Over the last few months I’ve been reading the book Stress Test by Former US Treasury Secretary Tim Geithner – written about the 2008-2009 global financial crises from his perspective as the head of the New York Fed and later as Obama’s finance minister. The central idea is that financial crises world over share a common theme: a cocky belief that the worst is forever past and that man has mastered the environment. In the US prior to the 2008-9 financial crisis, this meant a belief that the monetary authorities have mastered financial cycles and the only way was up. This hubris allowed the build-up of excessive leverage on runnable (short term) capital. As confidence sapped following the collapse of Lehman Brothers, this short term capital disappeared and the classic panic began as the tide pulled back.
Lesson from the past and recent past
Over the last few months, Nigeria has grappled with an economic inferno – growth is now negative something hitherto unthinkable. Worse the currency has weakened over 100% since the last quarter of 2014 officially and much worse if you use the parallel market. As with all crisis, the hubris came from the belief that oil prices above $100/bbl was the new normal and our policy makers concerned themselves less about building fiscal buffers but on spending the boom. In this light the legacy of Ngozi Okonjo-Iweala (NOI) will always be written in galling terms as with the presidency she served under. NOI’s reign at the finance ministry was characterized by a shocking low sensitivity to borrowing cost despite the good times with oil revenues. A lesson is here – Nigerian governments respond to increases in revenues by expansionary fiscal policy on themselves not on capital projects. Part of the fiscal splurge was on fuel subsidies to which the Nigerian people share blame for resisting its removal, though admittedly a massive trust deficit amplified the time inconsistency problem related to the abrupt nature of the 2012 removal.
Beneath the fiscal excess was wanton monetary policy bent on attracting capital flows to shore up the currency so the Central Bank of Nigeria (CBN) maintained interest rates at a record 12% even though inflation declined to multi-decade lows of 7-8%. Even more the apex bank did all its can to keep the naira yield curve attractive for carry trade by foreign portfolio investors as global interest rates fell under the weight of dovish central banks from the US, Europe and Japan. The result Nigeria received massive inflows of speculative runnable capital flows roughly $18billion on average between 2012 and 2014. As with the US the hubris that these flows would remain would to be Nigeria’s undoing. Once oil prices plunged in June, the flows grew legs and fled and with it the support for the naira. With its key policy anchor under pressure, the apex bank dithered on moving the upper band of its managed float even as fundamentals weakened leading to a drawdown on foreign reserves.
Enter the Buhari Administration with a philosophy that everything rose and fell under corruption, so in its misguided belief the PMB government failed to develop a plan to deal with the impact of the collapse in oil prices on the economy. Wasted six months picking ministers, five months passing a budget, dithered on the currency and a whole lot. By insisting on no devaluation even though the ground had shifted Nigeria’s economic managers failed to allow the FX rate absorb the displacement in the external sector. As in economics, all choices are about trade-offs and by refusing to allow markets determine the value of the naira, naira determination would not take place in a different market one with no rules – a black box aka the parallel market. The current administration broke the market. Now even though the government has embarked on a new wave of liberalization with freely floating currency and fuel pricing like humpty dumpty you can’t put its back together. Today we are in a hole and no plan to get out.
So as we celebrate 56 years I think the lesson in all of this is that we cannot allow anyone ascend the presidency without distilling his views on the economy. As a former Bill Clinton’s aid once said, “it’s the economy stupid”…not corruption.
So after the rant what is the solution? First the present government must stop this silly talk of we have a plan and actually come up with a plan. Call it whatever you want but we NEED a plan Mr President, Mr Vice President and Mrs Finance Minister. To be credible the plan should be ambitious for instance a plan to return Nigeria to 4-5% GDP growth in the next two years.
A Plan beats no plan
Firstly, we need to tackle the issues around oil production and the militants. In the Niger Delta, the issue at the heart of the unrest is resource control so let the PMB government break the ice by raising the derivation to from 13% to 20% unilaterally and declare that the long run objective is to deliver full resource control to the region. Beyond stealing the political thunder from the region’s anti-PMB stance, this provides PMB a way to wean the FG of oil receipts. Nigeria’s economy does not need to diversified (economic quacks and illiterates are wont to say) it already is massively diversified. Rather the issue is government revenues and exports are not diversified.
