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U.S. tightening policies, de-risking put Nigeria’s economy on red alert

By Geoff Iyatse, Assistant Business Editor
14 January 2022   |   4:30 am
A global tightening of developed economies, particularly as announced by the United States Federal Reserve System and other developed countries, has raised fresh panic about Nigeria’s investment outlook with capital flight feared to worsen in coming months if not checked.

• Policymakers of countries with high inflation, debts to brace up
• Debt refinancing, servicing cost may rise to unsustainable level, IMF, World Bank warn
• FG to fund 2022 budget N6.4 trillion deficit at higher cost 
• Direct investments won’t respond to interest hike, says Teriba   
• Nigeria’s market to expect higher interest, sources suggest

A global tightening of developed economies, particularly as announced by the United States Federal Reserve System and other developed countries, has raised fresh panic about Nigeria’s investment outlook with capital flight feared to worsen in coming months if not checked.
 
This comes as sources pointed out that Nigeria’s Monetary Policy Committee (MPC) is also contemplating a higher interest rate, as the economy is believed to have achieved modest stability while inflation continues to raise concerns.  
   
In response to the sticky U.S. inflation rate, which hit seven per cent yesterday, the highest since 1982, an inflation-weary Fed disclosed that it would increase the interest rate, at least three times in the year, but some Wall Street banks, including Goldman Sachs, see the Fed increasing the rate four times.

This has sent jitters across markets with high-risk assets. For instance, cryptocurrency losing in the first week of January for the first time since 2018, with bitcoin losing over 40 per cent from its all-time high.
   
But interest hike is just a part of the U.S. impending tightening. The Fed is also working towards unwinding its huge stimulus programme in March as it battles to firm up the value of the dollar and keep inflation at a manageable level. This tightening could trigger a massive outflow of assets from extremely risky markets, including Nigeria.
 
The interest rate hike will make the international debt market more expensive and servicing of existing dollar-denominated debts more challenging for political and corporate entities with huge exposures, economists have warned.

   
Nigeria’s external debt component was N15.6 trillion, 41 per cent of its total N28 trillion national debt stock. Of the N17.1 trillion total spending plan in the 2022 budget, over N6.39 trillion shortfall is expected to be funded with fresh debt and proceeds from the sale of public assets.
 
According to the document presented by the Minister of Finance, Budget and National Planning, Zainab Ahmed, the Federal Government proposed to source N2.57 trillion from the international market and another N1.16 trillion from multilateral and bilateral loan drawdowns to finance the fiscal deficit. Experts say the international debt market would be more expensive this year.    
  
This was corroborated by the World Bank, in its January Global Economic Prospects, just released. The Washington-based institution warned of impending rise in financial stress in emerging markets and developing economy (EMDE) regions as tightened monetary measures could drive up debt refinancing and servicing costs to unsustainable levels and trigger capital outflows. 
 
Amid rising de-risking across markets, the International Monetary Fund (IMF), on Monday, also called on policymakers across the globe to prepare for spillovers from the U.S. liquidity tightening, which it warned could hit vulnerable countries hard.
   
In a blog post, the IMF noted that the tightening could make “the outlook for emerging markets more uncertain” as the countries battle “elevated inflation and substantially higher public debt.”
   
A regression analysis, covering 2020 to 2021, conducted and reported by IMF in the post, supported that capital flows to emerging markets would weaken as the dollar appreciates relative to other major currencies.
   
“The impact of Fed tightening could be more severe for vulnerable countries. In recent months, emerging markets with high public and private debt, foreign exchange exposures, and lower current-account balances saw already larger movements of their currencies relative to the U.S. dollar.

“The combination of slower growth and elevated vulnerabilities could create adverse feedback loops for such economies, as the IMF highlighted in its October releases of the World Economic Outlook and Global Financial Stability Report,” it stated.
   
It listed possible financial system crises as a spillover of the U.S. tightening, urging national economic policymakers to consider plans to preserve financial stability. It stressed that “countries, where corporate debt and bad loans were high even before the pandemic, as well as some weaker banks and nonbank lenders, may face solvency concerns if financing becomes difficult.”

NIGERIA’S inflation was last estimated at 15.4 per cent, making it among the top countries with the most disturbing inflation growth. With the market interest rate currently lagging, real rates of return are in the negative region, making capital flight a major challenge.
   
Reacting to the alarm raised by IMF, Victor Ogiemwonyi, a retired investment banker, said: “The expected tightening will affect Nigeria and most of Africa, the low cost of capital in the U.S. has incentivised flows/investments into emerging markets, like Nigeria. This investment flow will now be very slow.”
 
According to the economist, the situation would complicate Nigeria’s “borrowing plan” as sources for funding the current budget will be more expensive and debt service, which is already a problem, will become even more problematic.
   
“Those banks with foreign loan exposure will also find servicing of the loans to be more expensive. The severity of its effect on Nigeria will depend on how well we are able to respond.

“First, we must do everything to push our oil production up. The budget projects oil production at over two million barrels a day (mbd). We are currently doing only 1.8 mbd; that in itself is already a problem. We must pump at least 2.5mbd and also hope oil prices will remain high in the $70 range. Higher oil production and high prices will raise our revenues and ease our FX scarcity. These are just efforts for raising revenues,” he said.
 
On the expenditure side, he said, aggressive efforts must be made to address waste and block leakages.

According to him, a measurable target could be reducing the cost of governance by 30 per cent in the short term. How the government addresses fuel subsidy and management of foreign exchange market, he said, would determine the country’s ability to weather the storm.

