Nigerian South African Chamber of Commerce

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Posted on: 23 Oct 2017

Nigerian economy has been recovering and has now exited recession as of Q2 2017. That is just the beginning and there is still a need to remain focussed and continue with reforms which need to be sustained and scaled up. Many activities still in recession or growing sub-optimally, bright prospects of output growth (especially in agriculture) in short term, but there are domestic risks in the short to medium term, and external risks in long term. More effort is required to diversify the economy and government revenue over the medium to long term.

Dr. Yemi Kale, Statistician General of the Federation, made this known while speaking on the topic “Nigeria: Growth Outlook Beyond Recession” at the Nigeria -South Africa Chamber of Commerce Breakfast Forum sponsored by Stanbic IBTC .

Dr. Kale added that Nigeria has witnessed several years of strong growth, economy started slowing down mid 2014 and eventually entered recession in Q2 2016.

There should therefore not been any strong surprise to anybody following the data just as there shouldn’t have been much surprise we exited when we did as the data showed things were also getting better from Q3 2016 though still negative.

According to him, the problem is often our economic managers don’t take data seriously because if they did the decline could have been corrected and the recession prevented or at least its impact reduced or if getting into recession was inevitable, the duration could have been shortened.

He cited that the initial reaction was one of panic as soon as the negative effects hit forcing the introduction of policies that may have hit confidence, worsened business calculations and exacerbated things even further.

In recent years, the Nigerian economy has experienced (and to an extent is still experiencing) several significant shocks: from commodity shocks to political instability, to security challenges disease outbreak to the on-going economic recession and exit from recovery.

We understand that economies inevitably go through boom and bust cycles. Nevertheless, it is also generally understood that macroeconomic indicators such as GDP and GDP growth, inflation, unemployment etc can be viewed as effects of policy choices (successful or otherwise). They are targeted directly or indirectly in order to influence the overall level and direction of an economy for some pre-determined policy objective.

In this sense, we can say policymakers are responsible for the movements and direction of such indicators to the extent that they seek to influence them. Policy decisions and pronouncements play an important role in influencing key economic variables and sentiments of economic agents. They also determine perception and confidence which though difficult to measure is also vital for an economy’s health and stability.

It is therefore important and necessary that decision-makers always and fully have an appreciation of how the economy works, the potency and limitations of economic policies, and the necessary conditions that makes policies most effective in influencing the economy in the desired direction. They should be aware of the implications of policy actions on the investment community and be fully conscious of the weight and timing of policy announcements. In many ways our recent experience with recession and exiting recession in a lesson in these principles.

But for me, this goes beyond just assessing the exit from recession. Is the exit from recession sustainable or can we go back into it as quickly as we got out and what are the triggers for both?

He said he is of the opinion that exiting an economic recession defined as positive growth following at least two quarters of negative growth (the most common definition) is it synonymous with economic recovery?

There are three stages we should first consider: first the economy needs positive growth i.e  get out of recession which is any kind of positive growth even 0.0000001%. Growth is the first stage that signals to producers that their capital will be rewarded and to consumers that their welfare is improving, or will improve no matter how little.

The next stage then is economic recovery which means going up to the level of economic activity prior to the slowdown, which in our case actually started mid 2014 i.e Getting back to the path of growth before slowdown which eventually led to contraction and recession. Thereafter, one can say the economy has recovered.

And in the third stage is maintaining the path of sustainable and inclusive growth over the long term, through innovation and the emergence of new economic activities.
At the moment, it would appear we are essentially still on stage 1and the fragile and weak nature of the recovery is very clear. The need to nurture the critical sectors towards expansion remains a key policy direction. From exiting recession you can either go back into recession or recover towards sustainable growth and the path will depend on what we do from this point in the short and medium term.

Firstly this isn’t the first time the Nigerian economy is witnessing a recession. It has happened at least twice since 1980s. Traditional economic theory expects boom and bust cycles so nothing unique here and every country experiences both at different times.

However, it is what you do during the boom period that will help withstand the bust cycles. Therefore prudent economic managers should expect good and bad times and adequately prepare for fluctuations in the business cycle.

