Nigeria and central banking in emerging markets
The next Central Bank of Nigeria (CBN) Governor will emerge in a period that one might call ‘interesting times for Nigeria’.
The nation will soon emerge as Africa’s largest economy in perhaps as little as next month when the rebased Gross Domestic Product (GDP) figures, may show its GDP jumping by 60 percent to $430 billion.
Nigeria currently straddles the Emerging and Frontier markets, with its bonds included in the JPMorgan emerging market bond index (GBI-EM) and its equities in various Frontier market indexes including the MSCI, helping to attract investor interest from BlackRock to Mobius and ex chairman of Goldman Sachs asset management Jim O’Neal.
This increasing integration of Nigeria’s capital markets with global markets will only continue to deepen in the coming years and the new CBN Governor would have to be prepared for whatever the fallout is, from the new era of global markets correlation.
Central Banks in established emerging markets have been dealing with this new reality for a while as cheap money from the developed markets – from zero policy rates and Quantitative Easing (QE) – poured into their respective economies, leading to fears of bubbles or overvalued domestic currencies.
Brazil famously declared a currency war on the US and Europe (in 2010). It set a tax on foreign borrowings and imposed capital controls in an effort to protect the country’s struggling manufacturers from loose monetary policy of developed nations in the wake of the financial crisis, which it blamed for directing a flood of hot money to the country and overvaluing the real.
“When the real (Brazil’s currency) appreciates, it reduces our competitiveness. Exports are more expensive, imports are cheaper and it creates unfair competition for businesses in Brazil,” the Brazilian finance minister Guido Mantega, said in March 2012.
Mantega might have spoken too soon however.
There has been increased volatility seen in EM currencies since May 22 of last year when the United States Federal Reserve Chairman Ben S. Bernanke first signaled that the US FED may begin tapering the pace of asset purchases at one of its “next few meetings.”
By August 2013 the Brazilian currency had lost 15 percent of its value versus the dollar and was one of the worst performers among major currencies in 2013, according to Bloomberg data.
This serves to highlight the tricky situation the next Nigerian CBN Governor and other EM Central Banks find themselves as they navigate a new global world in which actions outside of their control such as the US Fed taper of its bond buying programme, might negatively affect their ability to maintain monetary stability.
Brazil: Inflation vs. growth conundrum
Brazil’s Central Bank in 2010 stepped up direct intervention in the market, selling dollars and offering derivatives called reverse currency swaps to curb the real’s surge against the US dollar that year which led to its climbing to a 12 year high by July 2011.
It also cut its target lending interest rates, in a bid to discourage hot money flows and the carry trade on the real.
However the prospects of a reversal of fund flows as a result of the US Fed stimulus roll back has led to a slump in the real against the dollar, which the central bank has blamed for boosting the cost of imports, and keeping up inflationary pressures in the country.
Between April and December 2013 Brazil lifted its target lending rate (the Selic) by 2.75 percentage points to 10 percent, the biggest increase among 49 central banks, according to Bloomberg data.
The Central Bank raised its benchmark interest rate by a further 0.50 percentage points to 10.50 percent last Wednesday (January, 15).
Nigeria’s benchmark monetary policy rate (MPR) is 12 percent by comparison.
Brazil’s inflation rate hit a high of 5.91 percent in 2013, while growth has been disappointing with data in December showing Brazil’s economy shrank in the third quarter of 2013 for the first time since 2009.
The central bank’s IBC-Br index, a monthly proxy for gross domestic product, last week also showed economic activity fell 0.3 per cent in November from a month earlier.
The trade-off between tighter monetary policies to battle inflation amid slower economic growth is the conundrum facing the Brazilian Central Bank at the moment. This is further complicated by the QE programs of Japan, the EU and the US.
Turkey: Unorthodox monetary policy meets taper reality
Turkeys unorthodox monetary policy has relied on liquidity instruments to contain inflation rather than interest rates, however this has failed to staunch the decline in the lira (Turkish currency), which has been accelerated by prospects for reductions in U.S. monetary stimulus.
In December, the United States Fed said it would cut monthly bond purchases to $75 billion from $85 billion. U.S. policy makers will keep trimming stimulus by $10 billion at each meeting before ending the program.
