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Analysis > Analysis and Strategy

Variety is the spice of life in Africa

Paul Clark, Fund Manager, Ashburton Investments
June 3, 2015, midnight
755

Word count: 951

The diversity of Africa’s 54 unique countries is a fact which African experts and Africa-facing companies have been stressing for years. The varied effect of the global oil price decline on countries across Africa is simply a case in point, writes Paul Clark.

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The diversity of Africa’s 54 unique countries is a fact which African experts and Africa-facing companies have been stressing for years. The varied effect of the global oil price decline on countries across Africa is simply a case in point, writes Paul Clark.

At a high level it is obvious that Africa’s oil exporters – the likes of Angola, Nigeria and Libya - have been negatively affected, while oil importers – such as South Africa - should see benefits as prices decline. It is important to note that, overall, more than half of Africa’s economies (as measured by GDP) are net importers of oil or oil products. Lower oil prices have, therefore, been generally positive for the continent. In East Africa, where petrol prices are generally market related, the lower oil price has led to increased disposable income for consumers and lower inflation.

In Kenya, where the inflation rate was trending upwards during the first half of 2014, inflation declined to within the target band in the second half, allowing the Central Bank of Kenya to keep interest rates unchanged. Prior to the oil price decline, which began in earnest in September 2014, Kenyan commentators had been anticipating a possible rate hike. Therefore, certainly the economies of East Africa and consumer facing companies in the region in particular have benefitted from lower oil prices.

In Egypt, where fuel is heavily subsidised, the 2014-15 budget (to June) includes EGP 100-billion (US$14-billion) for fuel subsidies (a 31% reduction from the previous year). In order to achieve the reduction, pump prices were increased by between 60% and 80% for different grades in July 2014. Therefore, as oil prices began falling globally, Egyptian consumers were faced with substantially increased demands on their pockets from the fuel price increase and subsequent inflation in other products. For the government, of course, the subsidy funding requirements have been massively reduced and this could lead to a reduction of at least 2% in the budget deficit.

For Africa’s largest economy, Nigeria, the effects of lower oil prices have been more severe - Paul ClarkFor Africa’s largest economy, Nigeria, the effects of lower oil prices have been more severe. While making up only 11% of GDP on a direct basis, oil contributes more than 90% of exports and contributed about 70% to government revenues before the recent price weakness. Oil prices have a notable effect both on Nigeria’s current account and the government’s budget balance. Because Brent prices are a good proxy for the price of Nigerian crude oil, the prices mentioned herein refer to Brent. Estimates vary, but most analysts believe that the current account moves into deficit at around $70 per barrel.

This puts pressure on foreign exchange reserves (which have been coming down) and, ultimately, on the currency. In order to attract and maintain foreign portfolio flows in the fixed income market, the Central Bank of Nigeria has been raising interest rates and tightening liquidity in the local market. Despite actions to limit speculation against the currency it still declined 18% against the US dollar over the period of the oil price decline, and this will lead to imported inflation. From a budgetary perspective, oil prices between $65 and $70 per barrel should be sufficient to limit large increases in government borrowing. Nigeria has very low levels of public debt to GDP (at around 11%) and can, therefore, borrow in the short-term to make up for the shortfall in oil revenues.

With Nigeria’s newly-elected government taking office on May 29, 2015 it is not yet clear what changes will be made to the budget. While President Muhammadu Buhari has promised to improve infrastructure in Nigeria, this spending may well be delayed due to the current budgetary constraints. On a continent-wide level and a company level, sudden changes in oil prices can create shocks and risks. For example, an importer who has purchased oil product at a certain price could land it later when global prices have fallen. This could lead to bankruptcies and an increase in nonperforming loans for banks. Fortunately, with oil prices having stabilised since the start of the year, we believe that these risks have largely abated.

Looking ahead, a gradual increase in prices to the $65 to $70 per barrel range for Brent – the Ashburton house view – should not impact too negatively on Africa’s oil importing countries. This increase is unlikely to translate into significant inflation or a large cost to the consumer’s pocket.

Transport costs and fuel prices will still be substantially lower than a year ago, when Brent was trading around $100 per barrel. In addition, over the next few years, some oil importers (such as Kenya and Uganda) will develop their own production and become net oil exporters. On the other hand, higher oil prices will be supportive of oil exporting countries and will reduce pressure on both the current accounts and budgets of these countries. Because Nigeria is the largest economy in Africa, with the largest population, its economic health is a key focus of any analysis about the continent. The West African country also has large debt and equity markets with significant foreign participation, so it is being keenly watched by global investors. As mentioned earlier, oil prices between $65 and $70 per barrel should be sufficient to avoid any austerity measures in Nigeria which might curtail much-needed infrastructure expenditure.

Overall, the decline in oil prices in the second half of 2014 played out differently across Africa, impacting economies in divergent ways. But the effect was generally positive. A gradual increase in prices should support the large oil exporting economies that have suffered the most in a low oil price regime, but without creating too much stress for the oil importing nations.

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