There is no doubt that Nigeria is witnessing robust foreign reserves currently at over $48 billion and with the ability to finance about 13 months of imports.
However, there’s a problem with the estimated $12 billion or 18 per cent of portfolio capital inflows regarded as hot money, which is making the economy vulnerable to external forces, should the investors decide to withdraw their funds suddenly.
This capital flow reversal by investors is due to the United States Federal Reserves’ likely downward review of its monthly stimulus for purchasing securities in order to create liquidity. The end product of borrowing dollars at a cheap rate will make portfolio investors to reduce their offshore investments in naira denominated assets, e.g. FGN Bonds, and equities listed on the Nigerian Stock Exchange.
Consequently, the portfolio investors may have to reduce their investment positions offshore to cover for the gap that may arise. This implies that there would be demand pressure on the dollar as they repatriate their funds, leaving CBN to battle with defending the naira at all cost, necessitating a decline in the foreign reserves.
Indeed, an increase in foreign reserves based on fiscal savings rather than capital inflows serves as a buffer for the currency and thereby making the exchange rate to be stable.
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Unfortunately, the constant increase in the reserves has been slowed down in recent times due to declining oil production and prices, at $105.7 as at Tuesday, and the increase in sales by the CBN at the WDAS, which summed up to $8.01billion as at May ending. Nigeria depends on oil revenues for 90 percent of dollar earnings and up to 70 percent of the budget.
This has resulted in the weakening of the naira by 1.8 percent against the dollar this year to 159/$ at interbank market currently.
For instance, of the total foreign reserves amount, the excess crude account apparently holds about $5.3billion as at May, while about $1billion is domiciled in the sovereign wealth account; leaving the balance of about $41billion with the CBN.
Razia Khan, analyst with Standard Chartered Bank, London, said: “With portfolio inflows there is always some risk of reversal, especially if domestic reform momentum should slip, or if the election-environment in Nigeria takes centre-stage with accompanying deterioration in key metrics.
“The key risks are around what happens in Nigeria itself. If reforms disappoint, or if oil prices should slump, Nigeria is at risk of seeing a reversal of those inflows, with resulting pressure on the FX rate and/or FX reserves.”
Samir Gadio, emerging markets analyst with Standard Bank, London, recently said: “The current composition of offshore portfolio holdings is dominated by real money accounts (and less by hedge funds unlike in 2007-08), but this does not necessarily mean that real money investors will not be forced to partially pull out should they face significant redemption.”
Therefore, the immediate solution to the age long challenge is the diversification of the economy as the oil production challenge occasioned by activities of vandals and dwindling oil prices at the international market tend to compound the problem.
