That bark by JP Morgan By Henry Boyo

The threat, earlier this  year, by the United States-based international banking mogul, J.P Morgan to phase out Nigeria from its Government Bond Index, for emerging markets (GBI-EM) was made good last Tuesday, 8th of September.

In response to JP Morgan ’s “negative alert”, foreign portfolio investors, particularly, would expectedly become reluctant to lend money to the Nigerian government; however, subsisting federal government bond holders, may consequently, also hastily offload their stocks and, inevitably, hurriedly demand foreign exchange to facilitate repatriation of their funds, before the Naira rate suffers further depreciation. Indeed, since Nigerian government bonds are primarily denominated in Naira, holders of such debt instruments may have, lately, lost up to 20% of their stock value as a result of currency devaluation.

Thus, CBN is clearly concerned that a fresh surge in forex demand, triggered by sudden exit of foreign holders of government bonds, would further deplete CBN’s diminishing dollar reserves and ultimately fuel currency speculation which will in turn induce an even weaker Naira exchange rate, which will deepen those distortions which have continued to plague our economy.

The relevant question therefore, is why Federal Government Bonds have lately fallen out of favour externally, after the favorable ratings enjoyed since they became listed by JPM in 2012.

Well, according to a full page CBN advertorial last week, US banking giant had, indeed, earlier in January 2015, expressed concerns on the management of “Nigeria’s foreign exchange market”; the three major concerns were identified as, “lack of liquidity for transactions, lack of transparency in the determination of the exchange rate, and lastly, lack of a fully functional two-way FX market”.

Conversely, in the widely published advertorial, under reference, the CBN denied that it failed to provide enough dollars to match market demand; the apex bank insisted, instead, that it had infact “introduced (responsible) measures to improve the forex market and make it more investor friendly”.

Furthermore, the CBN also claimed that despite almost 60% drop in oil prices, in one year, and the predictable adverse impact on market liquidity, “the CBN ensured that all genuine and effective demands for forex, especially those from foreign investors, were met”. Incidentally, despite reduced oil revenue, invisible earnings, such as technical service fees, school fees, dividends, remittances of airlines, insurance, and portfolio investors’ capital outflows may constitute over 40% of total forex spending, while fuel importation may account for another 40%; curiously, however, payments for finished goods and raw materials imported as feedstock for industrial production probably account for less than 20% of total forex usage.

Ironically, despite the relatively meager allocation for imports of goods and industrial raw materials, this subsector, unexpectedly, recently became the primary target for reducing forex outflow, while much larger demands for fuel and other invinsible earnings were still favored in CBN’s forex allocations. Expectedly, both the Manufacturers’ Association and the Chambers of Commerce, are already up in arms against the CBN’s allegedly discriminatory policy, as they insist that the ban to official forex access to some of their members would lead to business failures and worsen the already high unemployment rate. These real sector operators have consequently argued that such disenabling outcome, cannot be the reasonable objective of government’s efforts to revamp the economy.

Nevertheless, in view of CBN’s insistence of preferential forex allocation to foreign holders of federal government bonds, the US Bank should quickily provide unambiguous evidence to debunk CBN’s claim of adequate market liquidity; clearly, if it fails to provide such evidence, Nigerians may be tempted to see JP Morgan ’s negative ratings as a calculated ploy to precipitate Naira devaluation, so that those bench marked foreign portfolio investors, who had earlier this year, exited the market with billions of dollars, could return and once more buy up federal government bonds and equity at much cheaper prices than before.

However, the expectation of portfolio investors for higher interest rates on government bills and bonds is probably more rational, as a hedge against a sliding exchange rate; for example, 15% interest rate on government securities may not be sufficient to restore the value of such investments, if the Naira also depreciates by, say 20%, in the short to medium term.

Conversely, if government pays over 15% for its sovereign risk free domestic borrowings, low cost of funds below 10% will elude the real sector and challenge the prospect of inclusive economic growth and creation of increasing job opportunities. Worse still, if the weaker Naira exchange rate currently demanded by J.P Morgan is embraced, industrial production cost will spiral, and drive inflation beyond 10%; prices of locally produced goods will generally become uncompetitive, fuel prices will rise, while consumer demand will also contract to reduce capital investment and deepen poverty nationwide.

Clearly, any promise that a weaker Naira exchange rate would promote industrial and economic growth, must be suspected, as the contribution of manufacturing has historically, steadily declined from over 10% in 1983 to less than 5% of GDP as the Naira exchange rate continuously lost value overtime from stronger than N1=$1 to the present N200=$1.

The CBN has also refuted JPN’s other allegation of lack of transparency in the determination of the Naira exchange rate, and the Central Bank claims to “have mandated that all FX transactions were posted online…so that all stakeholders can easily verify all market transactions”. Furthermore, the CBN claims to have also closed its erstwhile official FX window to ensure a level playing field in the pricing of foreign exchange.

Finally, the CBN similarly claims to have also sanitised the multiple abuses, in the market, with the introduction of an order-based two-way FX market which fulfills genuine customer ability to pay for eligible imports and transactions. This process, according to CBN, has, “resulted in exchange rate stability in the interbank market and has also largely eliminated market speculation.

Although some analysts have concluded that the Nigerian economy will be adversely affected by the withdrawal of foreign portfolio investors, the CBN, conversely believes that the “market for FGN Bonds remains strong and active because its inherent strength is primarily due to the diversity of the Domestic investor base and presumably not the presence of foreign portfolio investors!!

Evidently, the humongous Naira liquidity surfeit which CBN acknowledges in the system should be adequate to mop up future issues of federal government bonds and forestall the usual pressure precipitated by the hot money flows of foreign portfolio investors.

Besides, CBN’s claim to relatively bountiful ‘idle’ reserves, while our government humbly solicits precarious and fickle funds from foreign portfolio investors, is clearly one of the fundamental contradictions of our economy.



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