A piecemeal solution to the fx market challenge

It emerged at the autumn meetings of the IMF and World Bank in Washington earlier this month that the Fund was prepared to grant concessional loans at zero interest rates. The comment by the Fund’s managing director, Christine Lagarde, attracted interest in Nigeria because of the current fx shortage and the domestic sensitivities about borrowing from the IMF.

It is not clear whether Lagarde’s offer applied to all developing countries or merely those classified as low-income. Before the latest devaluation in June and after the reworking of the national accounts, Nigeria had been promoted to the ranks of lower-middle countries. If we assume now that it would be eligible, there would probably be a sizeable inflow to the balance of payments. To take the example of a stand-by arrangement, which is not available for low-income countries, the rule book shows that Nigeria could access 145% of its quota of SDR2.45bn (US$3.40bn) annually or 435% cumulatively.

We cannot be more precise because the offer was not (precise). What we can say is that the inflow would be substantial because Nigeria has never drawn down funds from the IMF (although it has signed credit agreements). If it was to borrow for the first time, there would be spin-offs in external financing. The talks with the World Bank and the African Development Bank (AfDB) on financing the 2016 budget deficit would become smoother. The sale of the Eurobond issue scheduled for Q4 2016 would become easier although the FGN is looking to launch in a market highly favourable to emerging and frontier market sovereigns.

We assume that the FGN would not accept the largesse said to be on offer because of the perceived implications for national sovereignty. In our view these fears are passé, and overdone. In May it raised the ceiling for the retail price of gasoline and in June it “liberalized” the exchange-rate regime. Both moves were supported by the Fund although they did not go far enough in the eyes of the multilateral. They were taken as a last resort because the FGN feared that the alternative (of doing nothing) would be worse for the macroeconomy and, probably, social cohesion.

The challenge then becomes how to create a substantial enough inflow to clear the backlog of demand and build a large buffer so that foreign portfolio investors will return in large numbers and the fx market will function with autonomous funds complementing the CBN’s.

The monetary policy rate hike of 200bps in July did not do the trick and is unlikely to be repeated. In late September a lively domestic debate on a sale of state-owned assets was initiated by a well-known industrialist. We are comfortable with the sale of the “family silver” in certain circumstances, as we are with borrowing from the IMF.

There are potential buyers. The oil majors might want to buy out the majority stake of the NNPC in the unincorporated joint-ventures provided that they could then operate under international standards of regulatory control. The same is true of Nigeria LNG. Few would support a sale to domestic interests that prompts issues of governance.

Our main objection is that, given the oil price and their fiscal difficulties, the authorities would be selling from a negotiating position of weakness. Further, the estimated sale proceeds of around US$15bn would not create the buffer required to create a fully functioning fx market. We think that the buffer should clear the full backlog and add perhaps six months’ import cover. The estimated proceeds would not reach half our target.

This leaves us with a piecemeal solution to the challenge and a slow movement toward the objective for the fx market. One element would be the forthcoming Eurobond issue. The yield on the Jul ‘23s is currently about 6.9% (bid) and we would expect little difficulty in raising the target of US$1bn without an IMF endorsement in place. Depending on the size of the bid, we hope that the authorities would consider a rather larger sale of bonds. It would mark a vote of confidence and a step towards the DMO’s medium-term target of a 60/40 split between the FGN’s domestic and external debt obligations.

Another element could become the talks between the Nigerian and Indian authorities on what appears to be a US$15bn advance payment for long-term crude oil contracts. Another possibility to explore could be the use of FGN guarantees of external loans. These would be for the infrastructure rather than the immediate requirement of budget deficit financing and the building of a large external buffer but would help to create market confidence in the authorities’ economic agenda.

There is therefore not one single step large enough and politically acceptable towards the fully functioning fx market. The journey is gradual. Once we approach the objective, other elements in the piecemeal solution should come to the party: these include non-bank and bank providers of liquidity, a higher proportion of remittances through official rather than parallel channels, and foreign direct investment that has been deferred.

Gregory Kronsten