It’s been a tough year for Nigeria and the government of President Muhammadu Buhari. With the country’s economy already buffeted by the fall in global oil prices, resurgent militancy in the Niger delta has had a sizeable impact on oil production levels. Meanwhile, foreign investment levels are down, and a shortage in foreign exchange has created a liquidity crisis – stemming in large part from the government’s rigid efforts to prop up the embattled naira and prevent an inflationary spike.

The country has slipped into its worst recession in a generation. And as a further sign of diminishing confidence in one of Africa’s most important economic powerhouses, last week saw a ratings downgrade for several of the country’s banks based on falling confidence in the government’s ability to bail them out in the event of a banking crisis.

Businesses are downbeat and we believe the next few months are likely to get worse rather than better given current economic and political conditions. But we also believe that the deepening of the economic crisis will force more radical reform and that there are accordingly glimmers of hope that could alter the trajectory of Nigeria’s economic fortunes and longer-term governance outlook.

The economic crisis has exposed Nigeria to itself, laying bare the losses, leakages and inefficiencies of a dysfunctional state system, burdened by corruption and mismanagement. The ruling APC party’s hard-won reform mandate has certainly lost some of its sheen against the constraints of the tough economic conditions the party inherited on coming to power in 2015, and the realities of a political system that is still replete with vested interests and debilitating ethno-regional competition. A battle is being fought between those seeking structural reform and enhanced discipline, and those using the current situation to further their own commercial and political interests. It remains to be seen who will emerge on top, but there remains at least some cautious optimism around what the government might achieve as it seeks to reinvigorate the economy and restore confidence.

After a difficult year in 2015, money has begun ploughing back into emerging markets amid stagnation and lower growth in the developed world. And with around US$38tn sitting in OECD markets earning 1% returns or lower, Nigeria offers significant opportunities to international capital if confidence can be restored. In this respect, we believe the government’s handling of three factors are going to be critical to tackling the current state of ‘stagflation’ and shaping Nigeria’s broader political and economic outlook:

• Negotiations with interest groups in the Niger delta
• Foreign exchange policy
• Debt-raising initiatives, infrastructure investment and economic stimulus.

In this note, we explore the dynamics at play around these three areas.

Trouble in the creeks: insecurity in the Niger delta

Buhari’s 2015 election victory shook Nigeria’s political establishment to the core. After 16 years of the PDP’s national dominance, rising dissatisfaction at perceived government underperformance and corruption, combined with an alignment of diverse political interests were at the heart of the APC’s landmark victory. But a power-struggle between the country’s main ethno-regional power blocs also sowed the seeds of the opposition’s triumph. The controversial presidency of Goodluck Jonathan led to perceptions that political power – and with it, economic control – was increasingly being monopolised by a southern cabal around Jonathan. This dynamic was at the heart of Buhari’s successful move to rally the northern Hausa-Fulani and south-western Yoruba against the ruling establishment. Yet this dynamic has once again sharpened the lines of ethnoregional identity in Nigerian politics.

Buhari’s government is inevitably dominated by the northern and south-western networks which brought him to power. With a handful of notable exceptions, it lacks heavy-hitters from the Niger delta and south-eastern Igbo community, most of whom remain aligned with the PDP in opposition. The curtailing of political influence and patronage networks in the delta and southeast has contributed to rising political tensions and resurgent restiveness at the grass-roots level.

The most evident sign of this worrying trend has been the emergence in the last year of the Niger Delta Avengers (NDA). The NDA is an organised militant group which has bombed several oil pipelines in the oil-producing region. Based in the western axis of the Niger delta, the group’s attacks – notably on the Forcados and Escravos trunk lines – have been relatively sophisticated and surgical, resulting in hundreds of thousands of barrels of lost production, but limited casualties. At their peak earlier this year, as much as 50% of Nigeria’s oil production was lost at a significant cost to the national coffers.

But the NDA is not operating in isolation. In fact, there are a number of smaller networks and community militias which have become more vocal in the creeks of the delta in recent months, while localised community issues remain significant, especially around the Forcados pipeline route. Meanwhile, the political demands of the NDA are also receiving broader backing from senior Niger delta power-brokers who feel the government needs to be doing more to support the region’s development needs.