The Turkish lira fell to an all-time low on Monday (Jan. 20) when it fell to 2.2508 per dollar.
Turkish Central Bank Governor Erdem Basci pledged in August last year to keep interest rates unchanged through the end of 2013 to support the economy, although the currency has weakened beyond the Central bank’s expectations (Governor Erdem Basci had forecast 1.92 to the dollar for the end of last year).
Inflation is also above the bank’s target of 6.2 percent in December. Inflation unexpectedly accelerated to 7.4 percent in December from 7.32 percent a month earlier, the state statistics office said on Jan. 3.
Turkey also runs a $60bn current account deficit that is widely seen as unsustainable; and has net reserves of around $38bn which only cover a few months’ worth of imports, while Turkey’s private sector has $255 billion in debt and the lira’s depreciation increases the burden on companies with foreign-currency borrowings.
“With inflation close to 8 percent, and inflation expectations for end year above 7 percent, this means that policy rates remain negative in real terms (sharply negative in the case of the one-week repo). This is hard to justify in an economy, where credit growth is still running at about 25 percent, and where the 5 percent inflation target is likely to be missed again. Thus, staff called for a significant tightening above and beyond the recent one, specifically: a one step increase of 250bps in the main policy rate (the one-week repo) to reach positive real levels, and a systematic provision of liquidity at this policy rate,” the IMF said in a report released December 2013 on its article IV consultation with Turkey.
The Turkish Central bank has however bucked the IMF advice on tightening.
The central bank kept its three main rates unchanged at this week’s meeting although, one of them, the overnight lending rate, would be raised from the current 7.75 per cent to 9 per cent on “exceptional tightening days”.
The lira fell to a record low after the central bank left the interest rates unchanged.
South Africa: Dependence on foreign capital flows expose rand
The South African rand has been caught up in the emerging market currency turmoil triggered by the US Federal Reserve tapering its asset purchase scheme.
South Africa is increasingly dependent on external capital inflows to finance its twin – current account and budget – deficits, which has made the rand volatile in recent years
The rand has slumped 6 percent in the past month against the dollar, extending a slide that began in early 2012.
The South African central bank has not raised rates to stem rand weakness, betting it will help the current account adjust.
South Africa was named among the fragile five. A grouping of 5 emerging markets: Brazil, India, Indonesia, Turkey and South Africa which are linked by vulnerability to current account and fiscal deficits, and most susceptible to US taper of stimulus.
South Africa, which is one of the most liquid and traded, emerging markets, is the only member of the fragile five that has not raised interest rates.
The Monetary Policy Committee left the repurchase rate at 5 percent, at the last MPC meeting in November.
The MPC lowered its inflation forecast for 2013 to an average of 5.8 percent compared to a previous estimate of 5.9 percent, and cut its 2014 projection to 5.7 percent from 5.8 percent, Governor Gill Marcus said.
The central bank traditionally aims to keep inflation within a 3 – 6 percent band.
However the continued weakness of the rand – which depreciated by around 20 per cent against major currencies in 2013 – has caused some economists to suggest the momentum is shifting towards a rate hike.
This year, the rand has been one of the worst performing currencies as it trades at close to R11 to the dollar.
A further challenge for the monetary authorities is South Africa’s labour unrests and weak growth outlook.
The Purchasing Managers Index (PMI), dropped 2.5 points to 49.9 in December, the lowest reading since April an indication that business conditions are deteriorating.
India: New Governor tries to calm markets
India, with large current account and fiscal deficits, was among the vulnerable economies earlier this year when talk of ‘tapering’ first sent emerging markets into a selloff.
The rupee dropped to a series of record lows against the dollar and vast amounts of capital flowed out of the economy.
Reserve Bank of India’s (RBI) new Governor Raghuram Rajan raised borrowing costs twice since mid-September 2013 to counter inflation and calm markets before leaving the repurchase rate at 7.75 percent at the last meeting on Dec. 18.
Its next policy review is on Jan. 28.
The RBI also capped cash injections into the banking system and tightened lenders’ reserve ratios to curb the supply of rupees, and stem the steep slide in the currency.
The RBI has recently started to loosen liquidity as the taper fears fade and it recently announced steps to boost cash supply in the financial system.