Most people have rightly pointed to the drop in oil prices from 2014 to be the immediate trigger of the recession but a more fundamental issue has to do with what I believe is the dysfunctional nature of the Nigerian economy on the basis in which we had posted very strong growth in the past. This structure has existed since the 1984 recession. Was still there in 1991 and still exists today. Our inability to break this unsustainable economic structure is what makes us vulnerable when such economic bust cycles hit.

A simple way of explaining the structure of the Nigeria economy is to think of a house built on foundation of 3 pillars.

Typically we say the economy can be divided into 2: An oil economy with accounts for 9% and a non oil economy which accounts for the remaining 91%. I reactively however, there are three.

First, an oil sector, that contributes about 9% to the Nigerian economy today, but from which 80% of total Nigerian government revenue for development and 95% of foreign exchange is derived. This makes government revenue unstable and vulnerable to earnings instability. It also means the importation of all we need and our attractiveness to foreign investors is also dependent on this single commodity that is relatively small and unimportant with respect to the whole economy, but nevertheless critical for growth and development.

Second, an import significant consumption-driven, non-oil sector, that relies on the oil sector via foreign exchange remittances from the oil sector and other capital inflows which also depend largely on the fortunes of the oil sector, to finance the imports of intermediate/finished goods and imported services to meet domestic demand e.g. manufacturing, real estate public admin, trade construction, financial services etc. This sector contributes 52% of the economy. Our economic growth of the past was essentially driven by consumption – which is a good thing given our large market – but only if consumption is driven by local production of goods and services can the benefits be localised.

All we were doing instead in the past was boosting our economy and growing by consuming imported goods and services thereby aiding production and employment in other countries. Even the few goods and services produced locally was dependent on imported inputs to survive.  Due to inadequate power supply in the past, the economy relied on imported diesel and petrol and aviation fuel to power our industries and other sectors. Our oil wealth in the past was used to develop and sustain a culture of buying imported goods many of which had local substitutes and as long as oil prices were high we could keep growing our non-oil economy and creating jobs and this is what we continued to do for years.

Finally, an Investment-driven, non oil sector, that does not rely principally on the oil sector or on foreign exchange remittances eg agriculture, arts entertainment, admin and support services and some manufacturing. This third pillar essentially harnesses local inputs of raw materials, intermediate goods and domestic labour as factors of production to meet domestic demand as well as exports. This all-important pillar however forms only about 39% of the Nigerian economy. Moreover, it wasn’t substantially strengthened during the periods of high oil prices and high growth as investment to GDP actually remained flat during the period.

What is the implication of all this? It means in reality, the Nigerian economy was 61% directly and indirectly dependent on oil which means we have essentially been building our house on one pillar supported by two other shaky but more dominant pillars that we did not have control off.  Oil is largely external so Nigeria is essentially only in control of 39% of its economy which is heavily dependent on issues of security, ease of business, weather and (good or bad) policy decisions.

The strength of those two other pillars or 61% of our economy was dependent on unpredictable and unstable international oil prices and on peace and order in the Niger Delta. Obviously as long the main oil sector pillar remained firm, our house continued to stand. But once that pillar became unstable, shaken by the developments in the global economy that are beyond our control, the house was prone to collapse.

So our economy has been growing as a result of consumption which accounts for the largest share of GDP and consumption dependent on imported products which are dependent on the availability of foreign exchange reserves linked to the oil price and oil production

We have established we have a dysfunctional economic stricture that needs to change and we will be vulnerable to these same shocks till then. However what were the immediate triggers to the recession on the back of this long term unsustainable economic structure? Well oil prices and oil production like I mentioned earlier

It is quite clear that whatever happens in the oil sector will have a significant effect on the country’s GDP. Thus, when oil prices collapsed in mid 2014 from over $100 in June to less than $50 by January 2015, the exposure of the economy guaranteed that that effect would be widely felt, and this is essentially the primary origin of the recession.

We can see almost perfect correlation between oil prices and GDP growth above

Firstly, Nigeria did not significantly save:

Secondly, not only did we not save, but Nigeria did not significantly invest either

Rather, Nigeria continued to consume, especially imported goods and services.

Now, Nigeria has certainly had a number of oil booms which led to strong growth in the past.

There are prudent and imprudent ways to use oil revenue and windfalls. Other countries have successfully managed their oil revenues but unfortunately ours has not been the case.
What are the   prudent ways of spending oil windfall so sustain growth? What do smart economies do especially ones with such a high dependence on a single commodity?