Next, PMB needs to deploy massive political capital towards getting all variants of the PIB passed quickly. With these twins strokes the PMB government will be well on track to drawing a firm line on the issues with oil GDP.
On non-oil there’s the misguided belief about a stimulus injection. Now let’s do some maths Nigeria intends to spend N6trillion in 2016, which it does not presently have, to stimulate a N100trillion economy. Exactly, even if you assume the most optimistic scenario of no leakages, as 70% of our budget is recurrent our fiscal multiplier is not as large as imagined – in simple English the budget is not going to stimulate jack. Overlay that with the collapse at state level, Nigeria’s fiscal spending this year (FG+SG) is more likely negative when you adjust for the current economic cycle. So why flog a dead horse by talk of borrowing and asset sales – to move the eye of the needle, salvation does not lie in the FG. The conversation we should be having is the need for greater private impetus in the economy.
Private Sector Driven Stimulus
To kick-start the private innovation government needs to reduce its footprint in the economy via a combination of asset sales or sell-downs and removal of all manner of arcane onerous regulation on private activity. Open up the economy to greater private participation – this is the key reform for Nigeria. The wealth of a nation is not in the benevolence of its government but in private activity governed by the invisible hand. As a friend of mine would say, let the FG simply commit to ensuring Nigeria rises 30 places in doing business per annum.
On the monetary sector, having consistently argued as to supply-side nature of Nigeria’s inflation and the fallacy of CBN claims about fighting inflation via rate hikes, I restate my dovish position again – you cannot be raising rates in a recession. It is important that Nigerian authorities communicate this picture to markets consistently: the cure to Nigerian inflation is NOT via interest rate hikes but supply side fiscal policy measures. This now leaves the only justification for rate hikes to logical conclusion from the impossible trilemma: raising rates to attract speculative FPI to shore up FX markets. In a lower-for-longer oil price world and Fedspeak of raising interest rates, the efficacy of this strategy is doubtful and does more damage to the domestic environment.
Do low-interest rates work to improve credit? No, but keeping rates at elevated levels does more damage to the economic structure as we are simply saying don’t engage in any risky activity; just play safe with your money.
In an economic recession, we must deal with the issues squarely and avoid dogmatic orthodoxy. No one ever came out of an economic crisis with double-digit interest rates. We can keep pretending for a while but as inflation starts to come off on base effects can the apex bank continue justifying enriching banks and portfolio managers in a recession? If you need dollars go and borrow dollars.
Nigeria’s current currency woes stem from an addiction to short term FPI flows in the 2012-2014 period induced by a certain emir. As with all financial crisis, the heart of the issue is an overleverage of the financial system with short term funds and hubris that this state of nature is permanent. The focus of Sanusi Lamido’s central bank tenure was to keep interest rates elevated to attract short-term foreign portfolio flows (aka hot money) to support the currency. As Hyman Minsky, the patron saint of financial crisis economics noted stability breeds instability. SLS made us believe that due to his tight monetary policy stance which made the naira stable he was a genius. In hindsight it was sheer hubris. Currency crises never end easy, they require some sort of overwhelming force, a bit of luck with exports but the exchange rate ends up badly devalued. Sorry we have to deal with this pain.
Recapitalize ailing Banks
In dealing with the issues, we cannot avoid the NPL issue which leads to talk of AMCON 2.0. I’m not a moral hazard fundamentalist I find it meaningless concept in an economic crises however, in contrast to other programs. My proposal is simple and transparent. The apex bank undertakes a special examination of all banks and identify those banks with hefty NPLs. Isolate these banks and force them to raise capital first failing which capital can be injected via convertible preference shares with return rates which pick up over time to force the shareholders to repay debt quickly. This way as bank earnings improve taxpayers get the benefit of the recovery. This reduces the size of intervention as only capital needed to get these banks above the threshold is put in place.
My plans are open to dispute off course so I encourage you to attack it and come up with yours hopefully this similar talk gets up the hallways in Abuja.