   
Ogiemwonyi, a former member of the Council of the then Nigerian Stock Exchange (NSE), said the stock market would be a major casualty of the U.S. planned interest rate hike by Fed. He envisages the remaining foreign investors would take their “cheat money” to dollar-denominated assets abroad.
 
A trade expert and consultant to the Economic Community of West African States (ECOWAS), Prof. Ken Ife, also agreed that the impact of the “inevitable rise in U.S. Monetary Policy Rate (MPR)” would reverberate around the world in different ways.
   
“Nigeria’s economy is exposed in many ways. Portfolio and other investments will head out as it has done substantially already. FDI has been weak; our exposure to dollar-denominated loans means we could see an increase in debt service and much tighter-lending conditions/concessionary rates.
   
“Nigeria is already implementing unpopular measures such as devaluation, aggressive tax revenue drive to rise from seven per cent to 15 per cent of GDP by 2025, backed by the Finance Act 2021. The fiscal authorities have already passed the Petroleum Industry Act (PIA) to pave the way to phase down petroleum subsidy and deregulate PMS,” Ife said.
   
Another investment advisor and economist, Olarenwaju Abimbola, said Nigerians will have outflows of foreign portfolio investors in the coming months as the local market does not currently provide sufficient incentives to counter the increasingly attractive U.S. and other market rates.
   
As argued by Abimbola, Nigeria’s equity market is increasingly unattractive. For instance, for the first time in decades, investments in the capital market will be subjected to capital gain tax of 10 per cent, in addition to the existing 10 per cent withholding tax on dividends.  
   
The new tax introduced by the Finance Act 2021 is applicable on the disposal of shares worth N100 million and above held in any Nigerian company registered under the Companies and Allied Matters Act (CAMA), except the proceeds are reinvested within a stipulated period.
   
Abimbola said it was unfortunate the additional tax “is introduced at a time other countries are creating fiscal incentives to attract new investments. It would now hurt Nigeria more with prospects for more capital gains elsewhere.”

The new tax coupled with the fresh worry over U.S. tapering comes as the Securities and Exchange Commission (SEC) moves to review the 10-year Capital Market Masterplan to attract more investment into the capital market.
   
Foreign stakes in the capital market have been anaemic, reflecting the definition of foreign portfolio investment (FPI) as fair-weather capital. It grows when the market is attractive and flees during uncertainty. There have been fears that many of the foreign investors in the Nigerian capital market could exit as the election year approaches.
 
But Chief Executive Officer of Economic Associates (EA), Ayo Teriba, insisted, yesterday, that no serious economy builds its economy on FPI as opposed to foreign direct investment (FDI). He said the U.S. interest rate hike could affect FPI but not FDI, which is needed to build a sustainable economy.
 


“Portfolio flows are volatile, and no serious country will do this for growth. FDI is not influenced by interest rate but medium- to long-term investment opportunities. It does not matter what happens to the interest rate, those who are committed to LNG will stay. If they were not committed before, they will still go ahead and be committed despite the direction of interest rate.
 
“Their returns are not based on the interest rate but the profits, which they will unlock with their investment. The returns are far higher than what anybody could get from portfolio investments. Serious economies are not interested in attracting portfolio investors that will come and leave next month.

“If you offer an opportunity to enter a new market, FDI will come. That should be our concern; we should liberalise the key sectors and ignore any alarm over portfolio investments. PFIs will come when you don’t need them but leave before you realise,” Teriba told The Guardian.
   
He also argued that the world does not catch cold each time the U.S. sneezes, as its economy has reduced in relative terms, adding that happenings in other markets like China, Japan and Europe could counter the impacts of the U.S. new monetary policy direction.
 
A partner at PwC, Taiwo Oyedele, said the quantitative tightening in the U.S. and other developed countries will pose a challenge to emerging markets as capital flight intensifies.
 
“However, I expect the impact on Nigeria to be minimal given the low level of existing foreign portfolio investment in Nigeria both in the capital and money market. Perhaps, the impact would be more on the secondary market for securities such as FBN Eurobond resulting in higher yield and lower bond prices.
 
“The proactive measure for Nigeria should be how to de-risk the business environment to attract long term foreign investment through policy reforms. Despite the tightening, there is still record liquidity in many matured markets looking for acceptable risk-adjusted returns. This is what Nigeria and other African countries need to focus on,” Oyedele, a tax expert and policy analyst, said.

  
David Adonri, an investment consultant, said the tightening measures of advanced economies could compound the inflation rate and worsen the FX outlook as “financial assets will rather migrate to advanced economies.”

While accessing fresh facilities could be more difficult, he said, the spillover could make it difficult for Nigeria to honour existing obligations. He added that the increasing uncertainty called for “refrain from taking more loans.”  
   
Nigeria’s policy rate, the floor of commercial interest rates, has remained at 11.5 per cent. At its previous meetings, the Monetary Policy Committee (MPR) admitted the dilemma of raising MPR in response to inflation concerns or reducing it to make a gradual recovery.
   
Yesterday, The Guardian learnt MPC could consider monetary tightening in its next meeting. Sources said “with the economy showing sufficient resilience as confirmed by growth data in the second and third quarter of last year coupled with the persistent inflationary pressure”, raising interest rate this year is certain.  
   
Ife, who was quoted earlier, also suggested the Central Bank of Nigeria (CBN) is “quietly signalling the intention to tighten policy from 2022 to rein in runaway inflation and ensure greater price stability”. This, he said, could do more “to hedge our exposure to foreign currencies.
   
“Obviously the worsening balance of payment deficit and the embarrassing trade deficit of over N3 trillion (with China dumping N2.44 trillion export on Nigeria) means that both may be in the line of sight of further tighter forex currency demand management.”