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What to learn from Nigeria's economic meltdown 22 Nov 2016

No two economic crises are the same. Nevertheless, policy pundits insist a crisis should not go to waste. We must learn from every economic meltdown. This entails noting both the causes and policy responses. What is learnt can help in warning against future crisis. But more often, the usefulness is in narrowing down future recovery efforts, since even otherwise smart people do repeat previous mistakes.

Latest Nigerian crisis

Nigeria has been contending with fiscal dislocation for more than two years. The problem has become more acute since President Muhammadu Buhari came into office in May 2015. Oil prices, which had averaged above $100 per barrel between 2011 and mid-2014, crashed below $30 in Q1 2016. The country has also suffered quantity shocks from sabotage of oil installations by militants in the Niger Delta.
    
With the leverage of high oil prices removed, compounded by the quantity shocks, the country has faced serious constraints in financing the record-level, 2016 capital spending plan of N1.59 trillion. Oil perennially accounts for 70 percent of government's revenue and 90 percent of its foreign currency receipts. This enables downside pressure on global oil prices to derail the wider domestic economy. The Nigerian economy has suffered the derailment, quite seriously because of high import-dependence for both intermediate and consumer goods.
    
The ensuing dollar scarcity has induced sharp depreciation of the local currency; sparked runaway inflation; and priced staple food items, including rice, beyond the affordability of most households. Moreover, the naira has fallen by 53 percent in the official market since June, when the Central Bank of Nigeria (CBN) removed its untenable naira peg to the dollar. Yet, there is a gap of 52 percent between the official and parallel market rates for the dollar. Inflation rose to 17.9 percent in September.
    
The financial system has consequently been in a crisis mode. CBN's foreign reserves fell below $24 billion in October – a level that doesn't cover six months' imports. Therefore, trade finance by the commercial banks has been constrained. The capital controls imposed by the CBN have restricted importation of even some manufacturing inputs, causing declining outputs, and pushing non-performing loans in the banks into the fearsome double-digit territory.
    
Under these circumstances, labour redundancy, and layoffs across industries, have been occurring. And, by implication, the national poverty rate has heightened.

Leadership failures
    
The failure of political leadership has been energising the fiscal crisis. For starters, the previous administration of President Goodluck Jonathan was spendthrift. It failed to save for the rainy day. Under Jonathan's watch, fiscal savings in the Excess Crude Account declined from $6.5 billion in 2010 to $2 billion in May 2015. This was regardless of the fact that oil prices mostly exceeded the budget benchmark prices during this period. Yet, under Jonathan's stewardship, infrastructure investment delivered underwhelming results. But then, the national debt service ballooned to crisis level – 40 percent of revenue in 2016.
    
From hindsight, the 2015 election was a decision on who the electorate should trust to better manage the budding crisis. Was it the then incumbent administration that was responsible for the country's unpreparedness to face the negative oil price swing? Or was it the opposition candidate, who had not demonstrated even adequate interest in economic management?
    
President Buhari came into office with the idea that the ominous economic meltdown served the purpose of invalidating the previous administration. Therefore, he seemed not to bother to contemplate a swift economic crisis response. He bided his time in constituting his cabinet. When he later did, he brought in plumbers, instead of firemen, to put out a raging fire. This even appeared to be deliberate, as Buhari dictated exchange rate policy to the CBN publicly, and has been bandying about anticorruption quite rampantly as alternative to deft public policies.
    
The political leadership for managing Nigeria's economic crisis has been lacking. Oil prices are beyond the control of the government. However, the bombing of oil installations in the Niger Delta – which at its peak earlier this year shut-in about one million barrels per day – was something that could have been avoided. But it is a moot point, whether the oil sabotage was altogether avoidable with Buhari's ascension to the presidency. If not, he increased the odds in favour of militant attacks of oil installations by his confrontational rhetoric.

Managing the crisis

Although Nigeria is in an economic recession, a key feature of the crisis is the foreign exchange crunch. The forex crisis has been driven by inelastic supply. The CBN's policy responses earned international opprobrium, instead of the understanding of foreign investors. CBN's capital controls, even when not targeted against foreign investors who were keen to exit their local portfolios, appeared to contrive dollar illiquidity to thwart divestment and repatriation of funds. The crisis of confidence has been lingering.
    
Just like the previous fiscal regime is blameworthy for the crisis, the monetary policy of that era, under then CBN Governor, Sanusi Lamido Sanusi (now Emir of Kano), was also culpable. Instead of building the foreign reserves, the CBN encouraged importation, by subsidising the exchange rate. The former CBN governor has recently justified the policy, claiming the country could afford it then. But the policy myopia has been exposed by the necessary reversal.

Useful Lessons

This crisis is far from over. When we are able to compare weak economic data of Q1 2017 with probable weaker data of Q1 2016, it may show a recovery. But the foreign exchange crisis will linger much longer and dampen real sector growth over the medium term. Therefore, it would amount to double jeopardy, if we don't learn from this crisis.
    
There are many lessons to learn, from both the causes and ongoing recovery efforts. One, it matters that a president should have more than a smattering of – but more importantly, regard for – sound economic management. Even as a recession President, it is doubtful Buhari has imbibed this imperative. No populist rhetoric or policy – including anticorruption – can make up for apparent inadequacy of a presidential candidate in fostering sound economic management, if elected.
    
Two, we have to build reserve buffers. Even during this recession, we should save. Some unfortunate reasons, including a further decline from the current oil price threshold of $50 per barrel, can make this a long and deep recession. In which case, the worst may still lie ahead. If not, there is also the possibility of a double- or triple-deep recession.
    
We now know that oil producing countries with hefty reserves have coped better and are able to borrow easily – like Saudi Arabia just did, raising $17.5 billion debt at will – than oil producing countries with weak reserves. It is to this extent that one must recognise the gesture that President Buhari made, when he added $250 million to the Sovereign Wealth Fund in Q4 2015. By the same token, it was a significant accomplishment when President Goodluck Jonathan instituted the SWF.
    
Three, as long as the country depends on foreign investment inflows to steady the currency and credit market, it would be important to 'guarantee' foreign portfolio exits under any kind of economic modelling. The alternative is to frontload tight exit conditions. While this may impede rapid build-up of foreign portfolio investment, it will help build credibility for our market, especially when no further encumbrance is faced when exiting under extant conditions.
    
Four, and this is anticipatory, raising the national debt aggressively – in particular external debt – during this crisis situation, will prove disastrous. The key provider of foreign debt, the IMF, has warned developing countries on allowing public debt to balloon. Dollarisation of the national debt will re-enact the 1980s to early 2000s foreign debt overhang. It will dissuade foreign investment inflows.
    
As an alternative strategy, a bet for smaller government should be made to rebalance high recurrent expenditure in favour of capital expenditure. Capital investments should aim to “nairalise” the economy and not dollarize public debt. This is best achieved by enabling domestic production.   
    
Ultimately, policies have to focus on supporting SMEs in the real sector to grow capacity for exports of value-added products and services. However, weaning the country off import-dependence is an easier near-term solution. We have to produce our staple foods. And we have to invest over the long-term in education to infuse necessary knowledge into our industrial development plan.