The Devaluation of the Naira and Other Stories

It was Claude Ake who described Nigeria as a disarticulated economy, that produces what it does not consume, and consumes what it does not produce. This description summarizes the dilemma that faces Sanusi Lamido Sanusi and his team at the Central Bank of Nigeria (CBN).

It is no news that what we suspected is eventually happening. The Naira is under significant pressure, and the CBN has emptied its artillery to protect our beloved currency. In various official publications on the exchange rate, the CBN has indicated target exchange rate corridor of NGN150: US$1 ± 3% corridor (i.e. NGN 145.5 – NGN154.4). At the close of business yesterday, depending on who you talked to, the Naira closed at NGN165 – NGN168. At best this is 11 Naira above the CBN’s target.

At an “expected” emergency meeting of the CBN’s Monetary Policy Committee (MPC), three drastic measures were announced. The most celebrated was the 275 basis point increase in the Monetary Policy Rate (MPR) from 9.25% to 12%. This is the rate at which the CBN gives loans to banks, and is the nominal interest rate anchor. This means interest rates will go up in a bid to encourage savings in the Naira, as interest rates, for once, will provide real returns (after adjustment for inflation). This will reduce the supply of Naira in the market, thereby reducing demand for the US Dollar. The downside of this is a resulting increase in lending rates, and a re-pricing of existing loans, priced using a floating rate (usually the prime lending rate of the lender).

But this does not tell the full story. The apex bank also increased the Cash Reserve Ratio (CRR) from 4% to 8%. This is the proportion of bank deposits held in cash by the CBN; therefore this huge increase in CRR means a sharp reduction on the amount banks are able to lend to the real sector. If we assume an industry balance sheet size of N9 trillion, that is N360 billion that could have gone to private sector loans, taken out of the industry.

By reducing the Net Open Position (NOP) of banks from 5% to 1%, the CBN has effectively reduced the amount of foreign exchange a bank can hold at any time. The Net Open Position is simply the difference between assets and liabilities of a bank held in a foreign currency, usually measured as a percentage of the shareholder’s funds of a bank. This reduction will significantly reduce the volume of foreign exchange deals on the inter-bank market and autonomous purchase of foreign exchange, because of this reduction of the amount of foreign exchange banks can hold for mainly speculative reasons. This might mean a reduction in the short term profits of banks, as the treasury function, impaired by this rule, is usually one of the most profitable businesses of Nigerian banks.

The MPC is a team of nine, and the vote to increase the NOP was unanimous. The vote on increasing the MPR was 8-1, while that for the CRR increase was 7-2 (2 members voted for 200bp increase). The unity in the voting patterns suggests a room of worried policy makers. The CBN has blinked, and the result could be harsh.

We know lending rates will go up significantly, and supply of credit will reduce. If you are an existing or intending borrower, this is the time to say a prayer. It will be harder and more expensive to get a loan now, like it wasn’t already very difficult. Government is the biggest borrower in the economy, therefore its borrowing costs will increase, as government securities will be priced higher to accommodate for this MPR increase. The effect on the bond market could be interesting. An increase in the risk-free rate (the rate at which the FGN borrows) will mean states yet to issue sub-sovereign bonds might be forced into offering a higher coupon rate. The same will apply to corporate debt.

As always, unpredictability is an investor’s worst nightmare. This sharp depreciation will affect investor confidence, at least in the short term. So, it is safe to assume a few wrinkles were added to the face of a certain Mr. Aganga at the Ministry of Trade and Investment last night.

How does this affect us, the ordinary Nigerians? Our taste for imported goods from Brazilian weaves to Rich Tea Biscuits will come at a higher cost. . That is the price we pay for being so dependent on imported goods. The road ahead is cloudy; we have not been in a similar position since the rocky days of 2008/9. It is never good to be a harbinger of bad news, but it is time to tighten our belts and build up healthy cash reserves. One principle that never changes in difficult times is the well known mantra “CASH IS KING.”