Sunday, 25 October 2015

Beyond Body Language and Rhetoric - A Compelling Case for the Devaluation of the Naira

I will try and make this as pedestrian as possible and focus on five cardinal points;
1. Increased Public Debt Vs Drop In Earnings – our Debt profile has increased from US$9.4 billion external and N10.1 Trillion internal in March 2015 (approximately US$60.4 Billion in total) to over US$11 Billion external and N11 Trillion internal (approximately US$66 Billion) as at October 2015. The escalating borrowing encourages increased inflation (note that inflation has hit 9.4%) as without a corresponding increase in earnings / revenue the country may need to print/create more money to service its debt (recall the FGN N615.96 billion borrowing from the CBN’s Ways and Means Account without recourse to the National Assembly). Printing / creating more local currency implies more Naira chasing the available US Dollars leading to demand and supply dynamics as increasing the money supply invariably encourages inflation and defacto real devaluation. This is asides from the increase in the default risk of local currency denominated debt as a drop in earnings while borrowings increase signals the possibility of default. Going by our current earnings trend, against a 2015 budgeted deficit financing of circa N1 Trillion, the reality is approximating N2 Trillion or 46% of the budget (with almost zero CAPEX spend) as we are not just contending with a drop in earnings but are still dilly-dallying and spending on unbudgeted Petrol subsidies which has so far exceeded N222 Billion in actual payments and N500 billion in debt owed Petroleum Marketers.
2. Inflation – This has hit 9.4%. Generally high inflation leads to a devaluation / depreciation of a currency in relation to that of the country’s trading partners. This is accompanied by an increase in interest rates as we already see / have in Nigeria.
3. Differentials in Interest Rates between Nigeria and its Trading Partners – Exchange rates, inflation and interest rates are highly co-related. As stated above, high interest rates leads to an increase in inflation as higher interest rates encourages foreign capital inflows (to invest in local currency debt instruments) and causes exchange rates to rise. As a corollary, lower interest rates drive down exchange rates. The high interest rates are partly driven by our current monetary policies. Specifically a CRR at 25% (reduced from 31%) is still very high compared to our Emerging Markets peers and astronomically high compared to developed Markets, but this has become necessary given the need to manage the amount of Naira chasing the available US Dollars (refer to point number 1). Also recall that CRR for public sector funds was only reduced from 75% in May 2015.
4. Current Account Deficit – With the steep drop in the price of crude (and by extension our US$ earnings) against our increasing import requirement the country is increasingly spending more on importation than it earns from export earnings. To fund that deficit the country has to either borrow more from foreign sources or print more money (refer to my first point and its effect). This excess demand for FX will naturally continue to put our Exchange rate under severe pressure (thus CBN’s recent ‘demand management measures) until our goods and services (exports) are cheap enough and / or foreign assets are too expensive to generate sales for import.
5. Political Stability and Economic performance – Do I need to say much on this? I recall that some people pooh-poohed JP Morgan’s removal of Nigeria from its bond Index without understanding its wider implications of signaling a loss of confidence in Nigeria’s currency and as such as a dampening of Foreign Investor’s enthusiasm for Nigeria as a destination for foreign capital.
Going by the aforementioned factors unless the CBN and FGN introduce further FX Demand Management Measures (trading a stable exchange rate for stagnating or contracting economic growth…but who does that, right?) this pressure will continue to build. Already we now have three exchange rates in the country, Official (CBN), Parallel Market (Cash) and Transfers, with a lot of the ‘Demand Management’ demand pressures transferred to the 'Transfers' Exchange rate. We also stand the risk of exhausting our already depleted foreign reserves defending the naira…that on its own will have an immediate negative effect on our exchange rate.
So this is not about me or what I want…this is about the reality of ‘market forces’ and it’s just a matter of time. If we don’t handle this as a controlled detonation, it will explode out of our hands and result in what I term ‘the catapult effect’, a violent whiplash from a piece of rubber that is stretched beyond its elastic limit.
Of course another option is to increase our Export and FX earnings, reduce the country’s debt profile, manage inflation, reduce interest rates and somehow communicate and reflect political stability to our stakeholders.
Onwero nke ana eme di easy

Jekwu Ozoemene

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