Friday, June 11, 2010

Which African economy will dominate in future?

By Razia Khan [Head of research at Africa Standard Chartered Bank]
Thursday, June 10 2010

While conversation is dominated by the question of which African teams will progress the furthest in the World Cup, an equally heated debate rages in the background: which African economy can lay claim to being the region’s powerhouse?

Footballing skills do not always equate to economic prowess. Bafana Bafana, the South African national team, ranks below Nigeria’s Super Eagles and many others.

But when it comes to which African economic giant will dominate in the future, the debate is just as heated.

Together, Nigeria and South Africa account for just over half of Sub-Saharan African GDP.

In absolute terms, a substantial amount of African growth in recent years can be attributed to democratisation in its two leading economies.

With recent changes of political regime, both countries have seen a rise in trend growth.

While South Africa’s outperformance, led by a consumption boom, only became clear a decade after apartheid, Nigeria’s democracy dividend — following its 1999 transition to civilian rule — appears to have been more immediate.

Both economies have large informal sectors, although South Africa, with recent revisions to its GDP statistics, has made more progress in estimating its previously “unmeasured” economy.

Nigeria is often thought of as an oil economy, its formal sector dominated by hydrocarbons.

In reality, successive years of declining oil production (until last year’s amnesty in the Niger Delta) have reduced oil’s contribution to GDP to just 15 per cent in recent quarters.

Nonetheless, with proven oil reserves of 36.2bn barrels (the eventual target is 40bn barrels, with production of four million barrels per day), gas reserves of 5.22 trillion cubic metres, and the highest reserves-to-production ratio of any Sub-Saharan African oil producer, Nigeria has vast potential.

It is the true giant among Sub-Saharan oil and gas producers.

South Africa, by far the world’s biggest platinum producer (although its ranking as a gold producer has slipped), also has substantial resource wealth.

However, growth in the last decade has failed to capitalise on the commodities boom.

Mining’s overall share of GDP is less than half its 1980 level, when gold prices last peaked.

Natural resource endowments aside, consumption typically drives African growth, and demographic trends therefore matter.

With a population of over 150 million, Nigeria has at least three people for each South African.

While Nigeria lags far behind South Africa in per-capita income (2,360 “international dollars” versus South Africa’s 10,500, on a PPP basis), its demographic strength may allow it to eventually overtake South Africa to become Africa’s largest economy. With an estimated 42 per cent of its population under the age of 14, compared with 31 per cent in South Africa, Nigeria is one of Africa’s youngest countries.

Population growth rates (2.3 per cent in Nigeria, versus 1.2 per cent in South Africa) suggest that it will remain so.

Nigeria’s population is set to rise to 179million five years from now, according to IMF projections.

South Africa’s will grow from a currently estimated 49.9 million to 52.7 million.

While Nigeria may have the demographic advantage, South Africa’s economy (which makes up almost a third of Sub-Saharan African GDP) has a clear lead.

Measured in 2009 nominal GDP terms and using IMF data, a 1 ppt increase in South African growth would add the equivalent of around $2.9bn to its economy.

To add this much value to its economy, Nigeria would have to grow by almost 1.7 per cent. Is this faster growth plausible?

Could Nigeria catch up with, or even overtake, South Africa?

To answer this question, we run the following simulation.

Based on our forecasts for average long-term growth and inflation, we assume a 17 per cent nominal GDP growth rate for Nigeria (consisting of a seven per cent growth rate and 10 per cent inflation) and a 10 per cent nominal GDP growth rate for South Africa (assuming four per cent growth and six per cent inflation).

Running simulation

Running this simulation, Nigeria will have overtaken South Africa by 2018.

But this nominal GDP projection is driven mostly by inflation, so it is not as meaningful as we would like.

Alternatively, using PPP measures of GDP, and assuming South Africa grows by four per cent and Nigeria by seven per cent, Nigeria will become the larger economy in 2023.

Assuming that South Africa achieves a growth rate equivalent to its recent cycle peak of 5.5 per cent, Nigeria will pull ahead in 2037.

Yet there is no reason why either country’s growth rate should remain constant.

Neither is immune to cycles, and as recent experience has shown, South Africa — with closer links to the global economy — tends to be hit harder in global economic downturns.

There is also no reason to assume that Nigeria can sustain its recent growth rate as its economy matures.

While its demographic outlook is a positive, it is not without risks.

The capacity of the economy to absorb a rapidly growing working-age population will be key.

The Super Eagles may soar, but there is still hard work ahead.