I recently had the pleasure of travelling to Nigeria on an investor trip. It was my first time in Nigeria, and the excitement really had a grip on me. I wanted to get a real-life experience of a country that I had only been familiar with from behind the screen, looking at how their data has evolved over time. Currently, it is evident that Nigeria is on a positive path and has been emerging from the ashes of 2023 to become an attractive destination for investment and positive returns. On a macro level, signs of improvement have been apparent, and whether these improvements have seen dynamics on the ground getting better, is a piece of the puzzle I am trying to solve for a few months now.
Tales of corruption scandals, foreign exchange (FX) availability and political intervention have been the labels stuck onto Nigeria over the past couple of years. However, the country and her people have continued to push through it all with tenacity and one can sense it. The reform story continues, but we are seeing Nigeria as an attractive destination and the Africa Frontiers fund has been increasing its position in Nigerian stocks.
Macroeconomic picture: A metamorphic turnaround
Looking back over the past five years, Nigeria's gross external reserves have followed a deeply uneven path. Gross reserves stood at $33 billion at end-2023. Net reserves, which subtract short-term FX liabilities from gross reserves, told a strikingly different tale: they stood at $14.59 billion in 2021, fell to $8.19 billion in 2022, and collapsed to $3.99 billion at end-2023. This near-total depletion of usable buffers was the real hidden fragility.
The low levels of FX reserves were further compounded by the restrictive FX regime that previously existed. The naira's collapse in 2023 was the culmination of a decade-long structural failure, not a sudden policy error. Under Emefiele, Nigeria operated a multiple exchange rate regime, dominated by a tightly controlled official rate, with little liquidity available to businesses and individuals, which drove demand to the parallel market at a significant premium. This led to FX backlogs piling up, remittances being diverted away from official channels, the development and growth of parallel and black markets for US dollar, encouraging arbitrage opportunities for Nigerians who could obtain foreign currency at the official rate and sell it at a premium in the black market.
The deepest root cause of the deterioration in external balances was Nigeria's catastrophic oil production collapse. Since 2020, disruptions and reduced investment in upstream development led to a significant decline in crude oil production. In the third quarter of 2022, production briefly dropped sharply lower because of extended disruptions from crude oil theft and pipeline vandalism. Nigeria's budget had been benchmarked at 1.88 million barrels per day, significantly higher than what had been produced, leading to a large shortfall in revenue for its government. This led to a widening fiscal balance, which had to be financed by the central bank, who had already surpassed overdraft facility levels to the government.
The combination of all these factors, widening government balances, weaker orthodox policies from the central bank, and the deterioration in its ability to increase crude oil production all increased pressure on the naira, leading to a devaluation in 2023.
Over the past few years, Nigeria’s fortunes from a macro perspective have turned around and have been on an improving trend. Starting off with their external balances, we see that Nigeria’s FX reserves have improved quite strongly over the past few years. This has been a meaningful contributor to the relative attractiveness of the naira vs other countries.
A positive move by the current regime has sought to implement reforms that have seen the FX windows collapse, coupled with the central bank reducing FX backlogs and improving clarity around price setting has improved the market functionality within Nigeria.
There has been a dramatic turnaround in crude oil production. Over Tinubu’s regime, the current President of Nigeria, sweeping reforms in the oil and gas sector have seen increased investment and output, leading to an improvement in US dollar availability in the country, with tax policies being made more transparent and clearer for companies. The recent formation of the Dangote refinery has also fundamentally changed FX dynamics, with Nigeria now selling both crude oil as well as refined fuel goods (gasoline, diesel and jet fuel), making US dollar availability within Nigeria much wider.
Reform momentum is expected to continue in the country, with most agreeing with the fact that these reforms have been necessary if Nigeria’s fiscal and external positions are to be sustainable over the long term. An increased focus on longer-term growth sustainability has been a resounding message during my time in Lagos and Abuja. The International Monetary Fund country representative and team also see the reform path as being good for Nigeria and are waiting for evidence of these reforms reaching the man on the street who has had to bear the brunt of the hardships coming from volatile inflation, currency devaluation and a falling GDP.
When we turn our attention to inflation, we see positive movements there ever since the central bank has adopted more orthodox policies, such as stopping the financing of government debt, and working on instilling an inflation targeting regime, which has proven to lead to more stable, lower inflation expectations, which in turn drives investor confidence and provides a more stable environment for Nigerian consumers who have had to deal with volatile inflation.
This is expected to continue as the central bank has highlighted their desire to be more data dependent and maintain a cautious stance in their policy setting. These are the hallmarks of a central bank that is considered orthodox and operates in a manner that can only give investors more confidence to invest in Nigeria.
The central bank rate remains high, which has added further support to the currency, as well as the Open Market Operations and Treasury Bill market as foreign investors look to receive higher yields on a government that has been improving credit, with T-Bills already signalling the improved investor confidence.
The vibrance and energy of the Nigerian equity market has also bounced back, performing strongly over the past year, as well as year-to-date, where we are seeing strong returns from the overall market index. Over the past year, we have seen the Nigeria market, proxied by the MSCI All Nigeria Index, outperform all other major African markets with a 127% return in US dollar terms, driven largely by the oil and gas sector, banks and telecommunications, and has continued this trend year-to-date, with returns hitting 68%.
A growing fintech revolution has also taken the country by storm as more companies look to integrate themselves in the informal economy, as opposed to waiting for the economic structure to change. An encouraging sign to see companies fitting themselves to the market economy, rather than lamenting the idea of going into the informal market and getting their hands dirty.
The likes of Moniepoint and Opay are becoming rising facilitators in the transactions and payments space. These businesses have been looking for ways to service a market that has been previously underserved, given their lack of formal employment or a formal bank account. The growth in this sector should see the country gain better visibility over its data, which by most accounts seem to be understating the country’s overall economic might.
The future looks bright for Nigeria as we see the current environment of elevated oil prices be a supportive tailwind for a country with vast oil reserves and a leadership that is sounding more orthodox and willing to do the reforms that will unlock Nigeria’s growth and drive more diversity in its economy. With improved external balances, and better FX availability and growing investor confidence, Nigeria increasingly looks more set to cement its place as Africa’s leading country by GDP.
At Old Mutual Investment Group, we believe some of the most compelling investment opportunities emerge when perceptions lag reality. Nigeria remains a market that many global investors continue to approach with caution, yet our research and on-the-ground engagement suggest a different picture: one of reform momentum, improving policy credibility and businesses adapting to serve one of Africa's most dynamic economies. Through the Old Mutual African Frontiers Fund, we seek to identify these underappreciated opportunities before they become consensus views. Nigeria's recovery is still unfolding, but the foundations being laid today give us confidence that the country can remain an important contributor to long-term returns within the portfolio.