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Slow Policy Response Hurting Economy

Posted: Jun 9, 2016 at 4:31 am   /   by   /   comments (0)

Investors Scared, Foreign Reserves Down, No Prospect Oil Prices Returning To Pre-2014 Levels In Five Years


Kirk Leigh

Lagos – Worsening macroeconomic challenges being experienced by the country, including negative growth are as a result of government’s poor policy responses, says BMI Research, a Fitch subsidiary.

Decelerating growth, high inflation and high unemployment are enough problems for the country but government reaction to these problems magnify the challenges. And because Nigeria is heavily dependent on oil revenues, the challenges will remain with the country till 2017.

“Aside from the external factors weighing on Nigeria’s real GDP growth – namely the oil price slump – policy responses within Nigeria are exacerbating the macroeconomic difficulties, and we expect that they will continue to do so through 2016 and 2017.”

But as the problems endure, investors find their ways through the door, according to BMI in its May report.

“Investors are becoming increasingly wary towards the country thanks to loose fiscal policy, and President Muhammadu Buhari’s steadfast refusal to devalue the naira and his backing of the more unorthodox monetary policy measures being implemented by the Central Bank of Nigeria (CBN).”

According to BMI, in a bid to protect the peg on the naira, CBN’s reserves have been falling sharply; it expects the reserves to drop to USD26.2 billion by end 2016, or around four months’ import cover. BMI also says that devaluation is inevitable, although it expects the rate to nearly approximate the parallel market rate NGN300/USD. But it expects the devaluation to begin as early as the second quarter of 2016. Painting a cause and effect scenario, with the cause being that given the “current NGN197-199 peg, we forecast a limited devaluation to NGN230/USD in Q2016, and NGN240/USD at end-2017”.

The effect of this oscillation, BMI postulates is that “current account dynamics will continue to exert depreciatory pressure on the naira, but as oil enjoys a moderate price increase and investor sentiment improves accordingly, these will moderate, and our projection is for a fairly sedate depreciation thereafter. This will in turn allow the CBN to rebuild reserves, which we see returning to USD28.3 billion by 2019, closer to five months’ import cover.”

After commenting on government’s fiscal loose policy stance with the government announcing an expansionary budget of NGN6 trillion for 2016, BMI says these factors, coupled with its projected naira devaluation, will keep inflation high at an average 9.3% in 2016, decreasing steadily to 8.0% in 2019.

Dr. Bongo Adi, economics lecturer at the Lagos Business School (LBS), believes the monetary authorities should take the gauntlet and devalue in order to get the country out of the woods.

“First thing is devaluation”, he says.

But the CBN has since pronounced that it would allow the naira to float even if details are sketchy.

Dr Adi is quick to add that devaluation in itself is not a panacea but must be effected in concert with other policies to achieve desired results.

“This doesn’t correct the fundamental distortions in the system but will momentarily stem the tide of capital flight. Long run solution isn’t going to be straightforward. The bottom-line is engendering growth, curbing unemployment, and stemming inflation.”

Dr. Adi, who teaches the Macroeconomics Module in the Bloomberg Media Initiative Africa (BMIA), Cohort 3, says, “In an economy with structural distortions and inefficiencies, it will require a cocktail of focused policies- growing productive capacities and creating attractive climate for foreign direct investment”.

Analyst Pat Malik of Nairametrics had put the Real Effective Exchange Rate (REER) or inflation adjusted dollar exchange rate at above N400 to the dollar, while the purchasing power parity estimate or Big Mac index (using Johnny Rockets as a proxy) would return something closer to N320 to the dollar.

After deriding the CBN’s poor response to the issue of devaluation, he advised that, “Using the markets will enable the CBN free up pressure on the naira as is done everywhere else in the world, a case in point being Vietnam”.

It would be recalled that the International Monetary Fund in the last Article IV Consultation with the government last February had advised the country to devalue because, “Nigeria is facing the impact of a sharp decline in oil prices”. So to eliminating existing “macroeconomic imbalances” and ensure competitiveness of the economy.

“As part of a credible package of policies, the exchange rate should be allowed to reflect market forces more and restrictions on access to foreign exchange removed, while improving the functioning of the interbank foreign exchange market”, the multilateral body had advised.

On Nigeria’s budget deficit, the BMI report projects a 3.5% of GDP in 2016 on the back of this expansionary budget, coming in thereafter to 3.1% in 2017 and 2.6% by 2019.

“This will be funded by issuance of external debt. Nigeria has traditionally had very low levels of external debt, and as such is in a strong position to fund this expansionary budget through borrowing.”

The government has announced plans to tap World Bank and African Development Bank funds and appears to have shelved earlier plans to supplement this with a eurobond issuance.

“This is one of the factors behind our continued expectation of limited naira devaluation, as we believe that it will be a condition of their assistance”.

BMI surmises the way out in a scenario where, “there is an effective move to adapt to the new conditions through taking painful but prudent measures to restructure the economy; the naira is allowed to depreciate, monetary policy is tightened and the government takes on increasing levels of debt in order to boost the economy and build essential infrastructure”.