During the week, US President Donald Trump tweeted, Oil prices getting lower. Great! Like a big Tax Cut for America and the World. Enjoy! $54, was just $82. Thank you to Saudi Arabia, but let’s go lower!— Donald J. Trump(@realDonaldTrump) November 21, 2018
Brent Crude Price, the benchmark oil price used to gauge Nigerian oil sales fell to as low as $60, the lowest seen since November 2017. It has dropped by about 30% from a year high of about $86 per barrel back in October. Considering the effect of oil price in the economy, this price drop has significant ramifications for Nigeria. More importantly, it has implications on how well your investment portfolio could perform by year-end and into the new year. But first, for the economy.
Effect on the economy: Latest data from the National Bureau of Statistics indicates that Nigeria’s Non-Oil GDP as a percentage of GDP was 91.45% compared to Oil GDP of 8.55% for the quarter ending June 2018. Despite this, the Nigerian Government relies on oil for about 70% of its revenues. A drop in oil prices could portend less revenue for a government that has relied heavily on debt to finance capital and recurrent expenditure.
Last month, the Budget Minister, Udo Udoma, revealed that the executive council pegged the price of crude oil per barrel at $60, as well as exchange rate at $305, while daily crude oil production is put at 2.3 million barrels per day for the 2019 Budget. With Brent already at $60, the government projection is already out of sync with reality.
With the external reserves threatening to drop below the $40 billion thresholds, a continuous drop in the price of oil could mean a harsher monetary policy tightening for the CBN. At the monetary policy committee meeting held last week, the CBN signaled its intention to continue to ban more items, while committing to defending the naira. It also held interest rates at 14%. But how long can it continue to defend the naira?
The emerging market sell-offs that have affected countries like South Africa and Nigeria has resulted in a net outflow of foreign investments out of the country, further affecting how much forex the CBN can keep in its reserves.
What this could mean for your portfolio: For investors in the stock market, a drop in the price of oil is as bad as it gets. Already, the stock market all share index is down 2.43% month to date and 17.7% year to date. NSE Oil and Gas index was down 12% year to date and down 0.14% last week.
Records also show that the Nigerian stock market’s performance has a positive correlation with the price of oil, meaning that when oil prices dip, the stock market also dips. The chart below buttresses this point.
Stocks have had a battering of late and indications suggest that things are not about to change till after the election in February. Even at that, a temporary election bounce could be short-lived if the pressure on emerging markets ensues into the new year. American stocks have also recorded significant price drops of late, as investors fear that a sustained US Fed rate hike could lead to more investment outflows out of emerging markets like Nigeria. Add that to the trade wars between China and the US and the fear of a global contagion, then the outlook is pretty dire for stocks.
If you invest in assets like treasury bills and FGN Bonds, a further tightening by the CBN may result in higher interest rates for your investments. Thus, a reduction in the country’s external reserves due to a continuous drop in the price of Brent Crude could force the CBN to offer higher interest rates on investments like Treasury Bills. Offering higher interest rates is a CBN strategy used to keep the exchange rate stable. This is on the premise that if you offer a higher interest rate on naira assets, there will be less naira chasing dollars as investors will prefer to hold the naira. While this favours investors in treasury bills, a higher borrowing cost for the government doesn’t ogur well for the wider economy.
Investors in Fintech products offering interest in exchange for loans or short-term investments could also record a spike in returns extended to their investors. A pass-through effect is expected if the CBN raises interest rates on treasury bills, thus investors in these products should anticipate a similar increase in their return. However, there is a risk of rising default stemming from an economy that may fall back to recession if the drop in oil prices fall below Nigeria’s benchmark.
What about Cryptocurrencies? Unfortunately, these are also not doing too well. The price of Bitcoins, the most important, fell below $4000 during the week with analysts projecting that it could bottom out at about $3,000. A falling oil price is not helping matters either as it only worsens the sentiments investors currently have towards cryptos.
What options exist: Retail investors in Nigeria haven’t had it this bad in years. With the little option to invest money at a return significantly higher than inflation, many are left with pursuing high-risk investments. We will not be surprised if Ponzi schemes resurface again next year, as investors look for higher returns on their investments.