Thursday, November 14, 2013 / By Abimbola Hakeem Omotola
As the world continue its smooth transition into a shrunken ball with the advancements in information, communication and transportation technology; all possible barriers to economic, technological, trade, capital and labour flows among countries of the world are being brought down by the powerful force of globalization. Consequently, markets, both real and financial are being integrated as trade barriers are becoming more relaxed and financial systems are getting more integrated.
It has often been argued that globalization has the ability of removing inefficiency; thereby improving the welfare of all citizens of the world due to the open market system entrenched in its capitalist root. The liberalization cum market fundamentalism proponents of this thought opined that producers’ surplus will increase as they will have access to cheaper and improved production inputs and a larger and more diverse markets for products and services. They also noted that consumers have a lot to benefit, as they will equally have access to product varieties from different parts of the world at competitive prices. All these sounds good on paper but globalization later turned out to be a game among unequals, as several developing economies including Nigeria were unable to be industrially competitive.
This meant these countries will continue exporting the relatively cheaper primary commodities they produce while at the same time paying more for the industrial manufactured products they import.
In the 70s and early 80s, Nigeria embarked on the structuralist protectionist import substitution industrialization which was unsuccessful, as we were unable to move past the production of consumer non-durables to intermediate, producer and consumer durables. This was after we’ve accumulated huge debts in the process of implementing the import substitution policies.
The chicken was finally home to roast with the global commodity market crash in the 80s which rendered our economy and that of several other Latin American and African countries that were also using the policy economies unviable. The huge debt burden and balance of payment crisis that resulted meant we have to adopt the Washington Consensus SAP (structural Adjustment Policies) of deregulation, privatization, interest rate liberalization (pegging) and fiscal austerity.
Adopting the policies and joining the market fundamentalism cum liberalization driven globalized world however came at a price. Even though the country has been able to generate investment inflows into its oil and gas, banking, telecommunications sectors and capital market, it has made the country susceptible to contagion crisis and other variants of external trade and finance shocks. Add these to the internal social-political and economic instability that have characterized the economy since independence and the problem compounds to give a volatile economy.
Nigerian Economy and Volatility
Nigeria’s major export, crude oil, which is also the country’s major source of foreign exchange and revenue - contributing between 80-95% to the nation’s budget over the last ten years - is a volatile commodity that is vulnerable to internal and external socio-economic and political conditions. These factors are responsible for the fluctuations in the price and volume of the nation’s crude production and export, which in turn leads to volatility in the economy. Incessant violence by bandits and militants in the Niger Delta oil- producing region, pipeline vandalism, bunkering and non-passage of the controversial Petroleum Industry Bill (PIB) are the major internal factors creating uncertainty in the nation’s oil and gas sector and partly responsible for the volatility in the nation’s economy in recent times. These internal problems, especially bunkering, which peaked between June and September this year is responsible for the country’s inability to reach the 2013 budget benchmark crude volume production target of 2.5m/b per day. It has led to a drop in revenue and created the cash flow problems the fiscal authorities are confronting now. The foreign reserve has also been hit as it has grown only marginally since June when the crisis peaked. In an economy that is dominated by the public sector that greatly depends on oil receipt, the GDP has also been hit by the below-target crude export, further strengthening call for diversification of the economy.
External problems have however contributed more to the volatility in the nation’s oil and gas sector. Socio-political and economic problems in other countries of the world, supply glut and financial crises are some of the factors that have had bearing on Nigeria’s oil production, export, revenue and ultimately the economy at large. It occurred in the 80s during the supply glut and more recently during the 2008 global financial crisis where oil prices which peaked at $150/b just before the crisis, declined by 80% to about $30/b at the height of the crisis. The nation’s economy of course followed in the same direction. To paraphrase Joseph Stiglitz, it was freefall for Nigeria’s economy.
The oil and gas sector used to be the only sector that exposed the economy to global uncertainties but since the return to civil rule in 1999 and the privatization, deregulation and liberalization policies implemented by former President Olusegun Obasanjo, the nation’s capital market has evolved and with that witnessed increase in Foreign Portfolio Investment (FPI) transaction. Many of the governments’ assets that were acquired by the private firms are now large cap stocks in the equities market and are subject to huge foreign interest. FPI transaction on the trading floor of the NSE has been increasing steadily and was a record 66.8% of total transactions on the exchange in 2011 and 61.4% in 2012. Though the foreign interest has helped deepen the market, it has also left the market and the economy at large very vulnerable to global uncertainties. The foreign exchange market sometimes witnesses huge pressures when the market is correcting and foreign investors are in profit- taking mood. At the height of the Fed taper or no taper talk earlier this year, the Naira depreciated 1.63% between July and August and the CBN had to draw from the nation’s reserve to support the Naira, consequently leading to a reduction in the reserve. The volatility caused by financial globalization no doubt has had huge impact on the nation’s currency value, foreign reserve, and inflation and GDP growth.