The government undoubtedly recognises the strategic importance of addressing the militant problem in the Niger delta, and is feeling the economic impact. Reduced production is costing the country billions of dollars and is exacerbating an already bad economic picture. But it has struggled to engage decisively and constructively on the issues to date.

Its response has been first to charge Petroleum Minister Emmanuel Ibe Kachikwu to negotiate directly with the NDA, and based on the Minister’s negotiations, to arrange a high-level meeting in Abuja on 2 November between a presidential delegation led by Buhari himself, and a delegation of senior representatives from the Niger delta such as Edwin Clarke and Timi Alaibe. Much hope was placed on this dialogue, but the initial signs have not been promising. In the lead-up to the talks, Kachikwu announced the creation of a $10bn reconstruction fund for Niger delta, but this was counter-balanced by suggestions that the arrangement for the 13% derivation of state oil revenues to oil-producing states would be reviewed. It was also unclear how the $10bn fund would be financed, with the government suggesting money would come primarily from the private sector, which has generally shown limited enthusiasm for taking on the reputational and financial risk of handling sensitive development projects in the region without significant government backing. Niger delta representatives were also unhappy the announcements were made with limited – if any – consultation, and disagreed with some of the plans. Meanwhile, the delta delegation attending the presidential meeting issued a lengthy list of demands suggesting unrealistic expectations.

Neither side seemingly walked away from the talks content, and personal rivalries within the negotiating parties further muddied the waters. Subsequent pipeline bombings by the NDA go to show that a swift resolution is unlikely and they may seek to further turn the screw by escalating direct intervention further in the run-up to Christmas as they do not believe the government is addressing the issues.

While the government clearly recognises the need to address a highly strategic issue, they may not be putting it at the top of their list of priorities. In the immediate term, Buhari has requested additional budget to support delta initiatives and even extend funding for the militant amnesty scheme that was launched in 2009, scoring some success in reducing insecurity in the creeks. But while this transactional type of short-term solution may continue to bear some fruits, a more robust strategy for peace and development is essential. In this respect, a broader dialogue is likely to play out in the coming weeks following the initial November meeting, but things may become worse before all sides seek a broader solution.

Although there remain some advocates for a more forceful military approach, the government currently remains wary of escalating conditions in the delta – especially given the sensitive politics that underpin relations with a region that is poorly represented at the federal level. However, as militancy potentially escalates, and an ongoing military build up continues into next year, the potential for confrontation is becoming greater.

Despite this, and the apparent failings of the first major talks in Abuja, we believe further dialogue is likely and the impact could be significant. With production levels hanging between 1.1-1.8m barrels per day in recent months, even getting production back up to its previous unremarkable levels of 2.2m barrels per day would bring hundreds of millions of additional dollars flowing back into the state’s coffers at a time when they are desperately needed.

Such are the socio-economic and political conditions surrounding the Niger delta, a comprehensive settlement and end to all militant violence seems unlikely. In fact, we view the risk of an escalation in attacks on strategic infrastructure as significant in the coming weeks. However, this could act as a trigger to force a more concerted and constructive dialogue, ultimately paving the way for a more far-reaching delta development plan.

Starving business: FX restrictions

Perhaps the greatest constraint for businesses operating in Nigeria at the moment has been the inability to access foreign currency, notably for importation of goods, and repatriation of profits. Monetary policy has been a highly politicised issue since the oil price drop, with a significant divergence in views between business and government.

The government’s foreign exchange receipts have dropped significantly since the oil price fall, placing the naira under sustained pressure. However, rather than allowing the market to determine its true value, the Central Bank of Nigeria (CBN) has sought to peg the rate and prop up the currency at whatever cost. Throughout 2015 and the first six months of 2016, this strategy eroded CBN forex reserves and severely restricted businesses’ ability to access foreign capital. Further government efforts to intervene by imposing import restrictions pushed more demand onto the parallel market, exacerbating a growing divergence between the official exchange rate and the rate being traded in the parallel market. Yet despite the significant constraints this situation placed on businesses and the inflationary impact it was beginning to have, CBN Governor Godwin Emefiele – with the strong backing of Buhari – resisted calls for a devaluation and free-float until June of this year.