The RBI will add 200 billion rupees ($3.3 billion) via a 28-day term repurchase auction, it said in a January 20 statement.
The monetary authority will also purchase as much as 100 billion rupees of debt due in 2017, 2019, 2023 and 2027 through open-market operations
A committee set up by the central bank proposed adopting a 4 percent consumer-price-inflation target by 2016 as part of a sweeping monetary-policy overhaul.
The recommendations, if implemented, will be positive for the rupee as it will enhance the monetary authority’s credibility, said some analysts.
Indonesia: Policy response to EM sell-off paying off
Indonesia was hit hard in 2013 when global investors pulled funds out of emerging markets on fears the tapering of stimulus was about to begin.
Bank Indonesia, the central bank, hiked interest rates to 7.5 percent – the highest level since May 2009 – from as low as 5.75 percent in May 2013, after the currency and stocks fell.
Indonesia’s new Central Bank Governor Agus Martowardojo approach to the currency has been more market oriented, and not to defend the currency at all costs.
Governor Martowardojo also embarked on the country’s most aggressive rate-tightening cycle in eight years within a month of taking the helm in May, leading to slower expansion and reduced imports.
The policy responses by the Indonesia Central bank seem to be paying off.
The Indonesian currency, which touched a five-year low of 12,285 per dollar on Jan. 7, has gained 0.4 percent this month to 12,120 as of 1:02 p.m. in Jakarta, on January 16.
Overseas investors have bought $239 million more Indonesian shares than they sold this year and pumped a net 2.08 trillion rupiah ($172 million) into local-currency debt, according to official data.
Indonesia posted a trade surplus of $777 million in November as imports fell 11 percent, the most in four years.
The full-year deficit was 3.5 percent in 2013 and the gap will stay below 3 percent this year, Bank Indonesia estimated on January 9.
Inflation is also expected to slow after exceeding 8 percent in each of the six months through December. Indonesia raised $4 billion from a sale of dollar-denominated bonds on January 8, 2014 as it sought to draw global capital and buoy the rupiah.
The current-account gap, at a record 4.4 percent of gross domestic product in the second quarter of 2013, may have narrowed to below 3 percent in the final three months of the year, the central bank said. The deficit may stay below 3 percent of GDP this year from an estimated 3.5 percent in 2013, according to the Central bank.
At its first meeting of the year held in January the Central Bank kept interest rates unchanged .The central bank maintained the reference rate at 7.5 percent, and kept the deposit facility rate at 5.75 percent.
Lessons for Nigeria
The Central Bank has to establish its credibility with the markets by being ahead of the inflation curve or adjust accordingly once inflation expectations begin to rise. It therefore means that the independence of the bank is imperative if it is to take prompt and necessary policy actions.
For Central Banks in EM, the actions or inaction’s of their developed market counterparts often leads to an outsized impact on their domestic markets and their ability to maintain macro-economic stability.
EM currencies are also often the first assets in the firing line once global financial markets become volatile and the next CBN Governor would have to decide the right level for the naira – dollar to trade at, and whether it can defend those levels bearing in mind its available dollar reserves.
Nigeria’s dollar reserves and fiscal buffers have been falling, with the Excess Crude Account (ECA), down to $2.28 billion (Dec. 2013) from $8.65 billion (Dec. 2012) and FX reserves down 9.7 percent from their 2013 highs to $43.2 billion (Jan. 15), meaning the next Governor has less ammunition to face any challenge.
Finally the central bank’s ability to conduct monetary policy effectively is often tied to the underlying structure of the economy and fiscal policy.
Running large current account and fiscal deficits, may lead to investors demanding higher yields for a country’s sovereign debt, and can also feed into pushing the currency lower, if investors decide to slow their purchases of the nations bonds.
It is said that an old Chinese curse says “May you live in interesting times.”
The next Governor of Nigeria’s Central Bank (whomever it is), will certainly be emerging at a most interesting period of increased co-relation in global financial markets as well as greater complexity in finance, banking and economics.
The onus is therefore on the Government to appoint an individual with the soundest of intellect, transparency and courage who is uniquely able to navigate Nigeria through these interesting times.
By: PATRICK ATUANYA