AMCON, Nigeria’s bad bank, announced its intention and a comprehensive plan to redeem and refinance its maturing obligations at the end of 2013 through 2014. The aggregate amount of the debt instruments with a face value of N5.7 trillion is to be affected. The principal amount issued as zero coupon bonds (where payment is retired in a final bullet payment) was N3.9 trillion.
This indebtedness was incurred on behalf of the CBN in its surgical intervention to stave off a looming systemic crisis in 2009. The bonds were issued in exchange for eligible bank assets (toxic) as well as recapitalisation of the banks that failed to be acquired after the CBN intervention.
The rationale, justification or motivation for this move continues to be a subject of controversy and endless debate. The leading question raised by most monetary economists is what the effect of this re-payment plan will be on monetary stability, especially the general price level in an inflation targeting monetary policy framework and environment. One has to bear in mind that the face value of the debt to be refinanced and redeemed is N5.7 trillion, which is 35 percent of Broad Money Supply (M2). Conventional logic dictates that there is a positive correlation between money supply growth and the rate of inflation.
Policymakers had been haunted in the last 48 months by the spectre of the transmission effect on the financial system and the supply-side shocks or its spill-over impact of the redemption on other leading economic indicators. Also, there is anxiety that the consolidation of AMCON bonds into the national debt may push Nigeria into the club of countries with debt sustainability problems. Nigeria’s total debt service to GDP ratio is still at 0.5 percent, which is well below the global average.
CBN intervention – a matter of necessity or choice?
Before we look at the wider systemic transmission implications, it is important to step back and ask whether the CBN intervention in 2009 was a move of necessity or choice. Revelations from the findings of the various reports ranging from the CBN, NDIC and SEC show that the line between an invasive or non-invasive procedure in the bank intervention in 2009 was only semantic. In reality, any responsible regulator at that time would have had no choice but to do something drastic. In other words, there was no alternative but to act decisively and quickly. The system, according to the reports, was tottering on the brink of a catastrophic financial crisis that was exacerbated by the global economic crisis. The last time the world witnessed the coincidence of a global recession and a financial meltdown was in 1929.
At this time, i.e., in 2009, global economic growth had shrank to 2 percent for the second consecutive year, well below the historical average of 4.5 percent. Nigeria’s GDP growth was also running below its 5-year average. This underscored the continuing costs and toll of the global crisis on Nigeria. It was also evidence of the repercussions of the unfolding crisis of liquidity, confidence and solvency in the financial system.
Therefore, even though the fiscal costs of the distress resolution option were in excess of N6 trillion, in reality, the social costs avoided, including a run on the banks, far exceed the financial cost. Also, the fact that the banks are bearing the financial burden, the taxpayer and fiscal costs is reduced to zero. The Nigerian commercial banks have agreed to underwrite the cost of this exercise by committing 0.5 percent of their total assets over the next 10 years.
An evaluation of the full macro-economic cost of this redemption plan raises a number of questions: Does this plan negate or contradict in any way or form the broad macro-economic objectives of Nigeria? The answer to this question is NO. The very broad objectives are: (i) Achieving an accelerated and sustainable rate of growth in the real GDP to make it one of the leading 20 economies by 2020; (ii) Diversification of the economy from excessive oil dependence; (iii) Reducing the economic vulnerability to exogenous shocks; and (iv) Accomplishing the Millennium Development Goals by 2015.
The redemption and refinancing of these instruments at this time in an orderly manner will reduce the possible contagious effect on other sectors and this enhances the capacity of the economy to meet these broad objectives. However, the distress resolution strategy is only a necessary and not sufficient step in accomplishing these goals.
The direct impact of this plan on money supply and inflation
The banks are the main holders of the AMCON bonds in their various portfolios. On December 31, 2013 the sum of approximately N1.7 trillion will fall due and will be retired. This amount is 11 percent of M2. Since most of the holders have it as part of their portfolios and even exchanged some of these for cash in repo transactions, the retirement will not add to total liquidity. On a one-for-one basis, money supply growth in the past 3 years averaged approximately 13 percent. This is well below the average growth in the monetary aggregates over the previous 5 years of 36 percent. Therefore, the CBN, in anticipation of the possibility of money supply saturation resulting from the plan, had mopped up more than an equivalent amount of liquidity from the system. This has created a money supply gap of N2.3 trillion which will be filled by the monetisation of the redeemed securities of N2 trillion in 2013 and the refinancing of the N4 trillion in 2014 by the CBN. The impact, therefore, is neutral to the allocation of financial resources.
The inflationary threats that typically accompany an explosion in money supply growth in a full employment economy will be relatively subdued in this case in Nigeria. There will be undercurrents of inflation that will bubble to the top, but this can be properly managed by a cocktail of measures within the ambit of the CBN.
If you simulate the impact on the various indicators the numeric impact still leaves the parameters within the comfort zone of the IMF, rating agencies and holders of Nigerian Eurobonds. For example, even if you assume that these instruments were newly created and added on to the current money supply, its impact on the exchange rate will, on a doomsday scenario basis, drive the naira down to N165/$. The current PPP value of the naira is N172, therefore an adjustment of the exchange rate to N165 in a doomsday scenario will still keep it lower than its PPP value. This is a rate that can be accommodated in a monetary adjustment to any deterioration in the balance of payments of Nigeria.
The other elements of the orderly AMCON exit of the intervention process include the sale of positions in assets held in equity, real estate and other markets. The holding of assets has two important systemic benefits. First is reducing the overhang in an equity market that was in a free fall. The fact that AMCON held off significant blocks of shares has allowed the equity market rally to enjoy relative sustainability. The other benefit is that the values of these assets in some cases have appreciated.
Therefore, in conclusion, the move by AMCON to redeem its obligations in an orderly manner allows for a seamless systematic assimilation of a huge chunk of financial assets which had the potential of constipating the Nigerian financial system and undermining economic growth. The big takeaway and lesson from the handling of this process is that fiscal and monetary policy coordination is not only necessary but imperative for any emerging economy in its transition from its current state to a BRIC, or better still BRINC, economic status.
Rewane is MD/CEO, Financial Derivatives Company Limited