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Policy options for ending the recession 20 Jul 2016

Ahead of the release of Nigeria’s GDP data for Q2, 2016 by the National Bureau of Statistics – which analysts believed would confirm the country has slipped into a recession – there was the notion that the country has been in a recession for many years. Nigerians who felt they were left behind during the “jobless growth” of the past years that was driven by a rigid economic structure couldn’t care less about any new declaration of a “recession.” While this sentiment deserves some consideration, it is nonetheless invalid and dangerous.
    
A recession occurs when an economy records two consecutive quarters of negative GDP growth rate. Official data says the economy contracted by 0.36 percent in the first quarter of 2016. Analysts polled by Financial Nigeria estimated that the national output contracted by 2 percent in the second quarter.
    
The lay people's argument that the country has long been in a recession would suggest they are already used to harsh economic conditions. This portends the danger of possible complacency by policymakers. In reality, however, the GDP data tells that a worse turn of economic reality only started sometime in the first quarter of 2016. Before then, we had a slower GDP growth rate of 2.8 percent in 2015. In the ten years to 2014, Nigeria's GDP growth rate averaged around 6 percent – one of the highest in the world. Therefore, we have just entered a more perilous economic zone that we need to get out of as quickly as possible.

An array of fiscal and monetary policy options can be deployed to end a recession. The United States has used deficit spending (often comprised of increased government spending and tax cut), price and wage controls, unemployment insurance benefits, interest rate cuts, and asset purchases to fight the recessions the country experienced between 1960 and 2009. But a number of these tools are beyond the reach of Nigerian policymakers, either because they are too expensive in financial terms or far removed from the practical reality of our economic situation.

President Richard Nixon deployed wage and price controls to fight the recession of 1969 – 1973. The policy, which was not really instrumental to the U.S. recovery at the time, has since assumed a higher level of negativity, and thus, ineffectiveness. Controls are incompatible with the free market principle, whereby economic value is determined by the interplay of demand and supply. While the IMF and some economists are milder now in their objections to controls, any control mechanism is acceptable only as a stop-gap measure, even as investors would rather not have it. As we recently experienced with the foreign exchange policy in Nigeria, the market frowns at controls.

Placing a lid on wages can help contain cost and boost production, while price caps can boost effective demand. But this works better in theory than in practice, given other countervailing factors. The notion that controls would be rolled back at some point in the (near) future tends to discourage investment in the short term. During a recession, this can delay recovery, except more powerful tools are brought into the policy mix.

Chairman of Federal Reserve, Alan Greenspan, earned his reputation by cutting the federal funds rate several times during his tenure. His aggressive interest rate cuts overshadowed the increase in payment of unemployment insurance benefits by the George Bush administration, as the first Persian Gulf War and rising inflation combined to plunge the US economy into a recession in the early 1990s. Greenspan validated a model that would later become popularly used; not only in the subsequent US recessions, but also in other global economies, including Japan.

But the structural rigidity of the Nigerian economy, coupled with high import dependency, makes persistent or sharp interest rate cuts a driver of inflation. The peril of over-reliance on crude oil proceeds to fund government's budget and finance the country's imports has come into a stark relief with the current crash in oil prices which started in 2014. Granted that the banks will lend, lower interest rates will put pressure on the naira, driving cost push-inflation of foreign inputs and imported consumer goods. But the banks may not even be interested in lending to the private sector. They have safe havens in government debt and Central Bank of Nigeria (CBN) securities. Moreover, banking penetration is tenuous in the informal sector which holds much of the growth potential of the economy.

Interest rate in the Zero Lower Bound moves monetary policy out of convention. During the Great Recession of 2008 – 2009, central banks, notably the Fed, Bank of Japan, Bank of England and, belatedly, the European Central Bank unleashed unconventional monetary policy in fighting the most serious economic crisis since the Great Depression of the 1930s. The central banks opened and left the liquidity taps running, purchased all manners of assets from the banks, and propped non-bank financial institutions. Such operations would easily be discredited if they were conducted by central banks in developing countries, including Nigeria.