Ideally, during periods of unusually high oil prices and robust oil production, prudent oil producing countries should do 4 things:

1. They pay off their debts and save for a rainy day

2. They invest in their domestic capacity to produce

3. They consume less imports and more locally-made products and export the rest

4. They invest the windfall in infrastructure and on projects that will yield sustainable development.

Oil and gas are non-renewable or wasting natural resources and as such oil revenues will one day end when our last oil well dries up and our gas reserves are finally exhausted or when the world shifts from their use to alternative energy sources as is happening already.

But what did we do as a country?

Thirdly, even though the nature of our exports was quite evidently unsustainable, still imports continued to increase. Our heavy dependence on a mono product (oil) for foreign exchange earnings has certainly not served the economy well over the years, and this calls for an urgent need to diversify the economy from oil.

We did not pay off our domestic debt

According to him, local industry was virtually non-existent, and huge part of the foreign exchange earnings was used to import subsidised petroleum products, which account for nearly 70% of total imports in Q1 2017 (Motor spirit + Gas oil)

The percentage of the federal budget dedicated to recurrent expenditure kept rising. The allocation of foreign exchange to pay school fees and medical bills abroad rose just as the amount of foreign exchange to import food kept rising. Large local producers continued to rely on imported raw materials instead of sourcing material locally.

The outcome was that by the time the bubble bust, we had nothing in reserves, we had no other source of government revenue, we had no investments to fall back on. Countries that inadequately prepare for periodic economic downturns suffer for much longer than they ought to.

The consequence of relying on an unsustainable economic structure and ignoring what the data was saying is the reality that surviving in contemporary Nigeria remains a challenge for many. The current climate has forced all economic agents (households, firms, government) to re-allocate our consumption expenditure in the face of lower output, rising prices, lower real wages and rising unemployment.

The decline in price and oil production resulted to a fall in government revenue as well as external reserves. Falling reserves itself was both a cause and an effect of a rapidly depreciating exchange rate that resulted from the outflow of capital when oil prices crashed and external reserves began to decline. However, the exchange rate depreciation was particularly rapid and severe leading to high cost of imports and consequently higher imported inflation.  Nevertheless, the depreciation presented a rare opportunity for local manufacturers with locally-source raw materials to turn relatively competitive, leading to a small increase in non-oil exports.

Falling government revenues meanwhile necessitated the administration to tighten fiscal resources through the implementation of the TSA which also affected the banking system (and by extension the capital market), both of which declined in performance. Overall, higher prices in the economy resulted in higher costs of production across most industries resulting to layoffs and increasing unemployment. Household consumption, already hit by higher inflation generally declined, leading to fall in government tax revenue, and further reinforcing the tight fiscal conditions. Thus, declines in key GDP components, notably household expenditure, government and net exports, resulted in decline in overall output growth.

He opined that there were also policy reversals and conflicts in managing the exchange rate at some time and which discouraged foreign investment inflows for a period (together with slowness in appointing ministers and passing the budget). All of these combined to constrain overall output growth leading to the recession in 2016.

Similarly, the co-movements between foreign reserves level and foreign capital flows indicates that foreign reserves is another signal to investors regarding the health of the economy, affecting the inflow of capital, further emphasizing the need to ensure adequate reserves in order to attract and retain foreign capital flows.

Nigeria’s continued dependence on crude oil as the major source of foreign exchange is often seen in terms of its share in government revenue as noted earlier.

However, there’s another important linkage through which the dominance of oil manifests in the economy, and that is the “perception” it creates among investors. It is not uncommon to hear: “as long as oil price is high and stable, the economy will continue to grow”.

The growth rates of crude oil price and market capitalization as well as the inflation rate over the period 2008 to 2016, giving a measure of the volatility of the underlying indicators.

It can be seen that the growth rates of market capitalization and crude oil price fairly closely track each other, with a correlation coefficient of 0.49. This would suggest that market sentiments generally also ride on movements in oil price, as a signal to investors about the health of the economy. Output dropped and costs rose.

What was government response?

In April the Federal Government officially launched the Economic Recovery and Growth Plan as a medium term intervention to address the recession and restore the economy on a path of sustainable development. ERGP is also closely linked with the country’s Sustainable Development Goals  Agenda.

