Nigeria needs buffers to avert financial sector crisis

By Moses Obajemu

Unless there are buffers in place in Nigeria, the recent dovish policies of some central banks, including the Central Bank of Nigeria (CBN), which have created huge pool of low cost loanable funds in the global market and in Nigeria by extension, may damage Nigeria’s financial market if the current trade tensions between the US and China subside and the economic growth in the two countries returns to an upward trend.

The dovish policies aimed at stimulating the economy have enthroned a somewhat low interest rate regime which has crashed interest paid by the Nigerian government on the risk-free, fixed income securities.

Analysts warned that if the economic outlook of these two economic powers and of Europe, and Japan improves, the low interest rate may change and there may be capital flight from Nigeria.

“This could damage the Nigerian economy and financial market unless there are buffers in place to counter the negative implications that may follow,” analysts at FSDH Research said in a report titled, “Easy Money: Time to Create Buffers”. 

They said the low yield on fixed income securities is already impacting on the total foreign portfolio investment (FPI) through the Investors’ and Exporters’ Foreign Exchange window (I&E FX window).

“Between January and July 2019, Nigeria recorded the lowest FPI through the I&E forex window in July, both in absolute number and as a ratio to the total,” they said.

FSDH Research notes that though FPIs may be seen as “hot money”, it however advocates for it because FPI does help in a way to increase the stock of foreign exchange in the country, adding that this would help to increase foreign exchange stability and curtail inflationary pressure arising from cost-push effects.

Many central banks in both advanced and developing countries are adopting an expansionary monetary policy stance in order to stimulate economic growth.

The monetary policy strategies differ in each country. The Federal Open Market Committee (FOMC) of the US Federal Reserve System cut the interest rate in July 2019, the first since 2008.  The Bank of Japan maintains a negative policy rate (the anchor interest rate). The European Central Bank (ECB) maintains the interest rate at zero.

Also, the Bank of England (BoE) maintains the interest rate at 0.75%, which is considered low compared with the historical average of 3.89% between 2006 and 2009 The South African Reserve Bank lowered its interest rate in July 2019. The Central Bank of Nigeria (CBN) also lowered its interest rate in March 2019 and has indicated its preference for a low interest rate, causing yields on fixed income securities to drop.

According to FSDH Research, These strategies have created easy money (low cost of fund) in the global market and by extension, Nigeria. The company warned, however, if conditions in the United States and China improve, there may not be a need for excessive expansionary monetary policy.

Speaking about the opportunities inherent in the present order of cheap funds, the analysts said individuals, companies and governments can now borrow money from local and foreign financial markets cheaper than in the last few months.

They also disclosed that many banks and other credit providers in Nigeria have recently begun aggressively pushing credit to their customers, while some companies are also refinancing their existing debt obligations at lower interest rates.

“Companies may wish to issue debt capital at this moment to expand business operations and create additional lines of business that can generate improved earnings for them. In doing this, it may be important to provide forex hedging mechanisms for foreign loans.

“When the financial market becomes tight again with rising interest rates, companies may then modify their capital structure in favour of equity capital and hopefully their earnings would have grown in order to eliminate the dilutive effect of increased equity capital of return on equity”, they advised.

They advised the federal government to take advantage of the current low interest rate to access long-term debt and channel it specific projects towards building the capacity of the economy to generate more revenue.

“Investment in infrastructure, security, education, healthcare and other forms of a social safety net would improve the productivity of the country and provide an opportunity for government to increase future tax revenue. This strategy should increase the stock of foreign exchange in the country and may reduce the inflation rate”, they said.

The analysts said the current low interest rate should not be seen as an opportunity for individuals, companies and governments to increase deadweight debt, but as an opportunity to access long-term funds that can be used to improve the wellbeing of the economy in order to generate increased revenue for all the economic agents.

It would be recalled that central banks in the US, UK, India, and South Africa increased their interest rates last year, following prospects of a stronger global economic outlook. Developments in the US and China affect the global economy as the two countries account for about 40% of the global economy in terms of Gross Domestic Product (GDP).

The US, the Euro Area, China, Japan, the UK and India collectively account for about 69% of the global economy. Therefore, economic and financial market signals in these  regions will have a direct impact on global economy and financial market.