2021-2023 MTEF: Key Implications and Market Impact

We recently received the 2021-2023 Medium Term Expenditure Framework (MTEF) and Fiscal Strategy Paper (FSP) released by the budget office of the Federation. We understand that the MTEF is largely in line with the provisions of the Fiscal Responsibility Act (FRA) 2007, which serves as a guide for the policy thrust behind Nigeria government’s public finances.

The framework highlighted the undesirable growth rate of the Nigerian economy, which has been growing below the 3% population growth rate. The wavering external condition in line with our view, was noted to be the major factor of the vulnerability of the Nigerian economy to the oil price shock which followed the COVID-19 pandemic. As such, the NBS projects the economy to contract by -4.2% y/y in 2020. The overdependence on crude oil as a source of revenue, low level of investment and the constrained public finance has made the economy vulnerable to the twin shocks of health crisis and collapse in oil price.

For one, since crude oil production has averaged 1.97mbpd over the last 3 years, we are unsurprised that the 2021-2023 MTEF assumes production estimates of 1.86mbpd, 2.09mbpd, and, 2.38mbpd in 2021, 2022 and 2023, respectively to ensure greater budget realism. Based on the recent play in the oil and gas sector and forecasts from the World Bank (2021- USD42/barrel; 2022- USD44.5/barrel; 2023- USD47/barrel) and IEA (2021- USD50/barrel), the MTEF also assumes an oil price of USD40/barrel for 2021, 2022 and 2023, which is below forecasts.

Thus the framework expects oil revenue to print at N1.98 trillion (2020 estimate: N1.01 trillion) at an exchange rate of N360/USD$. With expected production estimates of 2.09mbpd, FGN oil revenue is estimated to be N2.26 trillion in 2022 and N2.59 trillion in 2023 on oil production assumption of 2.38mbpd. We like the budget office remain largely conservative with its oil price assumption. For us, any positive upside will help in insulating public finances from the adverse effects of volatile oil prices as well as assist in building fiscal buffers which can be used to effectively respond to negative oil price shock in the medium term.

For the non-oil revenue, the MTEF aims to improve the tax collection system while assuming that a less aggressive tax elasticity to drive the nominal growth of tax base in the medium term. Thus, the MTEF considers the introduction of a new foreign exchange regime, Common External Tariff (CET), implementation of the Africa Continental Free Trade Agreement (ACFTA), gradual removal of Import Adjustment Tax (IAT), expected decrease in annual Average Duty Rate (ADR), expected increase in Import CIF as a result of new strategic plans in Nigerian Customs Service (NCS), and Import Duty on vehicles which has the highest tariff line in terms of revenue generation. The framework also expects aggregate consumption to increase marginally in 2021 by 0.8% y/y to N118.9 trillion, with VAT rate over the medium term being held at 7.5%. Thus, more taxpayers are expected to be brought into the tax net with the effective implementation of the provisions of the 2019 Finance Act and improving collection efficiency. The framework additionally envisage a 10% y/y improvement in collection efficiency of the Companies Income Tax (CIT) while also noting the expensive cost of operations of the Government-Owned Enterprises (GOE).

Based on the preceding, the framework expects total non-oil revenue to print at N5.56 trillion in 2021 (2020 revised budget estimate: N6.09 trillion)  after which is expected to improve by 14.7% to N6.38 trillion in 2022 on the back of positive effects from the assumptions highlighted above. In 2023, non-oil revenue is projected to increase marginally by 4.9% to N6.69 trillion. When adjusted for costs and deductions, the net non-oil revenue is expected to be N2.59 trillion, N3.16 trillion and N3.26 trillion in 2021, 2022 and 2023 respectively.

Based on the MTEF, it will take 2 years before the oil GDP will adjust back to the pre-COVID levels. With the compliance with the OPEC+ cuts by reducing base production of crude oil, growth in oil GDP is expected to contract by -12.96% y/y in 2020, resulting in slower growth in non-oil GDP by -3.6% y/y, which translates to decline in real GDP by 4.2% y/y. The framework also notes that the base effect resulting from the preceding year’s sharp drop in oil GDP will be reflected in the 2021 growth in oil GDP to approximately 8%.