The Key priorities of ERGP

¨  Stabilizing the macroeconomic environment

¨  Achieving agriculture and food security

¨  Ensuring energy sufficiency (power and petroleum products)

¨  Improving transportation infrastructure

¨  Driving industrialization focusing on Small and Medium Scale Enterprises

Some of the key targets for the ERGP include

  • Single digit inflation rate by 2020
  • Stable exchange rate
  • Real GDP to grow by 4.6 percent on average over the Plan period
  • Crude oil output to rise from about 1.8 mbpd in 2016 to 2.2 mbpd in 2017 and 2.5 mbpd by 2020.
  • Agriculture growth rate of 6.9 per cent over the Plan period, achieving self-sufficiency in tomato paste (in 2017), rice (in 2018) and wheat (in 2020).
  • Become a net exporter of key agricultural products, such as rice, cashew nuts, groundnuts, cassava and vegetable oil by 2020
  • Achieve 10 GW of operational capacity by 2020 and to improve the energy mix, including through greater use of renewable energy, net exporter of refined petroleum products by 2020.
  • Improve the ease of doing business to achieve average annual growth of 8.5 per cent in manufacturing.
  • Reduce unemployment to 11.23 per cent by 2020, or an average of 3.7 million jobs per annum. The focus of the job creation efforts will be youth employment, and ensuring that youth are the priority beneficiaries.
  • Reduction in the importation of petroleum products.

Thus far, significant efforts and resources are being devoted to the implementation of the ERGP. Some of the notable interventions undertaken include:

Improving the Investment climate

Launch of the presidential enabling business environment council (PEBEC), which is a high level body with the goal of initiating reforms to promote a business friendly Nigeria. Notably, the Vice President in May signed three executive orders that promote transparency and efficiency in the business environment, support local contents in public procurement by the Federal Government, and ensure timely submission of annual budgetary estimates by statutory and non-statutory agencies

In addition, renewed negotiations between the FG and community stakeholders in the Niger Delta has resulted in the decreased tensions there and resumption in oil production which contributed positively to the exit from recession.

Fiscal reforms

A host of fiscal initiatives have also been implemented as part of the ERGP. These include blocking of leakages in MDAs through centralised procurement, setting up of efficiency units, implementation of whistleblower policy and TSA to aid recovery of illegally-sheltered government funds as well as the efforts to use moral suasion to promote tax revenue generation through the Voluntary Assets and Income Declaration Scheme (VAIDS).

Interventions by CBN

The CBN has been implementing the Anchor Borrowers Program (ABP) to support agriculture entrepreneurs and boost local production and consumption especially in rice, cassava, poultry etc. The programme ensures that farmers have access to necessary start up funding for their agricultural operations and their produce have a ready market thus guaranteeing incomes and returns to farmers at pre-determined prices.

In addition, a more transparent and flexible exchange rate regime has been established to meet demand for foreign exchange especially by local importers and producers.

Employment generation

The Federal Government has also set up a Social Investment Programme with multiple components covering youth employment, school feeding and income transfers, which serve as social safety net for vulnerable populations, many of which would be considerably impacted by the recession.

Overall, policy intervention in key sectors are having the desired effect as demonstrated by the exit from recession.

The Nigerian economy exited its 2016 recession after recording real output growth of 0.55% in Q2 2017 following -0.91% in Q1, making half year real growth rate of -0.18%

This was the first positive quarterly growth seen in the economy in the last 5 quarters in real terms. While the economy recorded negative growth throughout 2016, it was clear that the decline had bottomed out by the end of the third quarter of 2016 following various reforms and policies implemented to restore the economy back on a path of sustainable and inclusive growth.

Real GDP had contracted by -0.67% in Q1, 2016, -1.49% in Q2 2016 and -2.34% in Q3 2016, but the contraction seemed to have slowed since then, with real GDP contracting by -1.73% in Q4 2016 and -0.91% in Q1 2017. The recovery has been led by improved output in Agriculture, and Industry (specifically recovery in oil and gas production and price stability, as well as manufacturing).  Oil production in Q2 2017 was 1.84 million barrels per day, the highest in the last one year.

Agriculture, which is a main focus of the current Administration, as stated in the Economic Recovery and Growth Plan (ERGP) and which grew strongly throughout 2016 despite the contraction in the overall economy, continued to grow in 2017 recording a 3.01% growth in Q2 2017.

