As the 4th variant of monetary easing looms, can Nigeria’s economy brace for the coming Euro wave ponders EDOZIE IFEBI
In August, recorded Eurozone inflation was lower than expected, at 0.3%. The newly released inflation rate stands at a five-year low. Growth in the three largest Eurozone economies also stalled over the last two quarters.
Facing new threats of deflation, the ECB president, Mario Draghi said in the Jackson Hole conference, a meeting of the world’s major Central bankers, that the ECB will “do everything within its power” to prevent the Eurozone from falling into a ‘Japan-style’ deflation.
Among his price-boosting arsenal are the Targeted Long-Term Refinancing Operation (TLTRO), and as a last resort, large-scale Asset-Backed-Security purchases. At the conference, he said that the ECB will “use all the available instruments needed to ensure price stability in the near-term”.
Running out of options in the fight against a looming deflation, Draghi is seriously considering the option of a euro-style QE. There are now increased chances of QE according to analysts from Nomura International and UniCredit SpA, both major Euro-centric banks.
The run-up to the adoption of QE is however littered with several major obstacles. First is the design of the program execution. BlackRock Inc., the largest money manager in the world has already been hired by the ECB to advice on designing a program for the asset purchase, further clearing doubt about the certainty of a QE move.
Also, EU rules prohibit the direct financing of EU governments by the ECB, hence the ECB is faced with the task of meandering through EU-set rules to reach the bond markets of the participants.
Alongside this is the attendant problem of moral hazard in choosing which of the 18 countries will benefit from the programme. “There are enormous political, legal and moral hazard constraints; the euro area isn’t a single sovereign nation state. That’s a fundamental obstacle,” says James Nixon, an economist with Oxford Economics in London, in a statement to Bloomberg.
Also, there is the disapproval of Germany.
The German Finance Minister has voiced his disapproval of QE, especially as the second (France) and third largest (Italy) Euro-zone economies have as of now, failed to carry out market-oriented reforms.
He opines that reforms should come first before QE, as QE will only make matters worse if the market structures meant to sustain resultant progress are absent. Measures will include boosting the productivity and competitiveness of the region, and ‘loosening rigidities within the economy’.
Furthermore, there are other concerns that the adoption of QE will negate the effects of earlier measures initiated by the ECB to boost liquidity and prevent inflation.
The ECB, wary of an ineffective large-scale ABS purchasing programme, is considering counterbalancing its mooted monetary policy measures with other fiscal efforts contributed by the participating governments.
The ECB ABS-Programme, the fourth monetary easing move by a major economy, follows that of the Federal Reserve, Bank of England, and the Bank of Japan.
Aside from the intended outcome of preventing deflation and boosting liquidity, other ‘negative side-effects’ of QE tend to occur concomitantly. Some of them are asset price bubbles and inflated government balance sheets. The biggest victims of QE however, have been known to be emerging or developing economies which were previously exposed to QE-inspired inflows.
“Empirical evidence shows that the investment driven African countries (frontier markets), which were more integrated into the global financial markets, were relatively more exposed to effects of QE than the rest of the continent,” says Mthuli Ncube, Chief Economist of the African Development Bank ADB.
Usually, with the initiation of QE comes an increased appetite for risk among global investors. This is manifested in increased demand for sovereign bonds and stocks in emerging/developing capital markets.
African frontier markets like Nigeria usually ‘suffer’ from this ‘hyper-flow’ because the markets aren’t deep enough and often volatile as a result of intense capital-flow activity.
Moody’s says that “QE tapering is most likely to have a negative impact on countries that lack buffers such as hard currency reserves or policy tools such as a floating exchange rate.”
As a result of previous bouts of US-led QE, “the currencies of South Africa and Turkey were hit the hardest by capital flow adjustments resulting from QE tapering. This is due to country-specific features, such as relatively larger current account deficits, lower-than-average total hard currency reserves and lower official interest rates”, it said in its report. It further said: “Brazil has so far not been affected because it began its own tightening cycle much earlier than other countries”. Also, “Russia’s current account surplus and larger hard currency reserves have so far shielded it from the tightening in global liquidity.”
“Events confirm previous expectations that the tapering process and its associated increase in US and global financing costs will, on average, have a considerably greater impact on countries in emerging markets than on advanced countries,” says Moody’s Sovereign Chief Economist Lúcio Vinhas de Souza. “Emerging market countries are among the most exposed to a reduction or reversal of financial flows given that they were the recipients of large amounts of capital during the quantitative easing period.”
In estimating the susceptibility of an economy to the adverse effects of QE, the first sign is often the degree of dependency of the economy on foreign capital, and the dependency of the local capital markets on foreign investment inflow. As a proxy, the size of foreign portfolio investment relative to total market depth or turnover is the parameter to watch closely.
Next are the strength of its macro fundamentals, and then the effectiveness of its monetary policies.
How has Nigeria fared?
Data from the Nigeria Investment Promotion Council showed that of the total Foreign Private Capital (FPC) inflow to Nigeria for 2012 (January – May), Foreign Portfolio Investment (FPI) accounted for 82.26 percent; Foreign Direct Investment (FDI) accounted for 10.93 percent, while Other Investments (OI) accounted for 6.80 percent.
In 2013, the trend continued. FPI accounted for 84.07 percent, FDI 8.31 percent, and OI 7.62 percent. Data for the rest of the year are not available. FPI are securities and other financial assets passively held by foreign investors.
Data from the NSE corroborates the trend. NSE 2014 year-to-date data (July 31 2014) shows that of the total transactions recorded on the bourse, total foreign transactions had a share of 55.06 percent while total domestic transactions had a share of 44.94 percent.
As at March 2014, foreign transactions accounted for 78.25 percent of total transactions on the NSE, while domestic transactions accounted for a paltry 21.75 percent. As at July however, the foreign share of equity transactions had fallen to 25.17 percent, allowing domestic share to climb to 74.83 percent.
These seem to be in line with the global investor behavioural trend where tapering concerns have forced investors to sell off assets in developing economies, affecting the local currency and the local bourse index as they do so.
Analysis of the data points out that the Nigerian capital market, and to a larger degree, the financial system is still vulnerable to the vagaries of external capital flows. The NSE ASI, swinging wildly through the period, shows that the markets are still characteristically shallow.
Nigeria’s macro fundamentals however, seem adequate to counter the double edged effects of more monetary easing. In the short term more hot money flows would be welcome in Niegria to help shore up the naira and build up reserves that have fallen from highs of just a year ago.
The monetary authorities will also have to contend with the inevitable pressures that will surface once the punch bowl of stimulus is removed. Some positive signs for Nigeria are:
The CBN has been active in deploying the external reserves in shoring up the naira following international pressures.
The strong grip of the CBN on the financial sector, and on the banks in particular signals that the needed monetary policy discipline is largely available.