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Business News of Wednesday, 11 January 2023


Riding the waves of naira volatility, debt services

Godwin Emefiele, Governor of Central Bank Nigeria Godwin Emefiele, Governor of Central Bank Nigeria

Analysts predict a turbulent year for the naira as investors grapple with election fears and the impact of dollar loans on domestic economy. Assistant Business Editor COLLINS NWEZE reports.

The naira will have a turbulent outing this year due to election-induced pressure and persistent scarcity of dollar.

After a year in which Nigeria’s post-COVID-19 economic recovery was derailed by the combined effects of surging inflation, geo-political instability, adverse weather and a looming risk of debt distress, negative impact for the naira looks set to continue into 2023.

Higher global fuel and food prices driving record inflation are a particular strain on government finances and consumer spending in the country, where for the majority of people, food accounts for over 40 per cent of spending.

International capital exiting speculative assets, which caused depreciation of the naira in 2022, shows little sign for now of a reversal.

The Naira opened the year broadly unchanged at N750/$ from N748/$ in the final week of 2022.

FX Trader, AZA Finance, Ikenga Kalu, said the naira lost almost a third of its value on the parallel market last year as Nigeria’s ability to benefit from higher commodity prices was challenged by an extended shutdown of its oil production facilities and crude pipeline vandalism and theft.

With FX reserves steadily depleting during 2022, the Central Bank of Nigeria (CBN) has halted dollar sales in the parallel market, further reducing supply and contributing to the Naira’s weakness.

“Given unwaning demand for dollars and reduced capacity for interventions in the parallel and official markets, we expect further currency depreciation over the next 12 months, with February’s presidential election pivotal in determining the pace of decline,” he said.

With naira depreciation come rise in debt service costs.

The World Bank predicted that steep depreciation of the naira would continue to worsen Nigeria’s debt, a large part of which is denominated in dollars.

World Bank President, David Malpass, said poorest countries eligible to borrow from the World Bank’s International Development Association (IDA) will spend over a tenth of their export revenues to service their long-term public and publicly guaranteed external debt.

The figure, it stated, is the highest proportion since 2000, shortly after the Heavily Indebted Poor Countries (HIPC) initiative was established, the World Bank’s new International Debt Report shows.

The report highlights rising debt-related risks for all developing economies—low- as well as middle-income economies. At the end of 2021, the external debt of these economies totaled $9 trillion, more than double the amount a decade ago.

“The debt crisis facing developing countries has intensified,” World Bank Group President David Malpass said. “A comprehensive approach is needed to reduce debt, increase transparency, and facilitate swifter restructuring—so countries can focus on spending that supports growth and reduces poverty. Without it, many countries and their governments face a fiscal crisis and political instability, with millions of people falling into poverty,” he added.

On the surface, debt indicators seem to have improved in 2021, the report shows. As economic growth resumed following the global recession in 2020, public and publicly guaranteed external debt as a share of GNI returned to pre-pandemic proportions. However, this was not the case for IDA countries, where the debt- to-GNI ratio remained above the pre-pandemic level at 25 per cent.

Equally, the dollarisation of the economy is expected to persist in 2023.

The International Monetary Fund (IMF) cautioned economic managers on the dangers of dollarising the economy, saying it could be difficult to reverse.

As a partially dollarised economy, Nigeria operates with dollar bias for international trade, finance invoicing and of recent, store of value.

The IMF said once a country gets used to a bi-monetary system, the process is not easy to reverse, even when the initial trigger such as high inflation, exchange rate volatility, subsides, are addressed.

In a report entitled: “Digital Money and Central Banks Balance Sheet”, the IMF said most economies operate with a foreign exchange (FX) (the dollar) bias for international trade and finance invoicing.

“The optimal choice between domestic currency versus dollars will depend on the monetary framework and the benefits that each may offer as they co-exist as two currencies,” it said.

The IMF explained that in a highly dollarised economy, there is extended use of the exchange rate for price indexation (high real dollarisation and almost complete pass-through from depreciation to inflation). Forex is also used in foreign trade.

“There is limited scope for fiat currency (tax payments, public expenditure, non- durable goods, and low-value transactions). Extended forex use for durable goods, real estate, capital goods, and high- value transactions. Also, forex takes over the role of store of value as lending capacity in domestic currency becomes limited. Most loans become forex- denominated when forex bank deposits are allowed,” it stated.

The IMF said a bi-monetary system limits the role of the exchange rate as a shock absorber, as real dollarisation implies a high pass-through from exchange rate depreciation to inflation.

“Financial dollarlisation creates currency mismatches and liquidity risks for the financial system and the economy as a whole. Therefore, the exchange rate amplifies negative external shocks rather than absorbing them”.

“Both financial dollarisation and real dollarisation jeopardise monetary transmission mechanisms, as inflation expectations are difficult to anchor with a weak interest rate channel. Financial dollarisation-related financial instability would need to be addressed via policy responses such as a central bank forex reserve buildup and associated regulation,” it said.

Speaking further, Managing Director, Financial Derivatives Company Limited, Bismarck Rewane said: “What will be the impact on the value of the Naira in the forex market? Theoretically, it should have no effect whatsoever.”

“But forex markets are usually a subject of panic and speculation. The first reaction to the new regulations is likely to be a flight to safety by investors, for example, anytime there is a major global market shakeout, investors scramble for gold and dump the U.S. dollar. So, we expect some initial speculation against the Naira but this should be short-lived.”

“Nigeria last changed its currency notes fully in 1984. It was done in a period of 21 days, the land borders were fully closed and inbound flights into the country were scrutinized”.

Rewane said many political pundits could read meanings into what should ordinarily be a purely economic policy issue if the new notes are counterfeited by political saboteurs, it could easily destabilize the country.