Keeping the naira stable

The zero interest rate policy (ZIRP) and quantitative easing embarked upon by central banks in most developed economies led to a flood of money moving into emerging and frontier capital markets.

Yields on 10-year US treasury bills rose to 3 percent since Ben Bernanke, chairman of the Fed, signalled that the US central bank may begin “tapering” at one of its “next few meetings.”

The strengthening of US economy and market speculation that the Federal Reserve will announce plans to slow its bond-buying programme this month has led to an outflow of funds from emerging and frontier economies.

These fund flows began to reverse since May 22 of this year, when More than $47 billion has left global funds investing in emerging-market (EM) bonds and stocks since May, according to data last month from EPFR Global, a U.S based fund tracking firm.

Nigeria has in recent times benefited from capital flow through investors who run the so called carry trade, in which they borrow money in a low interest rate environment to invest in assets in economies with a high interest rate.

Nigeria’s equity and debt markets attracted significant capital flows in 2012 with the NSE advancing by 35.42 percent. Foreign investors’ holdings in FGN fixed income securities amounted to $5.112 billion at the end of December 2012, according to the Debt Management Office (DMO). However just as the easy money phase lasted a couple of years the rollback of stimulus may also be a multi-phased affair. In other words, the structural underpinnings of the economy have to be strengthened if they are to survive the crises unscathed.

In Nigeria, on a first glance, the fundamentals of the underlying economy appear to be strong. The banking system is also well capitalized and in recovery mode.

The Nigerian economy grew by 6.72 per cent in the second quarter of 2013, while consumer prices rose 8.7 percent in July, according to data from the National Bureau of Statistics (NBS).

The current account surplus – a measure of trade in goods and services – may widen to $20.1 billion or 6.9 percent of Gross Domestic Product (GDP) in 2013 while the budget deficit should fall to 1.8 percent of GDP this year. Total debt to GDP is 30 percent, including AMCON bonds, well below the EM average. Nonetheless, Nigeria’s economy is strongly linked to the strength of the global economy and by extension the price of oil, ability to coordinate with fiscal policy towards the appropriate control of spending, and increasingly on portfolio investors and currency speculators.

The Central Bank of Nigeria (CBN) appears to be ahead of the curve with regards Fed taper prospects, with its laser like focus on price stability. The CBN has supported the naira by squeezing liquidity from the system with its policy of a 50 percent cash reserve requirement CRR on public sector funds, and intervening periodically to support the currency by selling dollars.

Nigeria’s naira is a relative outperformer in a basket of ugly emerging market currencies e.g. the South African Rand, Egyptian Pound, Ghana Cedi and Indonesian Rupiah. The CBN has adequate ammunition in the form of $48.6 billion in dollar reserves (Sept.4), while it is closely keeping an eye on the up-coming general elections, often a period of loose fiscal spending.

To maintain the successes recorded so far, the CBN must continue to combine prudential regulations with close coordination with the fiscal/treasury authorities. Capital controls while also a policy tool must be deployed as a weapon of last resort.