Most certainly, however, there are ammunitions that Nigeria can deploy to fight the current recession, even if they would be borrowed. In this regard, the deficit spending plan of the 2016 budget comes to mind and has assumed greater importance. Initially, the All Progressives Congress (APC) government of President Muhammadu Buhari presented this expansionary budget fancifully as a stratagem to reflate the economy. But now that the government has a recession on its hands, it no longer has the luxury of fancifulness, delays and negation of its humongous deficit spending plan.

The federal government will have to spend its way out of this recession. The 2016 deficit spending is the most powerful tool to fight the recession and restore growth to positive by Q4, 2016. After months of horse-trading, the National Assembly approved N1.5 trillion as the capital expenditure for the year. The programme of capital investments is expected to restore lost jobs and create new employment in the construction and allied industries. The capex is expected to deliver key infrastructure projects that will remove some of the bottlenecks to doing business in Nigeria. And in essence, public investment in infrastructure attracts further private sector investment.

Given the promise of paying contractors that were being owed to enable them return to site, the 2016 capital expenditure can make immediate impact. It is, therefore, very relevant to any plan for recovery from the recession. In concert with the capex, the federal government also plans to make important social investments. Put at N500 billion, this will put money in the hands of the needy, build skills, lend to micro enterprises and feed school children.

The infrastructure and social investments plan has potentials to deliver immediate consumption boost and attract investment into the real sector of the economy. These two aspects are mutually reinforcing, and they can stave off inflation by providing local products that are cheaper than their imported alternatives, in line with the import-substitution policy.

However, the emerging reality is that the government is losing faith in its ability to make this plan work. The Finance Minister Kemi Adeosun said the government is unlikely to be able to implement the capital expenditure up to 100 percent. More recently, the Minister of Budget and National Planning Senator Udo Udoma said that disbursement of the capital expenditure would be based on work done. This came as contractors who have moved offsite continue to wait to be paid for work already done in order to return to site. The payment process would confound contractors who need mobilisation payment to start work.

Evidently, the government has been struggling to raise the deficit financing, especially the foreign component of about $10 billion. But the dollar loan is crucial, given that the subsisting low oil prices and attacks on oil installations in the Niger Delta have reduced oil proceeds by more that 60 percent, compared to 18 months ago. Project finance for infrastructure projects, like the recently announced $80 billion infrastructure commitment by China, would delay the take-off of the projects and, therefore, be irrelevant to short-term plans for the recovery. Moreover, China usually sources project materials and personnel at home for its offshore projects in Africa, limiting local job creation. This makes a Eurobond a better option for the federal government, although China’s project finance has the appearance of being cheaper.

While the fiscal operation of the federal government is faltering, more dire situations for both capital and social investments exist in the states. Most state governments are owing several months of salaries. This forecloses any serious capital investment in the affected states. Productivity losses to delay in salaries and the negative effect on consumption are the reasons the federal government needs to work with the state government to clear the salary arrears. The moral hazard to doing so, like bailout of too big to fail financial institutions, is less damaging economically than to allow the current situation to persist and the recession to continue to take hold.

The Central Bank of Nigeria is not completely without credible tools in reversing this recession, even though its anchor interest rate is blunt. CBN's special monetary interventions, including funds targeting lending to SMEs, agriculture, power and non-oil exports are important. By channelling some of the funds through the development finance institutions for on-lending by the commercial banks, the CBN has created additional layer of bureaucracy. But direct disbursement to banks and direct management of the fund by the CBN has hardly worked in the past. So, one expects that the DFIs would justify their existence by managing the intervention funds more effectively.

The big elephant in the room is the federal government which still continues to struggle with policymaking and economic management. Fighting a recession can prove even more challenging, but the government must do all it can to end its knack for turning a crisis into a disaster.