Halting the decline in external reserves - BUSINESSDAY
by UCHE UWALEKE
Due largely to effective foreign exchange management policies introduced by the Central Bank of Nigeria notably the Investors and Exporters window helped by recovery in crude oil price and output, some degree of stability has returned to the forex market. But this stability is now under threat. Reflecting the impact of exogenous shocks, driven largely by monetary developments in the United States in particular, the near-term outlook for the currency market in Nigeria appears grim in the wake of dwindling external reserves. A broad retreat by foreign investors from Nigeria on the back of interest rates hike in the United States is largely to blame. Indeed Nigeria has good company in other emerging economies. As reported by Reuters, foreign exchange reserves held by the Reserve Bank of India, the State Bank of Pakistan and Bank Indonesia have recently come under pressure following massive capital outflows. According to the JakartaGlobe, Indonesia’s foreign exchange reserves dropped by about USD3.1 billion in September alone due in part to currency market interventions by the Central Bank of Indonesia.
Back home, while the US monetary policy normalization represents one major reason for foreign investors’ exit alongside concerns over potential fallout from an escalating trade war between the United States and China, another trigger has been the heightening political uncertainty. Besides these, other factors that could be putting a strain on the country’s external reserves include the increasing cost of servicing growing external debts, high import bills despite government measures and the high dollar preference over the naira by politicians which came to the fore during the just concluded political parties’ primary elections.
The fast depletion of the country’s external reserves of late provides disturbing evidence that foreign investors’ concerns about Nigeria show no sign of abetting. Political uncertainty is driving up perceived economic risk which in turn is drying up capital inflows. The country’s foreign reserves, which witnessed a remarkable surge in 2018 on the heels of improved oil prices and hitting USD47.8 billion in June is now a little shy of USD42 billion according to figures from the Central Bank of Nigeria.
Like every other country, Nigeria needs strong foreign reserves to meet international payment obligations timely, boost the country’s credit worthiness, provide a buffer against external shocks as well as maintain a stable exchange rate. Of all these, safeguarding the value of the naira is the overarching objective. According to data obtained from the CBN website, Nigeria’s external reserves comprise three components namely, the federation, the federal government and the Central Bank of Nigeria portions. The federation component consists of sterilized funds (unmonetized) held in the excess crude and Petroleum Profit Tax/Royalty accounts at the CBN belonging to the three tiers of government. The Federal Government component consists of funds belonging to some government agencies such as the NNPC,PHCN and Ministry of Defence for Letters of Credit opened on their behalf among others while the considerable CBN portion consists of funds that have been monetized and shared from which the Bank conducts its monetary policy and defends the value of the naira.
While the latest onslaught on foreign reserves may be due partly to influences beyond the control of the CBN, it should remain committed to ensuring stability in the forex market through adequate liquidity. With inflation rate once again on an upward trajectory, abandoning intervention in the forex market in a bid to conserve external reserves will be detrimental to its primary mandate of maintaining monetary and price stability.
It bears repeating that the solution to halting the declining external reserves does not lie in suspending the interventions which is tantamount to floating the naira neither does it lie in hiking the monetary policy rate in the hope that it could potentially stem the capital flow reversals. With the meeting of the Monetary Policy Committee some days away, it is most likely that not a few members will argue for a rate hike to arrest the current haemorrhage in external reserves. Be it known however that policy rate hikes did little to reverse the downward trend in the international reserves held by many emerging economies. As a policy response, it was not effective in India. As a matter of fact, Bloomberg reported that India was not alone in raising rates in Asia. Philippines and Indonesia tightened monetary policy as they sought to support their currencies. According to Reuters, the central bank of Indonesia (Bank Indonesia) has increased interest rates five times since May 2018 by a total of 150 basis points to maintain the attractiveness of Indonesian assets for foreign investors with little success.
In order to halt the declining external reserves therefore, the CBN should continue to sustain its demand side management measures including the policy on 41 items. Perhaps more than ever before, complementary fiscal policies are required. The government may consider the use of protectionism, the new weapon in town, to curtail imports. The short term solutions should also include getting wealthy non-resident Nigerians to play a role in ramping up foreign reserves. Instead of Eurobond sales, the government should issue more of diaspora bonds, as it did in the past, provided the proceeds are tied to viable infrastructural projects. By and large, a sustainable approach to foreign reserve accretion remains the pursuit of what has become a no-brainer, the diversification of the export base of the economy to create multiple streams of forex. The government should leverage the current high price of crude oil and implement decisive policies aimed at building international reserves to support the resilience of the external sector.
Uwaleke is Nigeria’s first Professor of Capital Market and the Chair of Banking and Finance Department at the Nasarawa State University Keffi