In the immediate aftermath of comments by Ben Bernanke on May 21, 2013 indicating that the U.S. Federal Reserve Bank (the board of which he was then chair of) was contemplating “tapering” (reducing) its monetary expansion programme, the markets went into a funk. Worried about the consequence of rising interest rates in the United States on global market conditions, traders, punters, and fund managers sought financial high grounds (“safe havens”).
Fast forward to 3 years down the road, and the greenback, yen, and gold have reached for new highs. Conversely, commodities and emerging markets’ equities, gilts, and currencies are down. All of this on the back of the decision by referendum in the United Kingdom to quit the European Union.
Once again, through no fault of ours, our economy faces the prospect of a shortage of capital inflows.
Yet there was a time when not just was our global operating environment different, the outlook for the domestic economy was brighter. In the 15 years to mid-2014 the domestic economy grew on the back of reforms to the structure of the economy (a large part of which was implemented between 2003 and 2007), a considerable inflow of foreign portfolio investment (FPIs), and strong crude oil prices.
However, following the seizure in 2014 of the global commodities markets, the local monetary authority simply circled the wagons. The Central Bank of Nigeria (CBN) did not just fix the foreign exchange rate at levels below which the market cleared these transactions, and pretended to pursue an independent monetary policy. It also erected barriers around trading in foreign exchange that helped remove transparence from the market.
Of course, this resulted in the capital account going into deep freeze. Arguably, the nearly 60% drop in global oil prices between mid-July 2014 and today, was a major dent on public finances, especially on the central bank’s ability to single-handedly fund the foreign exchange markets. Still, the turning off of the FPI faucets did have its own impact.
Accordingly, when the central bank came into a realisation of the futility of its efforts to solve the impossible trinity, the return of foreign portfolio investors to the markets was a major consideration in the matter of how hard currency liquidity was to be provided to the newly freed foreign exchange market. Once again the equities markets bounced on expectations of this inflow.
Alas, Brexit appears to have altered this equation considerably. With markets heading for higher grounds, we are not likely to witness a resumption soon of capital movement into the economy. Nor of an increase in personal home remittances, at least not from the UK or the EU.
Now all of these disruptions are of a near-term nature. Although it might take the final exit of the UK from the EU before there is sufficient clarity on the general outlook. But then there is no doubting one outcome: the global economy is going to take a beating from all of this. And so will commodity prices. In a chance meeting over the weekend, I was reminded that at 900,000 barrels a day, we are not an oil economy. Thus, it might not matter much that oil prices are likely to stay down for a while.
Nonetheless, given the central bank’s lean purse going into its flexible foreign exchange rate regime, its ability to continue to provide liquidity to the interbank market for foreign exchange was always going to be key. With a number of the sources from which the market was expected to be supplied now facing very strong headwinds, the CBN will be sorely tested in the new market.
The biggest danger is that despite the softness of pound sterling, the naira might begin to lose value against other currencies, especially the greenback. Precisely because demand remains elevated, while funding sources attenuate. Domestic output, inflation, unemployment, all already at unsupportable lows will be threatened further.
At which point it will be important that the central bank shows resolve. The temptation to return to the recently abandoned laager will be strong, especially when across rich economies, an instinctive reach for nativist solutions is now de rigueur. But it will, still, be the wrong response. This is partly because the integration of our economy with the global market place has been largely positive (albeit far slower than some would have preferred). Partly, too, because market solutions are still the best for optimising resource use.
On balance, however, the main reason why the CBN must stick to its newly found path, the new odds notwithstanding, is because the variables that it will be contending with going forward will largely be of an exogenous nature.