About a year ago (May 22, 2013) Ben Bernanke, then Chair of the US Federal Reserve System, spooked the markets. In his address to the US Congress’ Joint Economic Committee, he indicated that depending on emerging data, the US’ central bank could commence unwinding (over the next two Federal Open Market Committee – FOMC – meetings) the unconventional monetary policies it had put in place to keep the economy ticking through the Great Recession. Almost immediately after this testimony, we had a fair idea of what it means to integrate our economy into the global market place.
Policy makers in advanced economies had responded to the last recession by lowering policy rates, and aggressively purchasing of bonds (especially in the US), as part of arrangements to support recovery in domestic demand. On the other hand, idiosyncratic conditions in most emerging and developing economies meant that available policy options had to be relatively less accommodative. In our case, increasingly loose public expenditure management practices, which fed into liquidity in the banking system, and from there threatened domestic consumer prices, especially the exchange rate, was the elephant in the room.
In response, the Central Bank of Nigeria (CBN) continued to tighten policy, including maintaining the policy rate at 12% over the last year-and-a-half, despite inflation remaining “comfortably” within the single digit range. With real returns that much higher in emerging and developing economies than in their advanced country counterparts, portfolio investors beat a path through the bureaucratic and regulatory thicket to invest in Nigerian bonds, treasury bills, and equities. The naira’s exchange rate was the main beneficiary from so much “hot” dollars chasing after naira assets.
All of this changed as soon as the markets interpreted Bernanke’s testimony as indicative of tightening in the US. The yield on 10-year treasuries in the US moved up, and investors packed their overnight briefcases and started to flee places like here. The CBN had to resort to unconventional monetary policies of its own (destroying banks’ public sector businesses in the process) to cushion the negative consequences of this outflow.
Fortunately, the US Fed managed the tapering of the quantitative easing programme without putting up the policy rate. In addition, it let the markets know that there is to be no tightening of monetary conditions until clear signs of heating began to show up on the back of the current economic recovery. The spread on US treasuries narrowed. And fixed income securities in emerging and developed economies have become fashionable once more.
Arguably, domestic monetary policymaking has not been helped by any of this. True, the demand pressure on the naira has eased considerably. However, the ease with which the portfolio investors exited after May 22 last year does call for a medium- to long-term response to the vulnerability of the economy to this new risk source. This has not happened over the last 12 months; and only recently has conversation around the appropriate mechanism for this been initiated.
This need for an arrangement to backstop the naira in the event of a sudden spike in domestic demand, as portfolio investors seek to convert their investments on their way out, is especially so, when it would seem that headwinds are building up as we move towards the general elections next year. In the near-term, the CBN’s best shot is to put together a stopgap plan that ensures that whatever the eventual stimuli is to portfolio funds outflow, it can match investors’ request for dollars whenever this is made.
It is not enough in this case, I am told, to point to robust external reserves; recall that these reserves were in place when the previous near-crisis occurred. It would appear, instead, that it is necessary, first for the apex bank to estimate the value at risk from portfolio investors’ activity in the economy. In essence, how much these category of economic actors have sunk into the fixed income securities and equity markets; and consequently how much dollars they would asking for when they need to leave. Currently this is estimated at between US$12bn and US$20bn. This, putatively, is the amount that would flee the economy if there were a shock that investors found disagreeable.
It is unimportant what this shock could possibly be. What matters is that having estimated how much would be needed to accommodate fleeing investors, the apex bank then sets this sum apart. It might be necessary as part of the process of reassuring the markets to add a firm third party guarantee to this, by for instance locking this sum up in an escrow account with any of the big global financial players.
Having set this money aside, governance arrangements are no less important. Our history means that we often conflate “governance” with the need to ensure process transparency. Important though the latter is, the other need here is to define the bureaucracy around this contingency fund in a way that allows flexible access to and use of it. It would be counter-productive to have so many layers of authorisation if the immediate need is to assure portfolio investors of its availability as and when required.
This way, we get to ensure that the next shock to the economy will not be as disruptive of money market operations as the last one was. Still, it is but a near-term palliative. It cannot substitute for the structural reforms that are needed if domestic macroeconomic policies are to benefit more of our people.