By Lukman Otunuga, senior research analyst, FXTM
The United States Federal Reserve caught markets completely off-guard this week by lowering interest rates by 50 basis points.
It’s the first unscheduled, emergency rate cut since October 2008 and also marks the biggest one-time cut since then.
Rising concerns over the coronavirus outbreak impacting economic growth have forced central banks across the world to ease monetary policy with the Federal Reserve joining the squad. According to the Fed, “the fundamentals of the U.S economy remain strong. However, the virus poses evolving risks to economic activity.” This emergency rate cut certainly opens doors to further rate cuts in the future which is good news for emerging markets including Nigeria.
Lower US interest rates may provide an opportunity for the Central Bank of Nigeria to ease monetary policy in an effort to stimulate consumption which accounts for 80% of GDP. These efforts may be complicated by inflation which rose for the fifth straight month to 12.3% in January 2020. Although one of the central bank’s objective is to achieve price stability, a rate cut in the face of the coronavirus outbreak could support economic growth in 2020.
Sentiment towards the Nigerian economy has improved over the past few weeks amid positive economic fundamentals and encouraging Q4 GDP data. However, falling oil prices, global growth concerns and questions whether Nigeria will meet its oil revenue goal have fostered a sense of caution.
On the bright side, Nigeria reclaimed its title as the largest economy in Africa after South Africa entered a technical recession. Unstable domestic conditions inspired by power cuts weighed heavily on output and business confidence in South Africa with shaky global conditions compounding to the pain. While Nigeria was able to expand 2.55% in Q4, South Africa’s economy went the other direction by contracting 1.4%.
It remains uncertain whether Nigeria will be able to mirror a similar expansion in Q1 of 2020 due to severely depressed oil prices and slowing global growth. The commodity has dropped over 20% since the start of the year and could weaken further on demand side fears. Given how roughly 90% of export earnings and over 50% of government revenues are from crude exports, this certainly presents significant risks to economic growth.
The government needs to find other sustainable revenue sources to reduce exposure to external risks. It is widely known that diversification remains the key to Nigeria’s woes but this requires massive investments in infrastructure and time. There has been a push to expanding the tax base to raise non-oil revenues, but it remains to be seen whether this will have the desired results. Value added tax (VAT) has been increased from 5% to 7.5%. This could line the government’s coffers but it may come at the expense of rising inflation.
All eyes will be on the OPEC meeting this week which is expected to conclude with the cartel initiating deeper supply cuts. While such an outcome could push oil prices higher, the upside will most likely be limited by demand side uncertainties fuelled by the virus outbreak.