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If so big why so small (2)

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Last week on this column, we dwelt on the discrepancy in Nigeria’s financial depth relative to its GDP size.   We argued that Nigeria’s financial system largely lags its size when compared to peer countries around the world.   Based on an analysis of a time series data of over 10 years, we came to the view that most indicators of financial depth including the money stock have gradually shrunk in size relative to Nigeria’s GDP. Some other measures like equities have similarly remained stunted and therefore, unable to drive growth which consequently, has continued to dwindle.     Readers’ reaction to these claims necessitates this concluding part.

To start with, financial depth largely measures the financial sector relative to the rest of the economy. It is an aggregate measure of the size of banks, other financial institutions and financial markets within a country, relative to a measure of economic output such as the Gross Domestic Product or the GDP. It is also related to the oft-used term of financialisation which captures the increase in size and influence or importance of the financial sector relative to the overall economy of a country. The link between financialisation and economic growth has been extensively covered in the literature on finance and economic development. The received wisdom is that financial depth is a predictor of sustained economic growth.   “The ascent of money,” wrote Nail Ferguson, a Harvard professor and one of this century’s most influential economic historians, in his 2008’s The Ascent of Money, “has been essential to the ascent of man.” Quoting Frederick Mishkin, former governor of the US Federal Reserves, he argues further: “the financial system is the brain of the economy… it acts as a coordinating mechanism that allocates capital, the lifeblood of economic activity, to its most productive uses by businesses and households. If capital goes to the wrong uses or does not flow at all, the economy will operate inefficiently, and ultimately economic growth will be low.”

It therefore goes without saying that finance is at the heart of economic growth and its efficient deployment is the key to unlocking the prosperity of nations. As Ferguson argues in his book: “The evolution of credit and debt was as important as any technological innovation in the rise of civilization, from ancient Babylon to present-day Hong Kong. Banks and the bond market provided the material basis for the splendours of the Italian Renaissance. Corporate finance was the indispensable foundation of both the Dutch and British empires, just as the triumph of the United States in the twentieth century was inseparable from advances in insurance, mortgage finance and consumer credit….Economies that combined all these institutional innovations – banks, bond markets, stock markets, insurance and property-owning democracy – performed better over the long run than those that did not, because financial intermediation generally permits a more efficient allocation of resources than, say, feudalism or central planning.”

Private credit relative to the size of the gross domestic product is one indicator that has featured prominently in the literature as a proxy for financial depth. It is to this that we need look to understand a country’s overall economic growth prospects – it is positively and strongly correlated with both GDP and GDP per capita growth. Although private credit to GDP varies widely across countries, it however exhibits very strong correlation with income levels. It has been estimated that for high-income economies, this proxy could be as high as 103 percent (private credit to GDP ratio) which is usually more than 4 times the average ratio in low income economies. Countries like UK, US, Canada, Australia, Japan and South Africa are among those in the highest 20 percent in terms of private credit to GDP.

The sub-Saharan Africa average domestic credit to private sector to GDP ratio stands at 45.5% in 2018. The global average is 129% while Nigeria’s is dwarfed by both at just 17%. It is therefore not hard to see from this that financial intermediation is rather weak in Nigeria. We cannot overemphasize the role of financial intermediation which is a direct product of financial depth in the country’s economic development. It is clear that absence of credit both strangulates businesses and stifles private consumption. Both are deleterious to the growth of aggregate demand in the economy.

Poor financial intermediation is also evidenced by the fact that 95% of bank deposits mature within one year. This goes to prove that deposits are held primarily for transactions processing purposes. What is left for investment or speculative purposes is just a meagre 5%.   If we add the other indicators of poor financialisation which include bonds at 12% of GDP, equity at 13% of GDP and foreign reserves at just 10% of GDP, Nigeria’s overall financial situation does not warrant any optimistic conjectures about robust growth prospects.

Although it may be interpreted as tentative to link these developments to productivity without further rigorous and theoretically nuanced research, but it is hard to resist the temptation to link these developments to the low productivity that we have in the system currently. Total factor productivity (TFP) is the efficiency measure of the combined inputs to the production system and is the main predictor of future economic growth. China’s economic growth in the last 3 decades has been linked to the growth of its factor productivity which grew at an average of 3.5% and accounted for nearly 40% of its GDP growth. Nigeria’s TFP has unfortunately achieved a negative growth in the last 5 years.

In the case of China, TFP-driven economic growth was consequent upon institutional reforms and technological progress; efficient reallocation of resources – both labour, capital and finance; and economic structural changes. Nigeria’s low productivity on the other hand is of course, driven by perverse institutions that disincentivize efficiency; lack of technological progress; and inefficient allocation of resources.

One school of thought argues that monetary tools cannot fix the fiscal problems that the country currently faces – especially the fiscal gap where the sum of salaries, overheads and debt service is greater than government’s independent revenues. And the implementation of the new minimum wage will if anything, worsen the fiscal balance in the face of sub-optimal productivity which amounts to “a recipe for inflation and fiscal slippage” with a total wage impact of approximately 3.5% of GDP and 18% of broad money. The policy recommendation from this school of thought is the IMF recommendation of aggressive tax expansion.

Our take is that monetary policy or lack of it contributed to the problem in the first place.   It remains to be seen how businesses and consumers who have been hard pressed by low credit over the past years can be coerced into paying more taxes. The argument that an accommodative monetary policy stance would worsen inflation is at best lame.   A pertinent question that needs to be answered is certainly at what level of inflation would productivity begin to stall? Until we have a robust answer to this question, the claim that monetary policy accommodation will worsen the situation is unsustainable. But in any case, monetary policy has not helped the economy very much in the recent past as it appears efforts have been concentrated on managing the oil revenue rather than growing the economy.

 

Bongo Adi

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