All these factors have made it imperative to develop strong buffers to serve as a hedge against uncertainties associated with the interlinked globalized world. The buffers will help stabilize the nation’s economy in the short to medium term and ensure stable and long term growth.
The Buffers; Foreign Reserve, Excess Crude Account and Sovereign Wealth Fund
After the debt crises and commodities market crash in 1980 which affected Latin American and African countries and the 1997 East Asian crises; the developing world realized they need to curb excessive fiscal spending and start building strong foreign currencies (mainly dollar denominated) and financial assets reserve to stand as buffers against volatility in the global economy and financial markets. It was a general consensus that the unavailability of strong reserves was what made the developing economies vulnerable in the past crises. They learnt their lessons, though the hard way. Since then, Nigeria and other countries in the developing world have been saving billions in foreign denominated currencies and risk free liquid assets which are left exclusively for the central banks to manage.
Over the years, the reserve which exists to provide short to medium term stabilization buffer for the economy has been instrumental in stabilizing the nation’s economy at various periods of global uncertainties. The foreign reserve, along with the Excess Crude Account were particularly instrumental in stabilizing the economy during the 2008 financial crisis that rocked the world and has helped put the economy on a strong growth pedestal. Without these strong buffers, one can only imagine the damage the recession would have caused Nigeria.
However, to effectively manage the nation’s foreign reserve and keep it buoyant, both the fiscal and monetary authorities have a role to play. The fiscal authorities need to concentrate efforts on diversifying the economic base of the nation, so as to make the economy less exposed to oil market volatility. Industrial goods are less volatile and effort should be made to encourage industrial manufacturing. The monetary authorities on the other hand need to put considerable effort into regulating activities in the foreign exchange market, since there is a strong linkage between the foreign exchange market and the foreign exchange reserve. In order to keep the Naira stable within the target band, the CBN draws funds twice a week from the foreign reserve to intervene in the foreign exchange market. Thus, to ensure the growth of the reserve, the CBN must beam its regulatory light more on the forex market to prevent illegalities such as money laundering, roundtripping and other predatory behaviours that exist in the exchange market.
This is what informed the CBN’s recent move to substitute the Wholesale Dutch Auction System with the more transparent retail system. Following the re-introduction of RDAS, foreign exchange demand weakened at both the official and interbank markets, which shows there used to be some illegal foreign exchange demands’ which the dealers could not tender now that the process is more transparent.
With interest rate nearly zero in the US, investing reserves in US is no longer profitable as before and the challenge facing foreign reserve managers in recent times is where to get risk free investment that will give better yields than what obtains in the US now. The CBN governor, Lamido Sanusi at a lecture delivered in August urged central banks to diversify investment of their exchange reserves into different asset classes and geographical locations. The CBN itself has led the change in Africa, as it took steps to diversify the foreign reserve currency base to include the Chinese renmimbi two years ago, it turned out to be a good decision as the renmimbi has been appreciating since then.
The next CBN boss will be expected to tighten regulation around the foreign exchange market and seek safe investment opportunities for the reserve.
Buffer for the Uncertain Future; the SWF
The logic behind establishing the SWF can be likened to the Yoruba adage that says one should not eat with all 10 fingers. Like the proverbial prodigal son, Nigeria has been consuming substantial parts of her oil revenue without investing anything substantial for the future generation. The SWF can serve as a hedge, both in the short and long term, against uncertainties and many primary resource exporting countries like Norway, Angola and Saudi Arabia have looked to the SWF instrument to save for the future generation and provide stability buffer for their economies. The future of oil and gas is not guaranteed as supply potential has been expanding yearly with new oil deposit discoveries being made. The US is now more energy independent with the shale oil boom that will most likely spread to Europe once it recovers from its recession. This has made it imperative for the nation aside making efforts to diversify the economic base to also set some fund aside to invest in real and financial assets locally and internationally.
Nigeria, this year finally joined the league of nations with SWF. The Nigerian SWF which is divided into the stabilization fund, future generation fund and the Nigeria infrastructure fund is being managed by the Nigerian Sovereign Investment Authority (NSIA), which was established by act of parliament in 2011. The fund will be used by the NSIA to invest in short term financial assets which would provide a short term buffer for the economy, and higher yielding long term infrastructure and financial assets. Unlike the foreign reserve, the SWF can be used to invest in higher yielding risky long term assets.
The NSIA ha already resumed work with the $1billion seed fund it received from the states and federal governments, thought the state governments were coerced into contributing to the fund after fierce legal tussle regarding the legality behind establishing the SWF ensued between both parties. With that over now and the State governments having received their investment certificates, the bulk now falls on the on the governing council of the NSIA to ensure the future generation’s heritage is optimally managed.
Having discussed the volatility challenges the Nigerian economy faces in the globalizing world and the importance of the SWF and Foreign reserve in hedging against these volatilities, we invite you to also take part in the discourse.
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