Long overdue, the June devaluation was initially welcomed and helped to clear some of the backlog of forex demand in the market. But rather than allow a free-float, the CBN has continued a policy of a managed exchange rate, which has only renewed pressure on the naira and reduced investor’s trust in the regulatory structures. There are now as many as six official spot rates trading in parts of the formal market creating pricing arbitrage, while the unofficial rate on the parallel market has climbed back up well above the official rate, perpetuating a highly dysfunctional system. The few – often well-connected – businesses that are able to access foreign capital are able to make significant sums of money from round-tripping and price arbitrage and, as always in these situations, there is likely an element of political and systemic collusion. But for most businesses, aside from some positive outcomes around increased local sourcing, they are having to turn to more expensive forex options in the parallel market, which remain insufficient, or simply be starved of foreign currency for imports or repatriation of profits.

Both the timing and handling of monetary policy decisions have severely dented investor confidence and are in large part to blame for the dearth of foreign capital currently entering the Nigerian market. Investors simply do not have confidence in their ability to get money out of the country, while there is widespread belief that another devaluation will become necessary. Calls for Emefiele’s dismissal for his handling of the matter (and a broader lack of industry confidence) have largely fallen on deaf ears. In fact, his interventionist approach continues to draw the support of Buhari who firmly believes in the importance of a strong currency and is concerned by the short-term inflationary impact that allowing the naira to float could have. In his rationale for maintaining an interventionist stance, Buhari points to the fact that the June devaluation did little to reduce pressure on the naira. Yet the short-term pain of allowing the market to set the currency’s value is ultimately likely to be outweighed by the significant benefits this would bring in easing forex pressures and facilitating trade and investment.

For now, despite what some industry commentators state, the politics around this issue look unset to change, further compromising investor confidence and constraining business. Recent regulatory intervention has extended to include the arrest of bureaux de change operators for selling above an indicated price while attempts are underway to significantly tighten currency controls further, with potential legislation forcing anyone holding foreign currency to convert it within 30 days or face criminal sanction.

With the situation looking likely to worsen in the coming months, it is likely things will come to a head, and the government’s hand may become forced by the economic consequences of its intransigent position – particularly in the context of its efforts to secure foreign debt support. Pressure from bilateral and multilateral lenders, combined with the worsening state of public finances and forex reserves are ultimately likely to pave the way for this change, however much Buhari is opposed to it. And after Egypt this month announced a landmark floating of its currency following years of managed trading, Nigeria may well follow suit – but not until the market moves further against the naira as we believe it will in the coming weeks.

Spending your way out of trouble: public debt plans

In response to the flagging economy, Buhari has announced an ambitious plan to launch a major capital expenditure programme funded primarily by foreign debt. Following a major debt write-off in 2005, Nigeria’s debt-to-GDP ratio remains relatively low at around 13.5%. Although debt levels have already risen since the oil price drop and the debt-servicing bill has climbed considerably, there is scope to borrow in the short term. Moreover, it is positive that a number of multilateral lenders are at the front of the pack to provide loans with favourable interest rates and timelines. However, there remain significant questions around the impact that this level of debt issuance will have, stemming from concerns about the government’s ability to execute the associated projects efficiently.

The fall in government revenues has severely constrained the government’s capital expenditure capacity. Recurrent expenditure – the cost of running government – accounted for almost 90% of the 2015 budget. While this was reduced significantly for 2016, the government has been squeezed of the funds to invest in its CAPEX budget and so budget implementation has been limited. In response, Buhari has put forward a $29.96bn debt-raising plan to cover spending between 2016-18. This will principally be sourced from the World Bank, the African Development Bank, the Islamic Development Bank, China Ex-Im Bank and the Japan International Cooperation Agency, with a Eurobond issuance also planned at a commercial lending rate. But there remain significant questions around whether Buhari can get this ambitious plan through parliament, which has rejected the proposals once already. It is also unclear what concessional requirements the multilateral lenders will require. And finally, the government’s track record and capacity on investing money in an efficient and impactful manner for future growth and development is patchy, so it will be critical for the spending plans and implementation to be robustly structured and managed.

