Why Recession-Hit Nigeria ETFs Are Still Worth A Bet

Includes: AFK, FM, FRN, NGE
by: Zacks Funds

Nigeria recently slipped into its first recession after more than two decades. According to data released by the country's National Bureau of Statistics (NBS), Africa's largest economy witnessed a 2.06% decline in the second quarter of 2016 after the 0.36% fall in the first quarter. The two consecutive quarters of deteriorating growth clearly hint at a recession.

This recession is largely a result of the persistently low crude oil prices. Crude oil sales account for 70% of government income and 90% of export earnings. Thus, Nigeria has been dealt a heavy blow by the collapse of oil prices from the highs of about $112 a barrel in 2014 to less than $50 at present.

Economic Indicators Worsen

Apart from the decline in GDP over the last two quarters, Nigeria's inflation has hit an 11-year high of 17.1%. In addition to the slump in the oil sector, economic contractions in construction, manufacturing and trade sector have worsened the situation. Growing unemployment and scarcity of foreign exchange reserves are other pressing concerns.

The International Monetary Fund (IMF) has estimated a 1.8% decline in Nigerian gross domestic product (GDP) in 2016. If the prediction comes true, the economy will witness the first full year of recession after 1987. Rating agency Moody's Investor Services expects external debt to account for 5.2% of GDP by the end of 2016, higher than 3.3% recorded in 2015.

Moreover, Nigeria is suffering a political problem as rebel group Niger Delta Avengers (NDA) and others are carrying out attacks on the country's oil installations. Since May, these rebel groups have exploded pipelines, oil wells and other infrastructure facilities, resulting in a significant decline in oil exploration activities.

Can the Economy Turn Around?

The government of Nigeria has decided to diversify its economy, especially the non-oil sectors. According to Renaissance Capital, agriculture and telecom are the two big non-oil sectors which witnessed growth in 2016 despite the country's GDP being in the negative territory. In addition, solid minerals sectors also generated some growth. Meanwhile, even though growth in the wholesale and retail trade sector was stagnant, Renaissance Capital is hopeful of a recovery in the service sector in 2016.

According to Reuters, the government had approved a three-year plan to borrow more from abroad. Year-to-date, the government has spent over 400 billion naira in capital expenditure mostly on infrastructural development, part of a record 6.06 trillion naira (about $30 billion) budget for 2016. Nigeria also plans to borrow around $10 billion from debt markets, with about half of that coming from foreign sources.

Is There a Ray of Hope?

Several analysts believe that Nigerian economy will see an improvement in the second half of the year, but the country would still register negative growth for the whole year. The government is projecting economic growth of negative 1.3% for 2016 to a positive 3% in 2017 and an average of 4.25% in the 2018-2020 period.

According to Moody's the recent devaluation of the naira (Nigerian currency) is credit positive. It stated that the new system should allow the currency to better absorb external shocks over time, while dollar availability should gradually increase. Moreover, the naira has depreciated to a substantial level. At present, it is trading around 320 against a U.S. dollar officially and 425 against a U.S. dollar in the black market. According to Bloomberg, several investment banks like Exotix Partners LLP and Standard Bank Group Ltd. are advising their clients to invest in naira-dominated assets again.

ETFs in Focus

We believe Nigeria-focused ETFs will pick up pace in the rest of 2016. In view of this, we advise four funds to investors.

Global X MSCI Nigeria ETF (NYSEARCA:NGE): This ETF seeks to provide investment results that correspond generally to the price and yield performance, before fees and expenses, of the MSCI All Nigeria Select 25/50 Index.

Apart from NGE, a few other ETFs that have exposure to Nigeria and should be on investors' radar are VanEck Vectors Africa Index ETF (NYSEARCA:AFK), Guggenheim Frontier Markets ETF (NYSEARCA:FRN) and iShares MSCI Frontier 100 Index ETF (NYSEARCA:FM).

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