“All is well!”, they shout. But the place smolders still. Our Emperor? In the end, not even Nero Claudius Caesar Augustus Germanicus mattered any more after the “Great Fire” destroyed Rome in 64AD.
However, Thursday, last week, the Central Bank of Nigeria (CBN) issued two circulars that were essentially a counter-refrain. Worried about the eventual pass-through of lower oil prices to the economy, the apex bank excluded funding of six import items from the official foreign exchange market. As oil prices fall in the global markets, the main pass through to the economy would include through lower government spend, and lower accretions to the external reserve (and hence a lowering of the CBN’s ability to intervene in support of the naira).
Of late, a new vehicle has been added: the response of “hot money” to the sense that the economy may no longer be able (as oil prices fall) to meet its obligations. If this “money” (largely foreign portfolio investment in the economy) then rushes for the gate, it would put disproportionate pressure on the naira’s exchange rate. All of this, the CBN may have acted to pre-empt.
There are those who would argue that oil prices are an exogenous variable to our economy. I.e. that managers of the economy cannot really do much about it. Thus, it would be in extreme bad faith to blame the incumbent administration at the centre for the current “pseudo-crisis”.
The difficulty with this spiel is that it rehashes an exculpatory argument put forward by the Shehu Shagari administration after oil prices started trending down in June 1981 in response to the glut from reduced demand and over-production. The Ibrahim Babangida administration made the same case following the sharp drop in real oil prices in 1986 (when a barrel of oil traded below US$10, from US$27).
So despite the talking up we have been subject to over the last eight years, what has changed in the structure of our economy, and in the way it has been managed? Not even the composition of our imports has, if the CBN’s list of “banned” items is any indicator. This list is educative after a different fashion. If you back out electronics, finished products, information technology, generators, telecommunication equipment, and invisible transactions from our import list, what remains? Food? (According to the CBN’s numbers, invisibles alone accounted for 51% of foreign exchange use in the first quarter of this year, falling to 49.3% by the second quarter).
Effectively, the CBN has shut demand out of the weekly retail Dutch Auction for foreign exchange. Unfortunately, an economy is like a latex balloon. You do not eliminate air by squeezing it out of a part of an inflated balloon. You only drive it into other parts. The ink had not dried on the CBN’s circular, when this effect became evident. By close of business Thursday, the naira was already exchanging at US$1/N170 on the interbank market.
What to make of this policy direction? Evidently, the CBN is no longer minded to fritter away its reserves defending a currency that has been fatally exposed by falling oil prices, and a weak domestic economy. This is not a bad thing when you consider how low the reserves have fallen. (The balance on the gross external reserve was US$38.07bn as at Thursday) But what about the naira mid-point (US$1/N155) and the 3% band around which the CBN pledged to protect the national currency? Truth is that even this was already a convenient fiction several months back.
In truth, all of this might even turn out to be a Godsend. I have always worried about the potentially adverse consequences of portfolio investors fleeing the domestic economy. But that was because I had always imagined that the CBN was going to have to backstop the subsequent demand for dollars off very scarce resources. However, a movement to market-driven rates means that fleeing holders of “hot money” would have to fund their need for dollars from the (interbank) market (and most probably take a haircut along the way).
Are we then reconciled to a depreciation of the naira? This is what we are seeing at the interbank market, despite the CBN’s regular pledge to defend the currency.
The answer to this question does not matter as much as the tone of the apex bank’s actions would in the coming days — this period would include the November 24 and 25 meetings of the Monetary Policy Committee. If the second circular issued by the CBN last Thursday is a pointer, then we ought to be concerned. For different reasons, banks keep idle balances with the CBN’s standing deposit facility (SDF) (estimates coming out over the weekend put this at about N562bn), on which they earn some return. There is a context within which it could be argued that these are potentially loanable funds, and the banks do a disservice to the economy by warehousing such monies with the apex bank.
However, this argument misses several other points, especially the ones about the capacity of the economy to absorb additional funds inflow without seeing domestic prices rise, or interest rates fall (interbank rates touched 5% on Thursday). The CBN’s recent decision to remunerate (at the SDF rate of 10% per annum) banks’ SDF balances subject to a maximum deposit of N7.5bn, completely ignores this latter point. Instead, it makes the opposite arguments that these balances constrain the financial intermediation process, and limit banks’ lending to the productive sectors of the economy.
Unfortunately, the simple truth is that the CBN just lowered interest rates and increased domestic liquidity ahead of (or indeed during) a crisis that may have called for exactly the opposite response. The mechanism of lower oil prices pass-through to the domestic economy requires that we should be seeking to drive savings up. To, in other words, increase the attractiveness of naira-denominated assets. And not vice versa.
Eventually, banks’ new liquidity will show up in the interbank bank market, where it would join in driving the naira’s exchange rate down. It would be nice then to describe bankers as unpatriotic. But it would help well in advance to recall (1) that banks’ shareholders (Nigerians, for the most part) demand a healthy return on their investments; and (2) that the CBN’s perverse incentive structure may have had a hand in determining banks behaviour.