The 2021 budget has an estimated aggregate revenue N6.15 trillion (14.6% greater than the 2020 estimates) while aggregate expenditure is projected at N12.66 trillion (17.1% higher than the 2020 revised expenditure estimates), leaving a total budget deficit for 2021 estimated at N5.16 trillion. This shows a projected 6bps increase in the deficit as a percentage of GDP in 2021 compared to 3.57% in the revised 2020 budget.

The preceding is well above the 3% limit set in the Fiscal Responsibility Act (FRA) 2007. The FGN admitted that it will not be feasible to keep the deficits within the 3% target unless the country can find new revenue sources. Meanwhile, in terms of funding, 2021 expected deficits are expected to be financed by new foreign and domestic borrowings worth N4.28 trillion (2020 estimate: N4.20 trillion), N205.2 billion from privatization proceeds, and N674.1 billion drawdowns on existing project-tied loans.

We also note that of the projected 2021 aggregate revenue, there is a provision for stamp duty estimated at N500 billion, up from N200 billion, while the signature bonus is projected to be down to N343.4 billion from the revised N350.5 billion in 2020.

We highlight the elimination of the under-recovery costs by the NNPC as part of the measures of the FGN to increase oil revenue over the medium term. This is done with the recent elimination of subsidies in the PMS pricing. Other measures include accelerating licensing of Marginal Oil Fields and renewals of existing licenses as well as ramping up production from previously shut-down oil wells.

The projected monetary and credit indicative benchmarks for the entire MTF would aim at a cumulative average 11.9% growth in broad money supply (M2), net domestic credit growth of 16.3%, and external reserves of USD38.8 billion representing an average growth rate of 4.07% for the entire MTF.

Key Implications and Market Impact

• Given the precedent budget performances, actual government revenue has always been short of budgeted revenue while government expenditure in most cases have been equal to or greater than the budgeted expenditure. We therefore assume budget performance of C.95% over the tenor of the framework as the government tries to improve the level of economic activities through its fiscal operations. As such, our scenario analysis suggests the budget deficit over each of the three years period could range between N5 trillion and N5.38 trillion with budget revenue under-performing by approximately10% (2016 revenue performance: 83%) on the back of fiscal reliance on aggressive tax measures as well as the Ways and Means to boost non-oil revenue.

• On the measures taken to increasing oil revenues over the medium term, we do not see the FGN ramping up production from previously shut-down oil well, while complying with the OPEC+ crude oil production cut agreement. Therefore, extension of the OPEC+ cut agreement as well as compliance will be a major factor contributing to the strategy of the government in boosting revenue over the medium term. Elsewhere, until an act against fuel subsidy is signed into law, we do not rule out the return of under-recovery costs – especially as crude oil price starts gaining grounds, given that PMS prices are currently adjusted based on the price of crude oil.

• The negative real interest rate in the fixed income market is expected to persist over the medium term. With the current low interest environment, we expect much activities in the fixed income space with yields slightly moving up over the medium term and compared to the current levels. Activities are also likely to pick up in the Eurobond market with the expectation of the DMO raising funds in the market when the current global health and economic crisis subdue.

• For the equities market, once economic activities pick up, increased investors’ activities are likely to be experienced especially as investors look for better alternatives to earn attractive returns and diversify their naira portfolio. Thus, we continue to advise investors to seek trading opportunities in only fundamentally justified stocks.

• Given past budget performance especially after the 2016 recession, we believe the MTEF will achieve a high performance rate with huge fiscal deficit to support the aggressive government revenue generation. We are however wary of the government’s actions of increased taxing of those already in the tax net, rather than expanding the tax net. This would reduce the gross domestic consumption (c.60% of total GDP), which will ultimately drag the medium term GDP of the country lower than what the framework expects.

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