Industry which had contracted for nine consecutive quarters recorded positive growth of 1.45% in Q2 2017. This represents the first-time industry has expanded since 2014. The three key areas of industry – which are all areas of focus of the administration – performed strongly.  Solid minerals for example had grown strongly despite the recession in 2016 growing at an average of 5.63% between Q2 2016 and Q4 2016. In Q1 2017, the solid mineral sector grew significantly by 46% and in Q2 2017 by 2.24%. Furthermore, manufacturing which had registered negative growth for every quarter since Q1 2015 (except Q4 2015 when it grew 0.7%) turned positive in Q1 2017 with a growth of 1.36% and maintained its positive growth in Q2 2017 growing by 0.64%.

The services sector, however is still growing negatively, contracting for the fifth quarter in a row by -0.85% in Q2 2017. To address unemployment, strong growth in Services (especially trade services) is required.

What led to exit from recession?

As noted earlier, principally, increased oil output and stable prices resulted in first positive growth in oil sector since 2015.

Nevertheless, we know that risks remain. The growth rate at the moment is significantly slower than population growth rate, which means per capita income is falling.

Moreover, we know that inequality has remained a thorny issue across the country and the recession may have worsened it further as a result of inflationary pressure on household income.

Across several States, debt levels have been on the increase with many unable to meet salary obligations in time, and being forced to even slash workers’ pay.

Budget revenue performance has also not been as robust expected.

Key sectors that saw improved performance leading to overall real GDP growth in Q2 include:

Agriculture: Stable crop and improving livestock output helped ensure agriculture output at over 3% in Q2. In addition, there have been significant investment in agricultural production with several initiatives from both states and the federal government

In Q2, electricity sector output increased sharply by 35.5%, after five previous quarters of negative growth.

Similarly, activities in financial services maintained positive output growth in Q2, while public administration posted positive growth rate for the first time in over two years.

Sectors that recorded high and positive growth included:

Electricity and gas supply (growing by 35.5% compared to -5.04% in Q1 2017 and -10.46% in Q2 2016) and financial institutions (growing 10.45% in Q2 2017 compared to 0.67% in Q1 2017 and -10.82% in Q2 2016).

However, sectors that recorded negative growth included transport, accommodation / food, real estate, education, trade and construction.

Out of 46 economic activities, 21 recorded negative growth, compared to 27 last year.

Outlook for agric is expected to be positive, in view of the significant public investment and initiatives in the sector especially in rice and Cassava, both of which are targets for self sufficiency and exports by 2020.
We are also seeing interest in investment in Agriculture value chain and over the medium term,  the mature investments should begin to turn profitable, and with the huge market it’s inevitable for agriculture to be a big player for the economy.

The initiatives by the PEBEC, if successful should result in manufacturing expansion as well, especially in the food and beverage activities, which is also linked to agric production. Moreover, during recession and as a result of the exchange rate depreciation and higher cost of imports, some producers were forced to source raw materials locally which helped small-scale suppliers to expand. While access to forex has since improved, it can be expected that businesses have learnt their lessons and are now more likely to retain a better mix of imported and domestic inputs which should help keep manufacturing output growing.

Arts entertainment and recreation  and music and video production also has huge prospects but will likely remain relatively constrained till inflation slows to single digits and as real wages improve, more likely over the medium term rather than in the short term.

Increasing production in the oil sector, as well as the coming on stream of private refineries together with the associated value chain production of fertilizers and petrochemicals represents another major sector that will likely see strong growth in the short to medium term. Over the long term however, moderating oil consumption as well as the emergence of new producers will likely mean that long term price will continue to be subdued. Following the implementation of the Paris Climate Accord, several countries have announced their intent to ban the use of petrol based vehicles. So we expect slowing demand in this case over the longer term, rather than in the medium term since such structural transformation will not occur in the short to medium term.

The above also implies that progress with tax reforms will be key and there is a need to deepen the fiscal reforms to support an expansion of the tax base to improve tax revenue. (But we are not yet moving fast enough with respect to widening the tax net).  The financial resources required to intervene in power and in agriculture, as well as fund the restructuring of this dysfunctional system will have to come from an improved tax revenue system, which is currently still poor.

