Bold Economic Reform in Nigeria

Recent liberalization of fuel marketing and a proposed flexible exchange rate will do much to attract new foreign investment to fund an expansionary budget and mitigate risk of a state-level banking crisis.

On 24 May, Governor of the Central Bank of Nigeria (CBN) Godwin Emefiele announced that the CBN’s monetary policy committee had voted unanimously to adopt a more flexible foreign exchange regime. The naira currency’s 15-month peg to the dollar has overvalued the Nigerian currency, resulted in an economic contraction, and harmed investments. Emefiele explained that the CBN would retain the USD1=NGN197 rate for a small number of ‘essential transactions’, while other foreign exchange transactions by the CBN would be at a new unspecified rate. Local sources report that the new rate could be around USD1=NGN285, which would still be lower than the current parallel market rate for a dollar. At a meeting on 2 June between CBN officials and local currency traders of the Financial Market Dealers Association, no further details were provided by the CBN on the implementation of plans to abandon the naira peg and adopt a flexible currency.

Well-placed EXX Africa sources in Lagos believe that the proposed flexible exchange rate mechanism could still be reversed as the CBN fails to deliver a clear timeline for the devaluation. Instead, the CBN is more likely to come under political pressure to manipulate the current illiquid managed fixed peg regime and to reduce the discrepancy between the official currency rate and the black market currency rate which is over 40% and growing. As a result of the ongoing uncertainty the stock market posted a 16-month low in the first week of June.

Meanwhile, in May, the government hiked petrol prices by 67% to 145 naira, ending a burdensome state-subsidy scheme. As a key indication for the flexible exchange rate mechanism, it used a rate of 285 naira to the dollar to set the prices, compared with an official rate of 197 naira. The price increase added to fuel importers’ margins and will allow shipments of fuel to resume. Deputy Oil Minister Emmanuel Kachikwu has indicated that the new fuel price would be a base rate and that fuel retailers could charge any market price.

Risk implications: The liberalisation of the fuel marketing sector and the proposed introduction of a flexible exchange rate are both aimed at soothing foreign investor concerns and to attract new fundraising to finance a record budget deficit widened by a fall in oil revenues. Finance Minister Kemi Adeosun is due to meet investors over the next week ahead of a planned eurobond sale later in 2016. The government plans to raise USD10 billion of new debt of which USD5 billion would come from foreign investors. The move to abandon the 15-month naira peg to the dollar and to adopt a flexible currency regime was specifically designed to boost exports and local manufacturing and to stave off a recession, which will be crucial arguments to persuade foreign investors to fund another bond sale.

Moreover, the twin policy decisions will mitigate risk of state bankruptcies and a banking sector crisis. In 2015, the federal government orchestrated a USD2.1 billion bail-out of the states and assisted in restructuring their local bank debt. This bailout avoided the risk of a banking collapse resulting from debt service defaults by the states, even though the IMF criticized the government for not imposing structural reform conditions to the bailout. Finance Minister Kemi Adeosun plans to provide further funds to the states under the USD30 billion expansionary budget, which will further avoid a banking sector collapse as distressed states regain the ability to service their debts. Crucially also, the state governments will become increasingly important over the next few years as President Buhari’s governing All Progressives Congress begins to fracture and state governors begin to drift away from Buhari’s control.

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Robert Besseling is the founder and executive director of EXX AFRICA, a specialist intelligence company that reports on African political and economic risk to businesses. He holds an MA (Hons.) in History from the University of St. Andrews in Scotland. He also has an MBA and a PhD in African political and economic history.

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