The Head of Research/Chief Economist, Africa, Standard Chartered Bank, Razia Khan, says in line with the expectation of foreign investors, the Central Bank of Nigeria may need to devalue the naira again in order to achieve sustainable foreign exchange stability. The London-based economist spoke in Lagos during the bank’s economic outlook for 2015. OYETUNJI ABIOYE was there
Whenever you meet with foreign investors, what are some of the concerns they have about Nigeria?
I think there have been a great concern about whether the external reserves are holding up as officially reported and so one question that the Central Bank of Nigeria gets on a constant basis is on the foreign exchange reserves and there have been a lot of reassurance by the CBN on that. But the fact that investors are asking this question again and again, does seem to demonstrate some concerns about where foreign exchange reserves may be.
I think for a lot of investors, they are just looking at what has happened to oil prices. There have been over 60 per cent decline in oil prices, from peak to trough, in less than seven months and we have seen pressure on reserves. I think it is that, more than anything else that has given rise to concerns about the sustainability of Nigeria’s reserves position. The fact that the exchange rate is being held relatively stable also means in one sense that might benefit inflation.
You are not necessarily going to see a run-away inflation from severe forex weakness for every category of demand in the economy. But on the other hand, it also means that we don’t have visibility of the stress that might be building up and how much drawdown on reserves we might need to see. We know that if market mechanism were to work, the best way to safeguard reserves going forward, would be to allow for further adjustments in forex rates. The fact that investors haven’t seen that, isn’t necessarily a comfort to them. It is another thing that makes them more worried about the sustainability of reserves.
Do you foresee a problem of debt overhang in the light of increased borrowing by the Federal Government considering the country’s weak fiscal position?
There are two parts to that. One is the attractiveness of Nigeria’s yields to foreign investors. At current interest rate, yields are very attractive. But investors may be reluctant to come in if they think there is still a big adjustment that the exchange rate needs to do and until they see a more market driven mechanism of bringing about that forex rate, they wouldn’t know about the sustainability of these levels or not and that may be discouraging foreign investors from coming in and being able to finance the deficits the way Nigeria expects given its yields advantage.
Another thing is that Nigeria’s debt ratio and the likelihood of a debt overhang. The problem really stems from the low level of revenue collection as a percentage of Gross Domestic Product, factoring oil price or even Boko Haram, if you take the oil out. If you look at the debt commitments of Nigeria relative to the revenue that it earns, if you look at it as a percentage of the GDP ( 12 per cent), anyone can shrug it off.
But when you look at the difference between the actual stock and the flow, there is a big difference in terms of how much the Nigerian government is collecting as revenue and its ability to finance that debt. So, it isn’t yet a concern for market. I think for now the market has accepted the fact that yields in Nigeria are higher for structural reasons. It is not yet driving perception of there being an over indebtedness. The risk will come if time moves on and having rebased its GDP, Nigeria isn’t able to show the dramatic improvement in the pace of non-oil revenue mobilisation. I think that would focus investors mind much more sharply on the fact that you do have potentially a more serious problem developing.
For now, the consensus seems to be that Nigeria has room to borrow. It has room to borrow because of the domestic investor base, which is still considerably if you think of the $23bn assets under management from the local pension funds, it has room to borrow in terms of the willingness of foreign investors to potentially put more money in Nigeria and given the extent of issuance we have seen internationally, it’s got room to borrow there. What we don’t want is to see zero progress in term of the revenue mobilisation efforts, which then makes investors focus more on the amount of debt service commitments relative to the revenue coming in, which is a fairly high ratio.
Do you foresee the country borrowing from the international market before the end of this year?
I think it is possible given the willingness not to crowd out the domestic market so much with excessive domestic borrowing. We have obviously seen the passage of the budget and it is unlikely that any of the assumptions are going to change very dramatically. If we are right in thinking that oil prices will bounce back by the second half of the year that will certainly provide a certain element of reprieve in terms of acting as a buffer and there may not need be as much as borrowing as envisaged. But I think anyone looking at Nigeria’s situation would say there is likely going to be a case for external borrowing. What we don’t know yet is how open and favourable the external debt market is given what might happen at the Federal Reserve.
Still considering the country’s weak fiscal buffers, what do you think should be done to the controversial issue of fuel subsidy. Do you support its removal so as enhance the country’s fiscal position?
Absolutely, I think it should be removed. If you look at the reasons for the fuel subsidy and its economic effect, that subsidy is very regressive because it a cost on the whole economy. It takes away resources especially from the poor and rewards those who consume more fuel, which are mostly wealthy Nigerians. So, just from a perspective of having a tax regime that isn’t as regressive, there are very serious reasons to consider the modification or eradication of that subsidy. The other element to it, is how does the Nigerian economy actually benefits from it.
There is a lot of positivity and I think part of the long-term foreign account forecast we see is not just the assumption that food import would fall dramatically, but the imported fuel products, the hope is that by 2017, we would start to see some difference in terms of the amount of products that Nigeria needs to import simply because of the construction of refineries. But for that to be economically feasible, we do believe market forces need to start playing a greater role in Nigeria and that is another argument that is needed to consider getting rid of the subsidy regime which is a great distortion. But the third element as we know, is just how the subsidy has operated. In other countries, you might thinking of that as something that adjusts itself to market prices. But in Nigeria, the subsidy has been put in place as a cap.
That doesn’t make too much economic sense. It means when the country is perhaps least likely to afford it, it might be making larger and larger pay out of the subsidy. So, the economic rationale for the subsidy can be called to question. It is an incredible regressive policy intervention and I think if that would properly explain to Nigeria that it is actually rewarding wealthy Nigerians at the cost of greater service delivery to those who need it the most, greater provision of social service and I think there is an argument for rethinking the subsidy regime.
In precise terms, what do you think international investors want to see from Nigeria?
There is a mixed perception that what international investors don’t want to see is a great deal of forex weakness. For most investors, they want to know that they are making sound investment decisions and that means that the fundamentals have changed and there are pressure for a depreciation to emerge. Most investors would probably be more comfortable having seen that depreciation, than not seeing it at all, because the know that markets have the tendency to overshoot and if you try to dampen the pressure, perhaps with the willingness to run down forex reserves, the risk is that you lose that investor confidence entirely and that results to a larger adjustments in the forex rates than needs to be the case. So, I think for most investors, what would perhaps boost confidence the most is to have some elements of flexibility in the mechanism that determines the exchange rate.
Does it react to market forces? Is there an important price signal that is coming out in the determination of the exchange rate? If supply is excessive, does the exchange rate appreciate? If demand is excessive, is there an outlet to allow the exchange rate to weaken somewhat? That is what is more comforting to international investors. Barely few investors think there is a case for making free money and they don’t want to see an exchange rate that is fixed at certain level. They would rather understand the dynamics of the economy and the risk they are taking and make their investments fully informed. The problem is when you have the absence of that price mechanism in determining the exchange rate, it takes away a lot of the information content. So, what the investors don’t know is how large is the demand for forex.
Do you expect to see some changes in the country’s forex regime?
I think if things continue as they are, the naira would be very easy to forecast and would be in the N197 to N200 to a dollar range. But that, given the pressure on Nigeria’s forex reserves which we see emerging from the trade balance in Nigeria. Also, given the fact that we are going to see resurgence in investment that would see more flows coming in, there is also going to be an increase in the import requirements, I think it makes sense to assume that there would be some adjustments in the regime to allow for greater flexibility.
Punch