The main risk to growth in the short term remains the likely direction of oil price, as well as domestic crude oil output production.  Forecasts by the US Energy Information Administration (EIA) indicate stable oil price in the short term at $51 and slight rise to $52in 2018 (for Brent Crude oil).

The current stability in international oil price trends signals the possibility of sufficient oil supplies in key consumer markets, slower growth in major economies as well as the effect of the decision by OPEC member nations to restrict production.

The recent weather events in the US do not appear to have significantly affected oil price trends at the moment and unless there’s a major global catastrophe, it can be expected that oil prices will remain stable possibly for the rest of the year.

Over the short term, the oil price rally provides some relief and opportunity to rebuild depleted fiscal buffers. More important for long term sustainability reasons, Nigeria really does need to diversify the economy, pursue value chain manufacturing, and strengthen fiscal reforms to ensure that a growing debt problem does not become a crisis in the event of a global oil shock.

This is particularly crucial as oil consumption is expected to moderate as major consumers pursue alternatives to oil.

The economic moderation in China and India also present risks that could result in a decline in both oil and non-oil exports for Nigeria.  Both countries account for a significant share of trade with Nigeria, both on the imports side and the exports side. China, a major importer of Nigerian oil, is also one of the countries that has announced future ban on petrol/diesel vehicles.

So for trade, we still have price and production vulnerability

Furthermore, there is the impact of brexit on our non oil exports. The uncertainty surrounding Brexit may likely affect not only political and trade relations between Nigeria and the UK, but emigration, remittances and foreign capital flows as well, especially if the UK economy sees slower growth as some observers expect.

Significant progress with respect to Brexit may also provide additional fodder for emerging regional agitations across the country resulting in greater political instability and increased uncertainty both of which contribute to raising the investment climate and country risk profile at this time.

The decision of the US Federal Reserve to keep interest rates unchanged possibly till year end lowers the possibility of large and sudden capital outflows for the moment. However, it remains to be seen whether such stability will prevail for long considering that the tenure of the Fed Chair will be due for renewal in a few months. A hike in interest rate is widely expected in the near future and this will likely lead to capital outflows from Nigeria (as with many other emerging economies), increasing pressure on the foreign exchange rate, depressing external reserves, and the vicious cycle begins again, ultimately causing a fall in domestic output and rising inflation. Interest payment on the country’s dollar-denominated debt will also rise, further pushing the country towards an emerging debt problem.

On-set of the election cycle

With about 18 months to the next general elections, increased political activity will likely dominate the socio-economic space over the medium term. This will likely have two effects: increased public sector spending may provide further boost to output, but since a considerable size will go to political spending, such expenditure will not necessarily add to the productive capacity but rather crowd out private investment and even contribute to inflationary pressures.  Effective governance activities are also likely to decline as politicians focus on campaigns and debate stress.

In the past, the monetary authorities have proactively tightened monetary policy to counteract possible inflation effects from fiscal expansion. If this happens, further dampening effect on output may result.

Rising geo-political tensions

In addition to the insecurity situation with Boko Haram and herdsmen, agitations by regional groups have increased in the past few months, and with the forthcoming election season, it is likely that such actions will persist in the medium term. The main effects of these actions will be to increase the level of country risk and uncertainty for investors. Furthermore, the possibility of violent political protests and the expected response by law enforcement / military forces may be disruptive through one, or a combination, of the following: shutdown of major economic activities (eg oil production, agriculture, or trade), shutdown of activities for prolonged periods (eg closure of markets) or shutdown of regional economic activities (eg cross country transportation of agricultural products).  These present some reasons to be concerned about sustained growth in the medium term.

A few but notable industrial unions (health sector and university academic unions) have recently embarked on short-lived industrial actions with economy wide impacts. Participation of other unions (particularly petroleum workers and civil servants) to get a better deal from politicians seeking reelection could become a new normal and will negatively affect the medium term growth outlook for the country.

Pending review of electricity tariffs

Dr Yemi Kale added that an upward review of electricity tariff by the National Electricity Regulatory Commission (NERC) will likely help resolve some of the business concerns of utility companies, towards boosting electricity output. However, considering that electricity expenditure also accounts for the second highest share of household expenditure in the CPI basket (about 17%), an increase in tariff will reduce household disposable income, stifling the expected contribution of household consumption and business investment to growth in the medium term.