A little over a decade ago, the Great Recession was in its birth throes. Across the globe, there was no consensus over the nature of the beast that was going to emerge; but there was fear about how much of what was then the “new normal” was going to be altered by the fact. Back home, the echo chambers (economy and finance) reverberated to worries over contagion. From the then-governor of the central bank’s understanding (that the domestic economy was insulated from the ructions that had seized the global economic and financial centres), the conversation shuttled between concern with the likely transmission mechanism, and the length of the lag between a crisis abroad, and evidence of its ripples back home.
In the end, (besides the main lessons from the eventual seizure of the domestic economy in response to the Great Recession) two useful lessons were learnt from that episode. The first was that the trade route turn out to be the most potent channel through which global economic developments reach the domestic economy. This is as much the result of our continued failure to reform the economy away from its perennial addiction to hydrocarbon export earnings, as it is about these earnings making up a significant portion of official receipts. The second lesson was that no economy can afford to become more open to global trade, while thinking itself immune to developments in the global markets. Thus, the more open an economy, the shorter the lag between developments in the global economy and its transmission to the local one.
As it was then, so it clearly is today.
Last week, global equities markets were seized by a sell-off. By close of trading on Thursday, the Dow was down 1,000 points. By Tuesday, the S&P 500 was down 9.7% on the record levels it reached on January 26, 2018. And the contagion spread like a wildfire across the rest of the developed world ― Europe and Asia similarly saw sell-offs in their stock markets. The immediate cause of the funk in the U.S. was growing evidence of strong wage pressures there. For some time now, the U.S. economy has been in recovery mood. Output has grown steadily, and non-farm jobs have been created at a rate of about 200,000 new jobs monthly. Indeed, at a little above 4%, unemployment has lingered at a rate at which most commentators expected wages to go up. Their failure to do so until recently was one of the new conundrums before policy makers in the developed economies.
Rising wages feed into general price increases, and last year, the U.S. Federal Reserve’s Open Market Committee chose to act to nip possible price rises in the bud by raising its benchmark interest rates. Rising wages, also cut into companies’ profits, as labour takes a growing share of this. The reaction, in the U.S. markets last week was, thus, to the twin impulses of reduced company profits (as wages rose), and higher returns on bonds and associated gilts (as the markets tried to compensate for rising prices, and the U.S. central bank’s inevitable rate hike to keep domestic price rises in check — recall that the Feds had already signalled three rate hikes this year). By close of business last week, the yield on 10-year U.S. bonds were nudging 3%.
Part of the global sell-off, then, simply reflected fund managers plying into U.S. bonds. The dollar strengthened on the back of this demand (and the prospects of higher yields on dollar-denominated assets). By close of business last week, the greenback was at its highest against major traded currencies in nearly 15 months. And as the dollar rose, oil prices headed southwards (arguably because investors in oil stocks were selling these to build up their positions in dollar assets).
Lower oil prices are a big worry for us. Forget the focus on the balance on the gross external reserve, and on our multiple exchange rate architecture. The Nigerian economy is denominated in barrels of oil (currently roughly at production levels of about 1.8 million barrels a day). If the price of oil softens, domestic output slacks. At about 2.0% this year (according to most experts estimates) domestic output growth is nowhere near enough to address the needs of a population growing at around 3% annually. If the economy were to grow more slowly, it would matter a lot that about 40% of its youthful population is not in employment, education, or training.
Frightening, though, the prospects of the bottom falling out of the global oil market is, a rising dollar presents a more forbidding augury. Yes, it would mean we’d have to shovel out more naira to hold the precious greenback. But often, a strengthening dollar means rebalancing of global portfolios toward the U.S., which means that emerging markets and frontier economies (such as ours) will start to see non-resident portfolio investors closing their domestic positions, and moving out.
The All-Share Index fell all through last week, closely mirroring the global equity sell-off. And this wasn’t all bad news (or, indeed, because of bad news) some market watchers insist that this was purely coincidental (it was our season of “profit taking” it seems). The yields on domestic bonds were also up last week (by about 0.7 percentage points, according to a bank treasurer I spoke with). The jury is, thus, still out on the degree of sell-off of naira-denominated assets that we should expect in response to the on-going “correction” in the U.S. on the negative side of this conversation, another “expert” that I spoke to described “profit taking” in the local economy as a natural reflex for funds that have suffered losses from the sell-off elsewhere. Gains from the Nigerian end of the portfolio will come in handy plugging leaks elsewhere.
That said, more than the degree of responsiveness of the domestic economy to changes in global financing conditions, it would matter how the domestic monetary authority manages the potential exit of non-resident portfolio investors. It helps that domestic reserves are robust enough to match the dollar needs of non-resident investors were they all to up sticks and leave today. But it would be even more important how the central bank manages the flow of dollars to them. Clearly, therefore, this vulnerability means that for the Nigerian economy, a weak dollar is not the chance to cut interest rates and drive output growth that it ought ordinarily to be. Unhelpful, therefore, is the central bank’s current commitment to a single digit interest rate position by mid-year. The current fundamentals of the economy, and the changes in its operating environment seem to point to rate rises this year. Unfortunately, without its policy committee in place, the Central Bank of Nigeria (CBN) may be going into its most serious fight in a decade with both hands secured behind it.