Dr Sarah Alade, deputy governor, economic policy directorate, at the Central Bank of Nigeria, talks to James King about the measures the central bank is taking to boost foreign exchange, how it is mitigating Nigeria's risk from exposure to oil and why the effect of a US rate hike would be muted.

Sarah Alade

Q: Does Nigeria have an effective balance of monetary and fiscal policies in place to deal with the challenges currently facing the country's economy?

A: After experiencing an average growth rate of 7% over the past decade, gross domestic product [GDP] growth in the second quarter of 2016 stood at -2.6%. The Nigerian economy is facing a number of challenges as a result of the oil price slump. These include low government revenue, low capital inflow, a high unemployment rate, large currency depreciation and low financial buffers.

The inflation rate reached a high of 17.1% in July, eroding consumers’ real purchasing power and decreasing aggregate demand. The rising inflationary pressure is due to structural and cost-push factors, low industrial activities, high electricity tariffs, and the pass-through effects of the depreciation of the naira into inflation. The government’s fiscal balances deteriorated to -3.7% of GDP in 2015.  

To reverse this trend and restore macroeconomic stability, a number of short-term and long-term monetary and fiscal policy measures geared towards resuscitating the economy are being implemented. The fiscal policy measures have included mobilising non-oil revenue through broadening the tax base to increase the fiscal space; liberalising the fuel price regime to remove risks to public finances; and implementing policies to remove impediments to growth, such as measures to improve governance.

On the monetary policy side, measures include managing and conserving scarce foreign exchange resources, and implementing measures to increase the supply of foreign exchange. In addition, the central bank is working to restore confidence in the foreign exchange market to attract foreign direct investment and promote growth.

The tight monetary policy stance adopted by the bank is aimed at attracting foreign investment in the country and containing inflationary pressure. The persistent upsurge in inflation calls for monetary policy intervention. The increase in monetary policy rate will help to dampen inflation pressure, and also attract foreign inflows into the country to cushion the lost revenue from both lower oil prices and lower output.

This shows that there is an adequate and effective mix of both monetary and fiscal policies to deal with the emerging challenges. Nigeria’s fiscal and monetary architecture is robust enough to contain the emerging threats to monetary and fiscal stability. 

Q: Is the Central Bank of Nigeria prepared for the prospect of a US Federal Reserve rate rise?

A: Recently, the chair of the US Fed [Janet Yellen] assured markets that the data available to the Federal Open Market Committee [FOMC] suggested there were sufficient grounds to continue the monetary policy normalisation programme embarked upon in November 2015. With this guidance, markets expect that either before or by the November 2016 FOMC meeting, the Fed may raise its policy rate.

This would imply further capital outflows from Nigeria to the US. The impact is expected to be muted, thanks to central bank efforts to stem the outflow of capital and ongoing collaboration with the fiscal authorities to provide the enabling environment for the inflow of foreign direct investment.

Furthermore, the current monetary policy tightening stance adopted at the July 2016 monetary policy committee meeting was intended to evolve a positive real interest rate regime and yields to moderate the outflow of capital. The adoption of a flexible foreign exchange policy is intended to strengthen investor confidence in the foreign exchange framework to attract and retain foreign capital in the economy. 

Q: To what extent do oil and gas-related exposures constitute a risk to the stability of Nigeria’s financial system?

A: Oil and gas exposures constitute about 40% of the banks’ loan portfolio, but only about 50% of this is to the upstream sector, where the greatest risk currently resides. These loans were booked when the price of oil was $140 per barrel. Now that oil has fallen to about $40 per barrel, the obligors are finding it difficult to meet repayment obligations. Consequently, most of these facilities have been restructured.

The reduced repayments have exacerbated the foreign currency liquidity stress of the banks, as some of these loans were granted in foreign currency. However, stress tests conducted by the Central Bank of Nigeria show that if up to half of these exposures are lost, the banking system is resilient enough to absorb these losses with their exceptionally high capital ratios, which is made up mainly of loss-absorbing Tier 1 capital.