On the first point, the initial debt plan was rejected by the Senate last month. Senators from both the opposition and the ruling party felt the fiscal proposals lacked adequate detail and were concerned around the unprecedented scale of borrowing. There is also a more political dimension to the dispute with the legislature’s relations with the presidency proving fractious amid mutual discontent over the balance of power and decision-making approach of each body. A more intensive process of executive lobbying the legislature is now likely to occur, spearheaded by the President’s office, with support from the Minister of Finance and the Minister of Budget and Planning.

Meanwhile, although a number of major multilateral and bilateral lenders are in talks with the government around debt support, only the African Development Bank has formally committed to a $1bn loan so far. We believe some of these lenders will wish to see greater detail around how the money will be spent, and more reassurances around macroeconomic management – including on the all-important FX issue. This could be a key factor in ultimately shifting the government’s approach, as without the capacity to raise debt, Nigeria is likely to remain locked in its current economic quagmire.

The last point around the quality of debt expenditure is critical. Since coming to office, the government has made some extremely positive steps to improve governance and accountability across the state administration. Important reforms like the enforcement of the Treasury Single Account, and the requirement for state agencies to actually submit accounts in order to secure budget are reducing avenues for corruption and mismanagement by improving transparency and forcing accountability. However, there remain significant inefficiencies and dysfunction in state administration which will hinder the extent to which some investments reap quality results through effective execution. Furthermore, the government’s willingness and capacity to make tough reform decisions around streamlining the public sector is likely to remain limited on what remains a highly sensitive political issue. As such, debt raising in the coming months will certainly be a boost for the Nigerian economy, even if the full sum of $29.96bn isn’t achieved. Yet it is unlikely to be the elixir for transformative development as is hoped.

Conclusions: confidence is key

The achievements of the Buhari administration in office ranging from its military gains against Boko Haram in the northeast to its institution of important governance reforms have been drowned out by the broader economic malaise and sometimes wayward handling of economic policy. There remains a clear disconnect between the different offices of the presidency, cabinet and legislature which has added to the uncertainties, and raised questions around government performance in pulling Nigeria out of a tough situation.

The atmosphere in the business community is glum and rightly so. It’s been a harrowing period for many who have been pushed to the wall by the crisis of liquidity prompted by the oil price fall. But while we anticipate a tough few months more, there are several positives that can also be drawn from this situation.

Partly due to the political mandate of the current government and partly due to the economic realities it finds itself in, Nigeria will continue to witness reforms that will improve governance, transparency and accountability. From the highly dysfunctional and politicised oil sector to the new tech industries and commerce, this is likely to be transformative in impact. Never before has a government been so committed to supporting diversification of the economy, and this will provide huge opportunities for growth and development, which will require patience, but offers value to those first in.

But above all, businesses cannot overlook the long-term fundamentals of a country with unparalleled resource and market potential in Africa. Nigeria continues to challenge and disappoint in many areas. And the last few months have exposed some of the difficulties and complexities that come with operating in a market that is prone to volatility and dysfunction. But for all the travails it has gone through, Nigeria remains a country on the move that has enough dynamism, resources and opportunities to see it rise again from the ashes of its most difficult economic chapter.

With this palpable potential still very much in evidence, restoring investor confidence and reviving the fortunes of the economy over the next year will be critical before electoral politics once again creep onto the scene in 2018. The government has been a slow mover to date and has not always shown the type of visionary and decisive leadership needed to turn the economy around. Our belief is that a period of strife and uncertainty in the coming months will ultimately make way for a stronger and more functional economy, improving prospects from mid-2017 onwards.

Roddy Barclay is the Head of the Intelligence and Analysis team at africapractice, a pan-African risk advisory and strategic communications firm. It advises some of the largest institutions, companies and investors across the African continent, helping them to understand complex political and commercial dynamics, and manage challenging relationships with demanding and critical audiences including regulators, media, capital markets, customers and suppliers. Since the company was founded in 2003 it has supported progressive and ambitious leaders to transform organisations and to accelerate growth and development in Africa.

Roddy Barclay email: [email protected] | africapractice twitter: @africapractice