How faltering global, domestic economies propped ‘flexible’ policy

The assessment of the challenging global and domestic macroeconomic and financial developments, the short-to medium-term prospects for the domestic economy and the outlook for the rest of the year, were central in the recent policy shift by Nigeria’s monetary authority.

Specifically, the diminished growth and sustained decline in global output since 2014, currently estimated at 3.2 per cent in 2016, which is 0.1 percentage point below the 3.1 per cent in the corresponding period of 2015, have been traced to weak fundamentals in both the advanced economies and Emerging Markets and Developing Economies (EMDEs), including Nigeria.

For example, the United States (US) economy slowed to 0.5 per cent in first quarter (Q1) of 2016, compared with the 1.4 per cent growth recorded in the last quarter of 2015.

Japan, suffering from persistent weak aggregate demand, is currently in deflation, although it is projected to grow by 0.5 per cent in 2016, the same as in 2015, even as the Bank of Japan has adopted a negative interest rate policy since January, in an effort to stimulate spending.

Growth in the Euro area at 0.6 per cent in Q1, 2016, was an improvement compared with the 0.3 per cent achieved in Q4 2015, while it maintained its monthly asset purchase programme (stimulus), to further stimulate output growth.

The Bank of England (BoE) also retained its monthly assets purchase programme and retained its policy rate at 0.5 per cent recently, with a commitment to raise inflation to its two per cent long run path.

These economies, while having a varied economic outcomes and policy directions, along with their respective currencies, are one way or the other linked to Nigeria’s economy and growth targets, especially through international trade and exchange rate dynamics.

Weaknesses in major EMDEs, including low capital inflows, rising costs of funds, falling commodities’ prices and continuing geopolitical factors, have been identified as key constraints to growth.

Of particular reference is the adverse effects of commodity prices, which have continued to provide strong headwinds against growth, while defining other economic and financial conditions in the EMDEs.

Consequently, in the first quarter of 2016, Nigeria’s economy suffered from severe shocks related to energy shortages and price hikes, scarcity of foreign exchange and depressed consumer demand, including the delay in budget passage, among others.

Of course, the economic agents could not undertake new investments or procure needed raw materials and the shortage of foreign exchange arising from low crude oil prices manifested in low replacement levels for raw materials, other inputs as well as new investments.

The Governor of Central Bank of Nigeria (CBN), Godwin Emefiele, at the last Monetary Policy Committee meeting, noted that energy crisis experienced in the first five months of the year resulted in increased power outages and higher electricity tariffs, as well as fuel shortages, leading to factory closures in some cases.

“The prolonged budget impasse denied the economy the timely intervention of complementary fiscal policy to stimulate economic activity in the face of dwindling foreign capital inflows. Aggregate credit to the private sector remained highly tapered while credit to government grew beyond the programmed benchmark for the period.

“Many of the prevailing conditions in the economy during the review period were outside the direct control of monetary policy, but we hope that the implementation of the 2016 federal budget, supported by relevant sectorial policies and easing supply shocks in energy and critical inputs, would provide the needed boost to the economy,” he said.

The National Bureau of Statistics (NBS) in May 2016, indicated that domestic output in Q1, contracted by 0.36 per cent- the first negative growth in many years and this represents a drop of 2.47 percentage points in output from the 2.11 per cent reported in the last quarter of 2015, and 4.32 percentage point lower than the 3.96 per cent recorded in the corresponding period of 2015.

There was further increase in year-on-year headline inflation to 12.77 per cent and 13.72 percent in March and April 2016, respectively, led by food index, while pressure was traceable to legacy factors including energy crisis reflected in incessant scarcity of refined petroleum products, exchange rate pass through from imported goods, high cost of electricity, high transport cost, reduction in food output, high cost of inputs and low industrial output.

“In an economy characterized by high import dependence, the shortage of foreign exchange provided some basis for price increases as currently being experienced. The economy needed to aggressively earn and build up its stock of foreign reserves in order to avoid distortions when faced with severe shocks. The current inflation trend, being largely a product of structural rigidities and inadequate foreign exchange earnings would continue to be closely monitored, and in coordination with fiscal policy, with a view to addressing the underlying drivers of the upward price movements,” Emefiele said.

This, perhaps, was the precursor to the unveiling of the big plan to counter the assessed vagaries from the global and domestic macroeconomic and financial developments.

The average naira exchange rate remained stable at the inter-bank segment of the foreign exchange market during the review period at N197.00/US$ and closed at N197/$, with a daily average of N197/$ between March 25 and May 13, 2016. Of course, the level of activity in the autonomous foreign exchange market especially, prior and following the deregulation of the downstream petroleum sector have exerted pressure on the naira.

The Monetary Policy Committee had over the last two consecutive meetings, signaled the imperative of reform of the foreign exchange market, as it interrogated the issues around the current foreign exchange market regime, tracing them to the low foreign exchange earnings of the economy.

“While the bank (CBN) has been working on a menu of options to ensure increased supply of foreign exchange, there was no easy and quick fix to the foreign exchange scarcity problem as supply remained essentially a function of exports and the investment climate,” the committee noted, adding that the a dynamic foreign exchange management framework that guarantees flexibility could not replace the imperative for the economy to increase its stock of foreign exchange through enhanced export earnings.

For a start, the committee decided to embrace some level of flexibility in the foreign exchange market, but mandated CBN to work out the modalities for achieving the desired flexibility that is in the overall interest of the Nigerian economy and when the implementation of the new framework would begin.

“The Committee expressed concern over sustained pressure in the foreign exchange market and the necessity of implementing reforms to engender greater flexibility of rate and transparency in the operation of the inter-bank foreign exchange market. The committee noted that it was time to introduce greater flexibility in the management of the foreign exchange market,” Emefiele added.