The latest IMF Article IV 2016 report admitted that Nigerian banks are 'generally well-capitalised and more resilient' today than during the period of the global financial crisis of 2008/09, which resulted in several banking failures around the world and intervention in the Nigerian banking sector.

On the macroprudential front, the Central Bank of Nigeria has implemented a number of policies to help strengthen and ensure stability in the banking system. One of the policies implemented was to increase the requirement for general provisioning on performing facilities from 1% to 2% with effect from November 11, 2015.

In addition, banks are to maintain a capital adequacy ratio of 15% for banks with international authorisation and 10% for banks with national authorisation, to ensure that they have adequate capital to support their risk exposures. The regulators have also implemented a capital conservation strategy, which includes a reduction in dividend payouts to ensure banks grow organically and maintain adequate capital buffers for the bad times.

Q: What steps is the Central Bank of Nigeria taking to support the private sector's access to capital?  

A: Access to capital is crucial to realising the growth objective of the Nigerian economy. The Central Bank of Nigeria has always been conscious of the need to support growth, and to provide an environment conducive to growth through the formulation and implementation of appropriate monetary policies and development finance initiatives. In order to address the dearth of capital to the private sector, the bank has taken a number of steps. These include strengthening financial capacity and managerial support for development finance institutions via an injection of equity or long-term loans and the provision of board or management personnel to provide technical expertise and governance support.

The central bank has also deferred the implementation of the domestic systemically important bank capital buffer of 1%, to enable banks to have sufficient headroom for lending. Other forbearances on some prudential requirements without compromising the safety of the banks were granted. In addition, a lower risk weighting in the calculation of capital requirements for small and medium-sized enterprises [SMEs] and retail lending that meet the required criteria has been permitted, to encourage lending to those sectors.  

The Central Bank of Nigeria has also encouraged and supported microfinance banks to reach the economically active poor [in the shape of ] provision of various intervention funds at low (that is, single-digit) interest rates to support agriculture, manufacturing, power, aviation and SMEs. These funds are passed through the commercial banks for on-lending to the private sector. 

Q: What would you identify as the key risks facing the Nigerian economy over the coming year? How can these be addressed?

A: The crash in oil prices, which has remained persistent in recent times, poses a downside risk to the economy. It bases its budget and fiscal operations on crude oil earnings, which constitute more than 80% of government revenue. The decline in oil prices has led to a decline in accretion to foreign reserves – with implications on the government’s ability to adequately fund its budget.

The rising inflationary situation is another key risk as import supplies usually financed by foreign exchange receipts are falling short of demand. The exchange rate depreciation and its pass-through to import prices for factor inputs and consumer goods have continued to push the inflation rate northward. The continued erosion of the purchasing power through rising prices of goods and services could have severe social consequences.

The contraction of GDP growth in the past two quarters leading to recession is another risk facing the economy as the decline in growth indices discourages private investment. The infrastructural challenge remains a key concern in getting the economy back on the growth track. Reliance on oil revenues to finance government expenditure is no longer sustainable, as oil price forecasts do not indicate the possibility of any significant recovery in the near term.

Therefore, the combined effects of output contraction and rising inflation are evident in declining business confidence and activities, continued capital outflow, the increase in the inability of firms and businesses to service their debts, and threats to banking system stability, which has largely been contained.

To address these risk factors, the infrastructural challenge must be confronted by way of deliberately directing resources at building the necessary infrastructure that would help lower the cost of production and the ease of doing business in Nigeria. In other words, policy would have to focus on growth. The benefit of this will include the attraction of foreign investment into various sectors of the economy, an increase in output and low inflation.

While earnings revenues from the export of oil and non-oil commodities remains limited as global oil and other commodity prices remain low, it would be necessary to complement the limited export receipts with borrowing for targeted infrastructural projects. This is the time to explore the model of public-private partnerships in infrastructure provision in order to allow significant flow of private sector resources into infrastructure projects. Ultimately, a diversification of the economy away from oil is imperative.


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