Wednesday, June 10, 2015 5.27 PM / Development Economics with Temitope Oshikoya*
A year ago on June 5th, 2014, the new Governor of the Central Bank of Nigeria (CBN), Godwin Emefiele outlined his agenda in “Entrenching Macroeconomic Stability and Engendering Economic Development,” focusing on monetary and price stability, financial stability, and development finance.
In an op-ed article titled “The Unholy Trinity and Nigeria’s Misery Index” and in “Emefiele’s CBN and Nigeria’s Misery Index” published in This Day of June 16, 2014, this writer has discussed the themes of Governor Emefiele’s maiden speech and has tried to provide specific, measurable, relevant, and timely framework and indicators that can be used to assess the agenda going forward.
Monetary Policy Trilemma
The first set of monetary and price stability goals in the maiden speech are to pursue a gradual reduction in key interest rates, and include unemployment rate in monetary policy decisions; pursue lower inflation rates; maintain exchange rate stability and aggressively shore up foreign exchange reserves.
The afore-mentioned article has noted that it will be challenging for the CBN to manage in the short term the unholy trinity or monetary policy trilemma, which states that a country can only choose two combinations of exchange rate stability, monetary independence, and open capital mobility or financial integration.
The actual outcomes on monetary and price stability, exchange rates stability, open capital mobility, and foreign reserves objectives have been very much in line with the proposition outlined in the article. Inflation rate has increased from 8.1% in June 2014 to 8.7% in April 2015. Following a J-Curve phenomenon with a small dip to 7.9% in November, 2014, there has been five consecutive increases in inflation. The IMF predicts that the inflation rate will reach double digit at 11.5% by the end of 2015.
Rather than pursuing a gradual reduction in interest rate as espoused in Governor Emefiele’s agenda, the spread between prime and maximum lending rates has remained elevated at about 9.5%. The interbank borrowing rate shot to over 70% at one point. The Monetary Policy Committee (MPC) increased the monetary policy rate (MPR) from 12% to 13% in November, 2014, mainly to induce foreign portfolio investors.
The era of capital feast has been followed by capital famine from 2013 when foreign portfolio investors started taking a flight and continued throughout 2014. The NBS recently notes that capital imports into Nigeria in 2014 fell by over $570 million to $20.7 billion. Capital imports fell by nearly one-third to $4.5 billion in Q4 2014 from $6.5 billion from the preceding quarter.
The objectives of maintaining exchange rate stability and shoring up foreign reserves have eluded the CBN in the past one year. Capital flight and falling oil prices, which declined by over 60% from a high of $115 in June 2014 to below $50 in early 2015 put downward pressure on the exchange rate. At its November, 2014 meeting, the MPC adjusted the mid-point of the official retail Dutch Auction System (rDAS) rate from N155 to N168 per U.S. dollar, while widening the band from ± 3 to ± 5 percent. The CBN subsequently took a more drastic measure to price the exchange rate at N199 per U.S. Dollar and closed the rDAS window. In spite of these measures, exchange rate differential between the inter-bank and parallel markets rates remains stubbornly high at about N24.
The reality of a Policy Quadrilemma also sets in as the dwindling foreign reserves now became a major constraint to maneuvering around the Policy Trilemma. External reserves fell from $43 billion in January 2014 through $37 billion in June 2014 to $29.6 billion in May, 2015, representing 4.7 months of imports and declined from a high of 30% of GDP in 2007 to 6% of GDP, the second lowest since the 1980s. The Policy Trilemma also explains the resistance to the initial attempt by the CBN to have capital controls on the exchange rate, which poses risk for exclusion of Nigerian bonds in the JP Morgan index.
The IMF Article IV Consultation Report on Nigeria released in March 2015 appears to affirm the Monetary Policy Trilemma proposition noting that “recent developments have highlighted the challenges facing the monetary authorities, and risks to the current monetary and exchange rate policy framework. Monetary policy is driven by the CBN’s commitment to maintain a stable official exchange rate. Thus, international reserves have to adjust to balance supply and demand in the foreign exchange market, and the CBN has less room to manage its inflation target via monetary expansion or contraction.”
Financial Stability Trilemma
The second set of goals relate to financial stability, safety, and soundness by pursuing risk-based and sector-specific supervision, macro-prudential measures, and addressing issues relating to information asymmetry via collateral registry.
The CBN has started implementing the BASEL II Accord to ensure that banks are adequately capitalized with enhanced risk management systems. By January 2015, the CBN has undertaken the Risk Asset Examination of 24 banks as at December 31, 2014. Further, an enhanced framework for regulation and supervision of domestic systemically important banks (DSIBs) has been put in place with higher capital adequacy requirements, solvency and liquidity stress tests, an expanded reporting requirement, and recovery plan.
As part of efforts towards reducing information asymmetry, the National Collateral Registry (NCR) Bill is underway. The enrollment for the Bank Verification Number (BVN) for banks customers is estimated to have increased from 15,000 in early June, 2014 to over 11,140,000 towards end- May, 2015. In July 2014, the reform of the Bureaux de Change (BDCs) resulted in 2,501 BDCs with caution deposits and capital base of N35 million each; yet the Bank found 121 BDCs, accounting for over 90% of 130 sample BDCs were in breach of the provisions of its guidelines.
During the period under review, the CBN has maintained domestic financial stability and prevented systemic risk, which is the risk that an event will trigger a loss of confidence in the financial system. However, challenges relating to Financial Trilemma, distinct from Monetary Policy Trilemma, are emerging. According to Dirk Schoenmaker, “the Financial Trilemma states that financial stability, financial integration and national financial policies are incompatible. Any two of the three objectives can be combined but not all three; one has to give.”
