Download Devaluation of the Naira: Implication for Businesses in Nigeria

Devaluation of the Naira: Implication for
Businesses in Nigeria
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Introduction
 The global economy is currently evolving through a difficult phase in
a typical business cycles.
 Current phase of the economic cycle is sustained by continued fall in
the global oil price, slow and lagging growth in the Euro zone
countries, increase in world crude oil supply, slow and declining
growth in China and rising incidence on global terrorism (BH/ISILISIS/Crisis in Middle East/Crisis in Ukraine).
 Intensification of regional tension amid declining growth in China,
Russia, Euro zone, Asia and political upheaval in Egypt, Libya,
Ukraine, Syria and Brazil has further compounded the demand
supply dynamics of crude oil in the international market.
 Nigeria like most countries oil exporting and oil dependent
economies is not left out in the global crisis as the country is current
caught in the web of the famous “Dutch Disease”
Introduction
 Nigeria’s GDP was recently rebased with the result placing the
country as Africa’s largest economy with an annual GDP of $510
billion.
 Nigeria’s population and the size of the market has remained an
attraction for FDI inflow with the current population estimate
projected at 183 million people in 2015 (growing at a projected
growth rate of 2.82%)
 The country is currently ranked the 7th most populous country in the
world and has enjoyed a positive GDP growth rate in the last 10 years
and a relatively stable exchange rate regime.
 Between Q1:2013 and Q4:2014 Nigeria posted an average GDP
growth rate of 5.8%, a single digit inflation of 8.2% in Q4:2014 and a
relatively stable exchange rate regime.
Introduction
 By end of second quarter 2014, crude oil price started a free fall with OPEC
reference basket declining from US$105.38/barrel in February 2014 to
US$54.06/barrel in February 2015 and currently US$50.92/barrel at 24th March
2015
 CBN in reaction to the falling oil and dwindling international reserves
devalued the Naira from N155/$1 to N168/$1 and further to N199/$1.
 The series of devaluation that followed since November 2014, has created
new risks in the form of transactions losses for local firms and translation
losses for multinational corporation and firms exposed to dollar
denominated debt.
 In the face of dwindling foreign reserves, declining oil price, unstable
political environment, election cycle, rising government borrowing and tight
monetary & fiscal policies, firms in Nigeria are confronted new and rising
cost of doing business.
 In this presentation, we will examine the source of the current declining
global oil price, the reaction of the CBN, the effect on domestic firms and the
way out of the current crisis.
Source of the Current Declining
World Crude Oil Price
 Generally, crude oil price is determined in the international market
by the interacting forces of demand for crude and the supply of
crude oil.
 When global demand for crude oil is greater than supply of crude oil
prices will rise in the international market.
 When global supply is greater than demand oil prices will fall.
 The current scenario of falling oil price was triggered by;
 Slow world global economic growth compounded by sustained debt
crisis in Euro zone countries, declining output and productivity in
China, recession and declining output in Russia, escalating global
tension in Ukraine and the Middle East, technological breakthrough in
oil drilling and improvement in hydraulic fracturing in the US.
 These changes in the form of demand-side shocks and supply-side
shocks is responsible for the sustained fall in oil price.
Source of the Current Declining World Crude
Oil Price
 Supply Side Shocks
 Driven by improvement in
horizontal fracturing and
drilling techniques in US.
 Since 2004, US oil production
has risen by almost 56%
 The result is supply glut
 Current demand-supply
dynamics is such that oil price
is responding negatively to
rising geopolitical tensions
rather than the usual positive
impact.
 Demand Side Shocks
 Declining demand is triggered by
slowing productivity in China
and very slow recovery of the
Eurozone Areas.
 Global demand shock also driven
by rising geopolitical tension
across the world.
 Horizontal drilling techniques &
hydraulic fracturing technology
likely to be unsustainable should
oil price fall below a threshold of
US$60 /barrel
Source of the Current Declining
World Crude Oil Price
Bonny Light Crude Oil Price 2006-2015
160
140
120
100
80
Crude Oil Price,
61.88
60
40
20
Jan-15
Jul-14
Jan-14
Jul-13
Jan-13
Jul-12
Jan-12
Jul-11
Jul-10
Jan-11
Jan-10
Jul-09
Jan-09
Jul-08
Jul-07
Jan-08
Jan-07
Jul-06
0
Jan-06
USD/Barrel
 As at 24th March 2015, crude oil
price traded at US$55.14/barrel
(bunny light) and US$50.92/barrel
(OPEC reference basket price)
 Declining oil price has implication
for the advanced economy and the
domestic economy.
 For the advanced economy, falling
oil price produces a +ve impact on
the economy through a rise in
discretionary income.
 For developing oil exporting
nations, falling oil price will mean
loss of revenue to the government,
pressure on the country’s foreign
reserves, and an exchange rate
crisis.
