Nigeria: Floating the Naira Without a Life-Jacket (II) - The Guardian

August 4, 2016
By Naphtali Iringe-Koko

To float a currency, the economic fundamentals must be strong and accommodative to provide appropriate support to back the local currency. The economy must have enough fat (balanced and diversified) to withstand any distress call. In the case of the naira, the economic fundamentals are weak and do not add up. The country's reserves are only enough to cover six months imports. The international benchmark is three months imports cover; interest rate and inflation are on the high side. The world oil prices have crashed to a disastrous level. The President's bold steps in relation to fiscal injection and diversification programmes based on 2016 are on course but will take about 18 months to commence making impacts. The economy, therefore, is not equipped (balanced and diversified) to support the naira.

The new forex policy is still in its early stages. The little I can say now is that the market is short on dollar liquidity. The expected foreign investors are yet to make up their minds on the level of naira devaluation that can be attractive to them. Because the market is short on dollar forex, the CBN has introduced a forward delivery contract policy, which involves buying now for delivery in the future. At this initial stage, I expected a simple forex policy (plain vanilla). I am aware that because the market is short on dollar liquidity, the current forward trading takes off the heat from the CBN but unfortunately creates delivery risk for manufacturers.

They are likely to be forced to take up insurance cover to hedge against delivery risks (loses) in case the market fails to deliver at the maturity date. Pay now and get delivery in future can also affect production lines and overheads because of waiting time (idle time). The fact that CBN may be supporting the process with L/c (Letter of credit) does not eliminate the risk associated with future delivery. My advice to CBN is that because naira is not US Dollar, or Pound Sterling or Euro, it should avoid introducing exotic financial products.

The economy is said to be "technically" in recession. The government must borrow to spend more to support recovery (increase in fiscal spending). I do not have confidence in monetary policy as far as floating the naira is concerned. In times like this, we should abide by the Keynesian policies as is the case with developed countries.

Fiscal stimulus requires financing and the debt option is an unavoidable choice as long as the government borrows within the international bench mark (40% of GDP). In respect of the budget, deficit creation is not always a bad news. A temporary increase in government spending to pull an economy such as ours out of recession is acceptable. The government should remain focused and should not be distracted by the recent IMF forecast of 1.8% contraction in the GDP growth. After all, positive indicators in the past of economic wellness did not make sense to Nigerians as they did not pull them out of poverty. As the Economist has said "GDP should really stand for Grossly Deceptive Product".

I am also worried that the MPC has gone ahead to raise the interest rate from 12% to 14% to attract foreign investors thereby depriving our local investors especially the SMEs to join in driving economic recovery through downward reduction in interest rates. The IMF may have a hand here. IMF always advises countries in the developing world that to achieve real restoration of market confidence, interest rates should be raised. In 1999, Brazil heeded the advice of IMF by raising interest rates to restore confidence and this led to the plunging of the Brazilian currency (Real). CBN is treading dangerously. Increase in interest rate is likely to attract hot money and not inflow into real sector. As is often the case in economics, theory is currently just one too many steps away from practical reality. Foreign investors are not likely to rush to rescue the economy and the naira as was predicted. The game changer as usual is fiscal stimulus. The government must borrow now and also commence spending the looted funds that have been recovered.

Because of the commitment to fight corruption and the success recorded by the President in his foreign trips, Nigeria is now in the good books of the strong voices in the World Bank and IFC. Borrowing from the bank will not present any difficulty especially considering that Nigeria despite the crash in world oil prices is still very credit worthy (debt/GDP is far below the accepted international benchmark of 40%). De-facto IFC participation in any project is virtually a condition sine qua non for obtaining funding from most of the other main sources of cross border project finance for developing countries.

To be continued

Naphtali Iringe-Koko is a chartered accountant

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Steven Rich
Sep 17, 2018:
Well done
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