The recent decision by the US Federal Reserve Bank (Fed) to hike interest rate for the first time in almost a decade is triggering serious concerns around the world and poised to further pressure the Central Bank of Nigeria (CBN) to devalue the Naira.
The move is expected to lead to a reversal of the flow of cheap money, which had found home in emerging markets in search of higher returns. With over $500 billion already withdrawn from emerging markets in 2015, the expected adverse capital flow portends a bleak 2016 for many African Countries, who would be left to contend with the impact of the imminent capital flight.
In his article; “US rate rise: Why it matters”, BBC Business Reporter; Ben Morris posits; “For almost a decade money has been cheap – some would argue too cheap. But today’s rise in US interest rates could be the beginning of a new era, one in which the cost of borrowing rises – possibly for years.”
That reality brings fear to many African governments burdened with huge dollar debts and a minimized capability to service them. The development is rather worrisome as the cost of borrowing will rise as interest rate increase.
However, beyond the capital outflow from emerging economies, the other key impact is that the move will see the dollar strengthen against most currencies. For a country like Nigeria, who depends on commodities export for a high proportion of their government revenues, this is bad news. The sustained low price of oil is already hindering the national budget as the government is unable to meet recurrent expenditure needs due to the dwindling revenues. It is also expected that commodity prices which had fallen drastically in the past year with the slump in demands from china, would drop further with the strengthening of the dollar, considering that commodities are traded in dollars.
The US Fed might have inadvertently pulled the rugs off the feet of the Nigerian economic managers by this singular decision to raise interest rate by 0.25 per cent. Having stuck to the inexplicable decision to continue propping up the Naira throughout 2015, when there were clear indications that devaluation was inevitable to ease the barrage on the currency, that stoic stance now seems highly unsustainable. The local economy after all, is not as insulated from global events as they would have us believe.
With the CBN still unable to satisfy the demand for foreign exchange, the strengthening of the dollar will put even further strain on the economy as many genuine users of foreign exchange whose commercial activities are being hampered, would be willing to buy at any rate to avoid a disruption of their operations. At some point, necessarily, the Country’s dwindling reserves would be unable to cushion the shocks, leaving the CBN with little option but to devalue the Naira.
The Naira traded at a new low of 280 Naira to the dollar in the parallel market within the week and the continued intervention by the CBN at 196-198 Naira to the dollar to a privileged few would not just be ridiculous but irresponsible. The CBN intervention window has been shut for the year and it is critical that the CBN reassesses its foreign exchange policy when the interbank market reopens in January 2016.
Photo Credit: www.thisdaylive.com
As usual, very enlightening
Thanks Ekele. The dwindling revenues means this isn’t the time for an expansionist budget considering the growing cost of borrowing.
Thanks for the write up. Going by this analysis, Naira / dollar exchange rate may remain above 270 in the short to medium term! What impact will it have on inflation? My knowledge here is elementary.
Thanks Ogba. Increased inflation is inevitable in Nigeria in the long run considering Our reliance and penchant for imported goods. Devaluation will mean more Naira to import items and that will definitely reflect on prices of goods. Coupled with moves to increase electricity tariffs and reported increase in pump price of pms, we should expect increased inflation.
Interesting facts. I Was shocked the see that Pounds was buying and selling at N390 and N380 respectively…..I hope our policy makers will do the needful.
Thanks Sam. I am certain that there will be policy reactions to the development.
@Kene, Well put together.
However, in my view the problem we have on hand is more of a liquidity issue than a currency valuation issue. Even if you make the exchange rate $/N300, you can’t be sure that CBN will meet demand because we are simply not earning enough dollars. Then there’s the moral dilemma of the demand overhang which has been there for the better part of one year. Devalue without clearing that out and you are definitely cutting through the life of many a business.
My friends tell me that devaluation will make us attract more dollars. I argue that it is less likely because the external environment is correcting ( with the fed rate hike as an example) and thus investors’ models are likely to tell them that risk weighted return on Nigeria is less than risk weighted return on US because almost for every improvement in the external environment, our own environment worsens.
There are no quick fixes. This is when to bite the bullet and hopefully deploy the clarity of thought conferred by these hard times to restructure this economy. One thing is sure, no matter the policy option we take, it will get worse before it gets better.
Thanks Ileka. Your submission is quite enlightening. I agree that we need to face the reality of the times and not go on as if we are insulated from the global economy. We are facing the repercussions of our dependence on oil and unfortunately the external environment will force the hand of our economic managers in spite of their good intentions in resisting devaluation thus far. The Fed’s decision just worsened our case with the country’s reputation seriously dented by the defaults by Nigerian banks in meeting their obligations as a result of the squeeze.
Thanks sir for this eye opening piece, it’s high time our leaders create a process that can actually support our non-oil export sector, sadly as a nation can we truly operate without depending on importation? How do we carry on with this? This is going to affect household incomes especially with attendant inflation currently being experienced. ….