Foreign currency exposures of banks’ assets and liabilities have increased. Indeed, Nigeria is observed to be one of the largest importers of dollars in the world. Dollarization grew from 15% of deposits in 2011 to 23% by 2014 as the dollar has been used both as medium of exchange or currency substitution or and as store of value or asset substitution. Recent CBN directives on dollarization have been focused more on dollar being used for transactions or medium of exchange; while its use as store of value will remain with high inflationary expectations and exchange rate depreciations.
Further, about a fifth of total loans are denominated in foreign currency. In addition, a quarter of total loans are concentrated in the oil sector, making their loan portfolios vulnerable to the decline in oil prices. While the banking industry’s non-performing loan (NPL) ratios remain within prudential guidelines, it has been observed that the full impact of the oil price shocks and devaluation will result in higher bad debt positions.
The link between the Monetary Policy and the Financial Trilemmas is financial integration. Macro-prudential policies then provide appropriate instruments for fostering financial stability in countries with open capital movement. The CBN macro-prudential guidelines that limit foreign currency exposure by banks, including limiting foreign currency borrowing from 200 percent to 75 percent of shareholders’ funds, and banning the issuing of invoices in US Dollar for domestic services, are therefore appropriate.
Nigeria’s Misery Index
The third set of goals focus on engendering economic development and job creation with a new financing instruments for investments in SMEs, agriculture, manufacturing, oil and gas, and the power sector. In the afore-mentioned article, it was observed that Governor Emefiele has essentially started the journey towards appropriately redefining the economic welfare function of Nigeria and Nigerians for the CBN. He has taken a positive decision to include unemployment rate in the discourse of the Monetary Policy Committee.
To his credit, nearly half of his maiden speech has been devoted to issues of economic development and development finance. The objective is to address and tackle the very high Nigeria’s misery index--a simple sum of inflation, lending rates, and unemployment rates, minus year-on-year per capita GDP growth. It has been noted that his tenure should be measured by the progress and success in reducing Nigeria’s misery index from 48 by half to 24 in 2016, by another half to 12 by 2018, and by another half to 6 by 2020.
In reality, Nigeria’s misery index—has not improved much from 48 in 2014, with most of its components worsened: inflation rate has increased as noted above, with maximum lending rates in the mid- to high 20s. Although the National Bureau of Statistics (NBS) has changed its reclassification approach, Nigeria’s unemployment rate still jumped to 7.5% in Q1 of 2015 compared to 6.4% in the Q4 of 2014; with 4 out 10 youths between the age of 15 and 24 were either unemployed or underemployed. The GDP growth rates fell from 7.2% in Q2 2014 to 3.9% in Q1 2015.
Nevertheless, the CBN has since introduced a
N300 billion--Real Sector Support Fund, with half the amount approved for five projects; a quarter of the N213 billion--Nigerian Electricity Market Stabilization Facility to settle outstanding debts in the Nigerian Electricity Supply Industry has been disbursed. The guidelines for the Commercial Agricultural Credit Scheme guidelines have been reviewed to facilitate lending at an all-inclusive interest rate of 9 percent and extended the expiration of the scheme from 2016 to 2025. About N44 billion has been disbursed via the Micro, Small and Medium Enterprises Development Fund. The CBN has also invested about N500 billion in the Development Bank of Nigeria (DBN).
The CBN appears to have maintained financial stability with both micro and macro-prudential instruments. However, supervision and enforcements still need to go further given the fact that commercial banks have been able to circumvent its CRR position, with substitution of public sector deposits for private sector deposits compelling the apex institution to reverse its earlier position and reduced CRR on public sector deposits from 75% to 31%.
The CBN’s objectives of monetary and price stability have been severely challenged over the past one year. In particular, there is need to address persistent structural liquidity, with liquidity ratio reaching as high as 50%, often linked to attempt to first convert or monetize oil revenue earnings in dollars to naira for prior allocation among the federating units as per fiscal institutional and legal requirements. This fiscal dominance of monetary space with constraints on the transmission mechanism for injecting liquidity into the Nigerian economy is worth looking into.
On the third set of objectives, the CBN needs to anchor and align its development finance agenda with the overarching vision of the incoming administration, which appears to be a social-democratic welfare state with a dynamic market economy. The APC plans to pursue equitable, inclusive and shared prosperity while tackling economic diversification through labour-intensive manufacturing and agro-processing with SMEs Loan Guarantee of N10 trillion or $50 billion and Agriculture commodity trade board of N250 billion or $1.25 billion.
In this context, the Development Bank of Nigeria (DBN) can indeed become an important instrument for financing economic development as in the BRIC countries. It has been observed that the $1.6 trillion assets of the China Development Bank are ten times bigger than that of the Asian Development Bank. The $335 billion assets of Brazil Development Bank are three times that of the Inter-American Development Bank. Nigeria’s DBN should aim to grow its assets and surpass the $33 billion assets of the African Development Bank.
Indeed, if the fiscal authority can set its priority right and plug fiscal leakages, the development finance interventions of the CBN will be minimized and the fiscal agent will assume direct responsibilities for most of those activities. Then, the CBN could enhance economic development primarily by promoting a regime of low interest rate and access to financial intermediation.
In summary, the CBN over the past one year under Governor Emefiele has succeeded in maintaining financial stability, but has also been seriously challenged on economy-wide issues with persistent structural liquidity, depreciating exchange rates, rising inflation rates, high interest rates, high unemployment, and elevated misery indices.