Also no one knows how long the Covid-19 or oil price wars will go on for and that puts businesses & countries on edge. Meaning people/companies will try to spend less and save more and that is generally not good for global economy. The global economy needs people to trade.
Now, Nigerians. Well, the CBN has a number of tools at its disposals - it can restrict businesses that can access foreign exchange which means those not in that list have to buy dollar from parallel market at higher prices.
The CBN can also adjust the rate at which dollar is exchanged for Naira higher, which invariable devalues the Naira and will mean that the purchasing power of the Naira compared to the dollar will drop significantly.
For instance, despite having over $500b in reserves, Russia’s currency, the ruble has already depreciated in value today. Russia insists it has enough reserve to withstand prices being at $25-$30 for 6 to 10 years.
A devaluation also means the value of the Naira will drop significantly. Meaning whatever you and your savings are worth will get slashed. Last time there was a devaluation, Dangote Ltd lost 35% of its valuation (about $37 billion) and Alhaji Dangote lost about $5.4 billion.
The CBN can also adjust interest rates and pressure increased commercial lending as ways to provide solace to businesses and allow liquidity. Most business are affected by lack of operating cash than the exchange rate issues itself
The Government may also be forced to cut its budget. Already, servicing debts and recurring expenditure are 80% higher than 2019 actual revenue, so not much wiggle room here. Government may also borrow to fund the budget deficit due to the loss in oil revenue.
Also, borrowing will not be cheap. Yesterday, yields on Nigeria’s 2049 Eurobonds climbed 143 basis points to 10.18%, which is the highest on record & naira weakened 1.1% in offshore trading. Meaning it will not be cheap to borrow.
Also, very few lenders will be willing to borrow when oil is selling at $30 per barrel and any even go lower, especially when a country is hedging repaying those loans on oil sales. Makes either a tough sell or an expensive sell (i.e. high interest rate)
Now, some advice. People will tell you to buy dollars and just store. Fact is a few dollars saved won’t do much to salvage your situation if there is a devaluation or a serious global economic downturn.
Smart advice. If you’re a business, aim to earn revenue in dollars and try to ensure your expenses are paid off in Naira. Why? Well, it hedges your expenses so that you’re paying in Naira while you’re earning in dollars. This alone can increase your profit by several percentages.
If you’re a service provider, increase your base from just domestic clients and look to supply your services to international clients that can pay in dollars or any other foreign currency.
Also, if you have taken any loans. Ensure you are repaying the loan in the same currency in which you are earning revenue. So if it’s a dollar based loan, ensure you’re earning dollars. If not, restructure the loan now. Pays to earn in dollars but pay back your loan in Naira.
Also, consider foreign currency-based based investment. However, check the exchange rules for such investment. You don’t want to save and then lose all the spread to some funny exchange rules (Eg one that converts at rate at which you made investment etc). Do the maths first.
Also, find suppliers from cheaper markets or local suppliers for things you need. For instance, it may be cheaper to buy things in Ceddis or even Yuan (thanks to the CBN currency swap policy) than a transactions that is fully domiciled in dollars.
The Nigerian President has also convened a committee to study the impact of Covid-19 on the Nigerian economy. They may also come up with an interesting way to manage the economic situation or at least manage the market panic.
For instance, increased commercial lending and a reduction in interest rates in these times can do a lot to provide support to help business persons manage the economic fallouts talked about. Donald Trump is already talking of a economic stimulus package for US businesses.
keep listening to the news and important economic news. I will try to share important updates on my twitter. But in times like, this information is your best guide, not one copy and paste theory.
Things change overnight, who knows US-Saudi Arabia and Russia may just strike a deal and oil prices will normalize. Or a vaccine for Covid-19 is found and China’s factories and consumer market are back in play. Changing all the calculations dramatically.
As at this morning, US stocks seemed to rally in response to Donald Trump’s stimulus, but the rally didn’t last.
For now we keep observing the market. Be safe out there with your finances and businesses.
End (for now).
For now we keep observing the market. Be safe out there with your finances and businesses.
End (for now).
