By Lukman Otunuga
is FXTM Senior Research Analyst.
In January, the Central Bank of Nigeria (CBN) decided to hold the lending interest rate at 13.5 percent and significantly increase the Cash Reserve Ratio (CRR) from 22.5 percent to 27.5 percent. Far from following the global easing trend, the CBN is taking steps to tighten monetary policy.
The decision follows a worrying rise in inflation in December. Inflation rose to 11.98 percent, meaning that day-to-day living is becoming more expensive as prices for goods and services rise.
Part of the added inflationary pressures are because of border closures and food shortage fears.
On a long-term basis, the Naira’s softness feeds into the dam of rising inflation.
Despite the threat of higher inflation, the CBN has ruled out devaluing the Naira. Policy makers could have a point here. An even weaker local currency may trigger worse consequences. The overflowing dam could break and hyperinflation – a nightmare scenario for any emerging economy – could flood the economy.
The central bank’s reasoning for avoiding an official devaluation is that it holds ample foreign reserves to back the Naira’s value. Policy makers are also banking on rising Oil prices to shore up the $38.6 billion in foreign reserves, at the time of writing. The CBN brushed off the steep drop in foreign reserves from $42 billion to $38 billion in the last months of 2019, pointing out that fluctuations are normal.
Unpredictable CBN policy may impact banking sector
Less liquidity in the market might alleviate rising inflation but on the other hand, it could add to everyday economic pressures. A combination of high interest rates and less liquidity could squeeze corporate budgets, possibly leading to job losses and lower investment in development, not to mention increasing the chances of debt defaults. This may impact the stability of the banking sector in the medium-to-long term.
Fiscal deficit projected to widen
On the monetary policy side, higher Oil prices are pulling in more foreign reserves. But as Oil prices rise, so do fuel subsidies paid by the state, creating a precarious fiscal situation. Nigeria is now set to borrow N1.59 trillion to fund the 2020 budget and the government has increased VAT to 7.5 percent from five percent to boost tax revenues.
External threats pose significant risks to Nigeria’s recovery
Other pressures bearing down on Nigeria’s economy stem from the US-China trade war which is frozen at the moment but could heat up at any time.
The central trading issues for Nigeria in this situation are China’s economic health – China and Nigeria are strong trading partners – and the health of the global economy. If the global economy slows down further, demand for Oil would likely weaken and prices could experience more softness in the near term.
The economic costs of the coronavirus outbreak to Nigeria’s economy must not be overlooked. China is Nigeria’s largest trading partner with total trade hitting $3.25 billion during the third quarter of 2019. If the virus outbreak in China results in slower economic growth, the spillover effect is likely to be felt in Nigeria as trade falls.
The other major international shift is the Brexit process. The UK’s withdrawal plan from the EU has been approved by European and UK-based legislatures. Although the UK officially leaves the EU on January 31, over the next year trade agreements will stay as they are. After that, there is considerable uncertainty over the status of trade deals agreed with the UK through the EU.
As a start, the UK-Africa Investment Summit promises a way forward for future trade deals direct with UK partners. Four British companies signed deals with Nigeria for street lighting, airport control towers and smart metering. The question is whether this momentum can be maintained now that the UK has so many trade deals to put in place with the EU, US and China. On top of that, Nigeria’s trade relations with the UK are now separate from those with the EU, meaning that the UK’s negotiating power and economies of scale are considerably reduced.
In conclusion, Nigeria’s fiscal and monetary policy makers face a difficult economic landscape. The mountain of uncertainty around the US-China trade disputes; the quicksand of the Brexit process; economics impacts of the coronavirus and the rising tide of inflation.
Could the next step be for the CBN to raise interest rates? Amid the current uncertainty, nothing can be ruled out but the impact of stiffer borrowing rates would likely pressure economic growth. With GDP on a growth trajectory, this would add to Nigeria’s economic headwinds.
