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Emerging Markets

NIGERIA: Crisis of confidence

Nigerian authorities should reveal the true extent of the damage to the banking system. Only then can confidence return to fuel an eventual economic recovery, says <b>Martin Oluba</b>

Nigerian authorities should reveal the true extent of the damage to the banking system. Only then can confidence return, however tentatively, to fuel an eventual economic recovery.

Nigeria is struggling to pull itself out of the slump brought on by the global economic crisis. But its predicament is also partly of its own making.

At the outset of the global crisis, the government and the central bank downplayed its likely impact: the refrain from Abuja was that Nigeria was ‘immune’ to the fallout. But the effects didn’t take long to appear: declining oil prices and weakening government revenue, a rapid drop in value of the naira, burgeoning inflation, collapsing equity markets and profound uncertainty over the health of local commercial banks hit by toxic debts.

The catastrophic drop in the price of crude oil – Nigeria’s main foreign exchange earner – from a peak of $147 per barrel to $50, wreaked havoc on government revenues. The government revised down the oil price benchmark for the 2009 fiscal year from a projected $62.5 per barrel to $45 as the basis for its revenue projections.

This coincided with a massive withdrawal of funds by foreign portfolio investors. And capital flight was made worse by a belief among many investors that bank shares, which comprise the bulk of Nigeria’s capital market, were grossly overvalued.

The combined result of these developments placed inordinate pressure on the foreign exchange market. The central bank soon found itself faced with a dilemma of intervening aggressively to save the naira or protecting its dwindling foreign exchange reserves. Given the threat reserve losses posed to the government’s fiscal programme, the central bank opted to devalue the currency by 30% within a 30-day period.

This was followed by the imposition of foreign exchange controls in January that require commercial banks to use money borrowed from the central bank, rather than inter-bank transactions, for loan disbursements. The naira/dollar exchange rate shot up from N116.00/$1.00 to N150.00/$1.00 on the official forex market. The premium on the parallel market jumped to about 63%.

The impact of foreign exchange controls has been severe on businesses as well as ordinary Nigerians, who are struggling to recover from the knock-on effects of high import and input prices. Partly as a sop to the public, the government has floated four fiscal incentives: a N70 billion textile fund, a N200 billion agriculture fund, the pegging of lending rates at 22% as well as deregulation of the downstream sector.

Bad plan

But these initiatives are flawed. First, the efficacy of the textile fund is hampered by excessive government bureaucracy. Although the fund will provide a short-term economic boost, its effect will be minimal, as many of its likely beneficiaries are still in a queue.

The conditions for accessing the agricultural fund demand that applicants must have at least N350 million in assets, excluding land. By implication, the fund does not target the majority of peasant farmers – approximately 98% – who generate about 65% of the nation’s output. This raises the question of whether the government is serious about economic stimulus: only a very few can qualify to access the facility.

Fixing interest rates has also failed to produce the desired result. Last month, the central bank announced that banks would be fined if they offer deposit rates above 15% and lending rates above 22%. The problem is the scheme penalizes banks – whose health in many cases is already doubtful – by its inflexibility: existing arrangements are not taken into account, and as a result, banks will lose interest earnings on loans prior to the new regime.

Banks are also required to adopt a common accounting end-of-year, starting December 31 this year. Fears that banks have incurred high losses from the financial crisis have put pressure on the cost of commercial funds, with a result that lending rates now exceed the imposed ceiling. This has heightened the crisis of confidence that has hit the financial sector. It has also – counterproductively – stalled the resumption of full economic activity.

Finally, the planned deregulation of the downstream petroleum sector, even if it might help reduce prices in the long run, will likely result in a short-term price rise – a development that would fly in the face of the urgent need to stimulate the economy.

No let-up

The central bank has taken a number of restrictive measures, largely because of a growing risk of insolvency in the banking sector. When the crisis hit, the central back stopped its liquidity mopping operations and moved to pump about N750 billion into the financial system. It then cut its policy rate – the benchmark for other interest rates – from 10.25% to 9.75%; reduced the cash reserve ratio from 4.0% to 2.0%; and eased the liquidity ratio from 40.0% to 30.0%.

The bank also expanded the discount window from 24 hours to 360 days and accepted as collateral many instruments that were previously off limits, in an attempt to ease liquidity conditions.

But these efforts have scarcely eased the crisis within the financial sector, given the high toxic debt levels on bank balance sheets. As a result, the central bank issued a directive for the banks to restructure margin facilities, since the inability of borrowers to pay back their loans to banks for trading purposes has exacerbated the illiquidity problem.

Even in the wake of massive central bank liquidity injections, the financial system remains illiquid.

The central bank and the federal government could do much more for the Nigerian economy by revealing the true solvency of the banking system. This would help to put aside lingering doubts that have fed a crisis of confidence which itself is killing hope of a speedy recovery.

Martin Oluba is president and CEO of ValueFronteira Ltd

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