CBN and the return of ‘Animal Spirits’

The term ‘’animal spirits’’ was coined by John Maynard Keynes to describe the psychological factors that influence economic activity. To the celebrated economist, business cycles (periodic fluctuations in economic activity) are caused by volatile expectations about future sales and profits. Optimism and pessimism -the “animal spirits”- drive not only investment but also household consumption and saving.

Not too long ago, signs of depressed animal spirits dotted the economic landscape not least because Nigeria’s mono-product economy was severely hit by plummeting crude oil prices. Waning confidence in the economy, which officially entered into a recession at the end of June 2016, led to capital flight and foreign reserves nosedived. Sustained depreciation of the naira due to foreign exchange scarcity took a heavy toll on virtually all sectors of the economy, most especially the manufacturing and financial services sectors. For instance, the Purchasing Managers Index (PMI), a measure of manufacturing activity, was below the 50 point threshold for the greater part of 2016.

The stock market was not spared either as major indicators remained in the negative territory reflecting bearish market sentiments with equities market capitalization dipping from N9.86 trillion on January 1 2016 to N9.25 trillion on December 30 2016. Indeed, the performance of the stock market for quite some time mirrored the downturn in economic activities. The National Bureau of Statistics reported negative GDP growth rate of -1.51 per cent for the full year of 2016 amidst high unemployment rate and soaring inflation.

Today, the narrative is changing. Although Nigeria is still technically in a recession, the economy is showing signs of gradual recovery. One indicator of rising business confidence is the Purchasing Managers Index for April which stood at 51.1 index points indicating expansion in the manufacturing sector after many months of contraction. According to the report by the Central Bank of Nigeria: “Manufacturing PMI for the month of April 2017 showed recovery, production level is growing faster; new orders and raw materials inventories growing from contraction and employment level is declining at a slower rate’’.

There is also the business activity index which spiked to 53.3 points in April 2017 from its level of 49.8 points in March 2017. In a similar vein, the stock market has been on a bull run lately as the All Share Index posted gains all through the week-ended May 5 2017. World Economics, a London-based organisation, even declared recently that the economy was already out of the recession on the strength of its Sales Managers Index and Market Growth Index which recorded upticks in the month of April.

Several reasons account for why animal spirits seem to be making a comeback. These include the relatively high crude oil price – at least well above the 2016 budget reference price of US$38 dollars per barrel; stable crude oil production in the neighbourhood of 2 million barrels per day- just 200,000 barrels shy of the budget target of 2.2 mbpd; relative calm in the oil-producing Niger Delta region; accretion to foreign reserves from about US$27 billion at the beginning of the recession in June last year to over US$31 billion currently; the release of over N1trillion to federal ministries, departments and agencies from the 2016 budget to fund capital projects as disclosed by the Minister of Finance, Kemi Adeosun and the recent launch of the Economic Recovery and Growth Plan by the Federal Government.

Undoubtedly, a major catalyst to the return of animal spirits has come from the CBN’s efforts at stabilizing the exchange rate given the fact that this variable is a key influence on business confidence. This it has done through sustained interventions in the foreign exchange market. The apex Bank is estimated to have sold about US$6 billion in the interbank foreign exchange market between January and April this year. The introduction of a foreign-exchange window for foreign investors has gone a long way to buoy confidence; so also is the special forex window for small and medium-sized businesses to enable them import the much-needed raw materials.

These initiatives have improved liquidity in the forex market, minimized speculative attacks on the naira as well as reduced the tendency for arbitrage. Consequently, the naira is beginning to strengthen in the parallel market with the exchange rate dropping from a high of N525 to the dollar sometime in February this year to stabilize at between N380 and N390 at present thereby narrowing significantly the gap between the official and the parallel market rates. In its Consumer Price Index Report for the month of March 2017, the NBS had reported that the drop in inflation rate by 0.52 per cent was in part a direct consequence of lower exchange rates.

It all boils down to animal spirits. Many (including the CBN Governor, Godwin Emefiele, who is reported to have predicted a positive turn-around by the end of Q3 of 2017) are upbeat that the economy will exit the recession sooner than later. Citing recovery in oil production, continued growth in agriculture, and higher public investment, the IMF has predicted that the Nigerian economy would grow by 0.8 per cent this year. This much was disclosed in its World Economic Outlook released during the April 2017 IMF-World Bank Spring meetings in Washington D C, United States of America. A more ambitious Real GDP growth target of 2.19 per cent for 2017 is contained in the recently launched federal government Economic Recovery and Growth Plan. Notwithstanding the recent drop in crude oil price to less than US$50 per barrel following an increase in US Shale oil production as reported by Bloomberg, the short and medium term economic outlook remains bright. In its April Commodity Markets Outlook report released recently, the World Bank put its crude oil price forecast for this year at US$55 per barrel and even projected an increase to an average of US$60 per barrel in 2018.

The CBN deserves commendation for the bold initiatives it has taken so far to strengthen the naira and for not succumbing to pressure to completely leave the fate of the domestic currency at the mercy of the so-called ‘invisible hands’. In order to ensure effective forex policies, the Bank should not spare the rod on any financial institution under its watch that is in breach of forex regulations. Now that the country’s revenue outlook looks good and headline inflation has headed south, the Monetary Policy Committee of the apex Bank may well consider bringing down the policy rate from the current high of 14 per cent. Doing so will further speed up the process of building business confidence and lifting animal spirits.