Nigeria's Unconventional Policies Aggravate External Vulnerability


Wednesday, August 28, 2019   /08:58AM  / Fitch Ratings / Header Image Credit: BBC


The Central Bank of Nigeria's (CBN) recent attempts to boost economic activity through incentives to bank lending jar with its goal of maintaining a stable exchange rate, Fitch Rating says. Attempts to reconcile competing goals through unconventional macroeconomic management and weaknesses in policy settings are raising medium-term vulnerabilities to shocks, which could make the economy more exposed to falling oil prices or disruptions to hydrocarbon production.

Tight management of domestic liquidity has been the key pillar of Nigeria's exchange-rate policy in recent years. However, several recent measures to boost lending have contributed to a temporary loosening of domestic financing conditions. This has combined with falling oil prices and deteriorating investor sentiment towards emerging markets to put pressure on the naira. The measures, announced by the CBN in July, included a requirement for banks to have a loans-to-deposits ratio of at least 60% at end-September and tighter restrictions on the amount of remunerable deposits that banks can park at the central bank.

Exchange-rate pressure led the CBN to resume its liquidity tightening operations this month by auctioning Open Market Operations (OMO) bills, and to increase the supply of foreign currency, releasing about USD800 million from its foreign-currency reserves between mid-July and mid-August. (Foreign-currency reserves were USD44.2 billion at 19 August.) These moves have contributed to a rebound in domestic interest rates and limited the depreciation of the naira on the Investors' and Exporters' FX Window to 1% since end-June.

The competing goals of preserving naira stability and supporting Nigeria's fragile recovery are pushing the CBN towards increasingly complex policy measures, with a risk of aggravating external vulnerability or causing macroeconomic distortions. We expect the CBN to continue to pursue a combination of tight liquidity management, segmented exchange-rate markets, and foreign-exchange (FX) interventions and restrictions. It will be aided by ample international reserves of more than six months of expected 2019 current account payments, and a small current account surplus conditional (we estimate) on Brent prices averaging at least USD60 a barrel.

However, the CBN's policy of auctioning OMO bills to non-residents has led to a rapid build-up of short-term external liabilities with non-resident holdings of these bills amounting to USD15.8 billion (4% of GDP) at end-April, equivalent to a third of reserves. This generates meaningful rollover risks, which could necessitate persistently high interest rates, holding back growth and increasing the government's debt-servicing costs.


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Furthermore, the CBN has recently moved to intensify restrictions on FX access for imports that were imposed in 2015. Milk and dairy products have reportedly been added to the list of 42 categories of products subject to restrictions on access to FX. Nigeria's president, Muhammadu Buhari, recently called on the CBN to restrict FX access for all food imports, but the scope, modalities and timeline of such measures remain unclear.

FX restrictions are unlikely to foster an expansion in domestic food supply, in our view, as Nigeria's agriculture and food industries suffer from deep-seated challenges from infrastructure gaps, communal conflicts, insecurity and weather hazards. Instead, these restrictions could push more traders towards the informal economy and compound inflationary pressures.

Inflation at about 11% already raises the risk of an overvaluation of the real effective exchange rate, which could put more pressure on the naira and increase the risk of a sharp adjustment following an oil price shock. Withdrawal of portfolio investors would aggravate potential balance of payment pressures.


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We affirmed Nigeria's Long-Term Foreign-Currency Issuer Default Rating at 'B+'/Stable in June. High dependence on hydrocarbons, subdued GDP growth, high inflation and weak governance indicators are key rating constraints, balanced by a large economy, a record of current account surpluses and a relatively low general government debt-to-GDP.

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