Nigeria was fortunate in the first half of this decade. Gross domestic product increased from $412bn in 2011 to $568bn in 2015 and GDP per capita more than doubled from about $1,500 to $3,100. This is made all the more impressive by the fact that the population increased by about 10 per cent in the same period.
However, this was more a function of good fortune than of dextrous macroeconomic management. Now, fortune has changed and it is hard to see how the current monetary policy effectively serves the national interest. GDP is falling, at an annualised rate of -0.6 per cent in the first quarter of 2016, -2.06 per cent in the second and -2.24 per cent in the third. Nigeria’s recession is deepening.
This situation is exacerbated by a policy of three exchange rates – official, sector-specific and market – that opens opportunities for arbitrage and adverse systemic effects. In June, after a year of pegging the naira at 199 to the US dollar, the Central Bank of Nigeria (CBN) finally realised that it did not have sufficient reserves to defend the currency, and partially floated it. As expected, it depreciated significantly – the parallel market rate was already about 300 to the dollar. Since then the difference between the new official rate of 315 to the dollar and the parallel market rate has widened, with the latter now at about 490 to the dollar.
Interest rate policy has also been inconsistent. In the third quarter of 2014, the CBN’s monetary policy committee (MPC) interest rate was increased to 13 per cent and stayed there until November 2015, when it was cut to 11 per cent. In March this year the rate was raised to 12 per cent and then in July it was raised again to its current level of 14 per cent. Between May 2015 and September 2016, inflation almost doubled from 9 per cent to 17.8 per cent.
What should we do? Having opted for a fixed exchange rate, a country can have either monetary autonomy or capital mobility but not both. So the first step is to let the naira float fully. But just before we do that, we should go to the International Monetary Fund and negotiate a standby facility of approximately $26bn. This is more than 5 per cent of GDP and more than double the size of the budget deficit of approximately $11.5bn.
Under these circumstances, initially, the naira would depreciate as it did earlier. Thereafter, a J-curve effect would take place and the currency would appreciate. By how much? It is hard to say precisely. In the current circumstances, this would partly be related to the size of the IMF facility and, more importantly, to the credibility and clear explanation of the overall policy stance. Shortening the depreciation J-curve would dampen inflation, reduce investment hurdle rates and help crowd in investment.
Going to the IMF for support elicits a range of emotions in developing economies such as Nigeria. But the IMF is there for a reason and should be used. As with any lender of last resort, its terms are more onerous the later you leave it and more so when you are in a crisis.
And on inflation and interest rates? Interest rates should have been raised much earlier and, given the current circumstances, would have to be higher than they are at present. If the CBN followed a “Taylor rule” (more than 1 percentage point increase in nominal rates for every 1 percentage point increase in inflation), the MPC rate would have been increased by 13.5 percentage points since the recent hyperinflation trend began in May 2015. However, interest rates would only need to be at this level for a short time – with a Taylor rule, a reduction in inflation would lead to commensurate cuts.
In sum, the choices are clear: continue with the current policy, or change. If we continue with present policy the outcome will be sustained and protracted high inflation, low investment, low growth and high unemployment. Alternatively, change policy and implement a fully floating exchange rate and rule-based interest rate regime. The outcome is also fairly predictable. The short-term pain may be fairly intense. Inflation will rise at first but then drop rapidly. Thereafter, convergence of higher portfolio bond flows and reduced yields will be followed by higher real-sector investment and a sustained period of even lower inflation with higher growth.
With a population of 180m, a low employment to population ratio and increasing restiveness, this is a most inappropriate time for monetary policy in Nigeria to be so confused.
Charles Okeahalam
