Crude Awakening for the Naira
After weeks of playing the ostrich, the Central Bank of Nigeria finally caved in by shifting the mid-point of the NGNUSD to N168/$ from N155/$. In addition, the bank widened the trading band of the exchange rate from +/- 3% of the mid-point to +/-5% suggesting the bank is more tolerant of wider currency moves. To bolster the efficacy of its decisions the bank topped it all by hiking all interest rate tools: 100bps in its key policy rate the MPR to 12% and 500bps in private sector CRR to 20%. Monetary policy also underwent a violent twist with the Governor Godwin Emefiele reversing his prior dovish posturing by signaling a hawkish policy outlook.
More importantly is the marked departure in the governor’s forward guidance – no longer would naira defence be at any cost rather the apex bank would now take into consideration the state of FX reserves. This effectively conditions naira outlook to movement in oil prices. However, the decision by the Organization of Petroleum Exporting Countries (OPEC) not to trim its cartel output and the resulting drop in oil prices to fresh lows has raised concerns over whether the CBN actions are enough to stem further naira pressures. Indeed, in the immediate aftermath of the CBN decision, the naira appeared to have stabilized only to succumb to new weakness upon the OPEC decision.
Post to two decisions, fears have heightened across board with Nigeria’s equity markets entering strong bear territory and interest rates starting to climb. On the fiscal side, the finance ministry has signaled the commencement of austerity measures to manage the crisis. Amidst the turmoil, reverberations have commenced across the blogosphere and commentariat with all manner of editorials, articles and declarations by a motley crew of analysts, politicians, doctors, lawyers etc. All seem to be in agreement as to the struggles that lie ahead for the Nigerian economy though consensus hardly exists on the underlying causes or, more importantly, the way out.
In hindsight, it is easy to blame the Finance Minister and there has been all manner of criticism. However, if we step back and look at sabotaged attempts at institutionalizing fiscal savings, the elevated recurrent expenditure levels and snail pace of reforms aimed at tackling fuel subsidies and growing self-sufficiency in food production and manufacturing, the current problems are hardly surprising. The downturn in oil prices is a mirror of the broader commodities asset class where across board the picture is one of oversupply. Not that this should have been unexpected, but the decade long bull run across commodities starting in the mid-2000s as emerging market demand led by China exposed persistent under-investment in global commodity oversupply.
The lag between supply appropriately responding has disappeared, coinciding with a period of weak emerging market demand resulting in plunging commodity prices. across board: Gold, Iron Ore, Sugar, Wheat, Rubber, Palm Oil, if it is a commodity its tanking, bar the odd weather inflicted or Ebola impacted crops (like Cocoa). With oil prices, this is the homestretch, the past four years of $100/b prices have induced a reaction on the supply side resulting in the current bear market. Although, current speculation about a floor for US shale producers has resulted in a search for the mythical number below which oil prices cannot plumb through. Whatever that number is if it exists, we are likely to see depressed oil prices over the next few years.
With the background in mind, the goal of domestic policy makers should be to drive an adjustment, however painful. Had we built fiscal buffers back in 2008, we could afford to power on unperturbed like the Saudi’s of today. Unfortunately, we ruled out that leg room necessitating the need for painful adjustments. Some are automatic, the Finance Minister has hinted at halving the subsidy bill though it is like clock-work the plunging oil prices is automatically halving the subsidy budget. Expected PMS pump price going by the PPPRA website is now at N111.4/litre.
Should oil prices plunge further there will not be a subsidy to be paid as it is even more likely that the expected pump price could dip below N97/litre in which case petroleum marketers should abandon the government scheme. The Nigerian Federal Government is likely to find wiggle room to pay salaries and maintain itself comfortably. Worst case scenario they can issue bonds – our strong PFA sector will double up on FGNs vs. Equity Market Risk. In this regard, as rating agencies have stated Nigeria’s low debt profile most of which is naira anyway shields her away from severe pressures.
Does this mean Nigeria will be fine? Not exactly, the problem with dwindling revenues is that our current economy revolves around the government. If it spends less, the growth picture is likely to be weakened. Secondly, Nigerian states largely rely on federal allocations to meet their expenditure needs. With lower handouts from the centre, many states are likely to go through tough times in 2015. The tight monetary policy stance only compounds the woes for businesses with financing now much more expensive.
How then do we get out of this situation? If commodity prices are by nature cyclical then every period of high prices is followed by lower prices necessitating a counter cyclical policy stance across board: monetary and fiscal. Though the latter point is a bit disguised, the ultimate thrust for counter-cyclical economic policy given the largely homogenous nature of our economy implies ultimate leadership should come from the fiscal side. Nonetheless, we should not be naïve as the obvious constraints, Nigeria’s constitution places on the fiscal policy minders. Unfortunately, our policy makers allowed the mistakes of all currency crises repeat itself – do the obvious, after exhausting all ridiculous options. For months, the new CBN Governor stuck to the ‘No Retreat, No Surrender on Naira’ mantra even when the fundamental picture of the economy had changed necessitating an adjustment in the exchange rate to reflect the new scene.
Firstly, a decoupling of the Nigerian economy from oil is largely needed. Though oil is a key source of fiscal revenues, It is only less than 14% of economic activities implying any successful decapitation must involve reduction in focus on oil. Diversification in one word. If only it were easy. This is where the current crisis must be put to good use. With oil revenues low, government must develop the tentacles into the non-oil sector. The market system works best if rules are fair and enforced. A policy of economic liberalization across key sectors: power, transport, natural resource extraction, and manufacturing are a start. Lessening the oil off-take of the centre should lead to its becoming independent.
Secondly, the currency pressures emanated from demand for dollars. The CBN contends it is speculative, banks contend it is genuine. However, as spot FX rates are higher than current forward FX rates, it is harder to disagree with the apex bank. The reason for the mispricing of the naira is because it is out of sync with its equilibrium rate thus a policy to float the naira is a step in the right direction. Floating the naira might create initial problems the flexibility benefits they ultimately confer are worthy of the pain.
Ultimately, Nigeria’s policy makers face hard choices which are likely to be resisted by an untrusting populace given the political class’ profligacy. This trust deficit will not go away, nonetheless, it behoves on a nation’s economic policy managers to at least push, there are no choices this time, reform is compulsory.