Link Between Falling Oil Price, External
Reserves and Exchange Rates
 A well known link exist between oil price external reserves and
exchange rate for oil exporting countries that relies on over 90% of
her annual revenue crude oil sales.
 The link is such that an oil dependent economy relies on a robust
foreign reserves to pay for her import demands.
 During periods of high and sustained crude oil price, the domestic
currency (Naira) tends to appreciate in value because of sustained
inflow of FDI and foreign capital.
 When oil price is declining, the revenue from crude oil sales falls
exerting pressures on the foreign reserves. The result is fluctuation in
exchange rate and a resultant rise in capital flight.
 It is this reason that breeds the so called “Dutch Disease” for a mono
product economy.
Link Between Falling Oil Price, External
Reserves and Exchange Rates
 How Falling Oil Price Feeds into the Economy
Declining Oil
Price
Declining
Government
Revenue
Reduces the External
Reserves
Exchange Rate
Devaluation







Budgetary
Constraints
Falling price of export in relation to import
Rise in interest rate and cost of borrowing
Government borrowing crowds out private sector investment
Inflationary pressure on the economy
Rising inventory and cut in production by firm
Declining Output
Rising Misery Index
Reduction in
Government
Spending
Increased
Government
Borrowing
Tight Fiscal Policy
Increased Tariff,
VAT and Tax
Link Between Falling Oil Price, External
Reserves and Exchange Rates
150
100
50
Apr-14
Jan-14
Oct-13
Jul-13
Apr-13
Jan-13
Oct-12
Jul-12
Apr-12
Jan-12
Oct-11
Jul-11
Apr-11
Jan-11
Oct-10
Jul-10
Apr-10
Jan-10
Oct-09
Jul-09
Apr-09
Jan-09
Oct-08
Jul-08
Apr-08
Jan-08
Oct-07
Jul-07
Apr-07
Jan-07
Oct-06
Jul-06
Apr-06
0
Jan-15
200
Oct-14
10
5
INTBR, 197.8
0
-5
-10
crude oil price, 61.88
-15
App/DEP, -18.6
-20
Jul-14
250
Jan-06
USD/NAIRA/USD/Barrel
Exchange Rate, Crude Oil Price & Currency Devaluation
 The chart above captures the relationship between exchange rate, crude oil price and
currency devaluation.
 Between October 2008 and July 2009 oil price declined slightly below US$50/barrel
this was followed by rising exchange rate and a massive devaluation of the Naira.
 Similarly, between October 2014 and February 2015 oil price fell below S$50/barrel
this again triggered a rise exchange rate and a massive devaluation of the Naira from
N155/$1 to N199/$1.
 Currently, IFXEM is trading at N199.7/US$ while the BDC is trading at between
N225/US1$ and N227/US1$
 Question: Why the need for devaluation and how does this impact on firms?
Reason for Currency Devaluation &
Reaction of Central Bank
 The term currency devaluation is often used loosely to mean
the same thing as currency depreciation.
 It refers to the deliberate lowering of the value of a country’s
currency in relation to other country’s currency within the
context of a fixed exchange rate management system
 Devaluation or depreciation of a country’s currency is
usually triggered when the country is experiencing an
adverse BOP/BOT crisis or by worsening economic
conditions transmitted into the domestic economy from the
foreign market.
 The current devaluation of the Naira is linked to shocks
emanating from the falling oil price driven by a global
supply glut and a declining world demand for crude oil.
Reason for Currency Devaluation &
Reaction of Central Bank
 Nigeria’s economy is a mono product economy that relies on crude
oil sales for over 85-90 % of her annual revenue.
 Between 2006 and February 2015, Bonny Light crude oil price
averaged $94/ barrel while the average monthly oil price between
2010 and end 2014 stood at $104.4 /barrel.
 Despite the positive windfall gains arising from the benchmark oil
price of $79, $77.5 and $65 in 2013, 2014 and 2015 respectively, the
country’s external reserves declined precipitously from $53.6 Billion
in 2008 to the current to $30.9 billion in March 2015.
 This declining trend in external reserves reflects the current concern
of the Central Bank of Nigeria as continuous defending of the Naira
in the face od dwindling reserves became unsustainable .
Reason for Currency Devaluation &
Reaction of Central Bank
 Before the spate of currency devaluation that has taken place since
November 2014, Nigeria operated a “dirty float” exchange rate
management system where the Central Bank allows the exchange
rate to float around a band.
 The official exchange rate was allowed to float around a midpoint of
N155/US$ within a band of +/-3% with MPR held constant at 12%
between the 2012 and 2014.
 Reacting to the declining global oil price, the government advised
business operators not to panic but responded by coming up with
series of drastic macroeconomic policy measures ;
Reason for Currency Devaluation & Reaction of
Central Bank
 Increased Monetary Policy Rate (MPR) by 100 basis points to 13% from
12% with a symmetric corridor of +/-200 basis points
 Increased Cash Reserve Requirement (CRR) on private sector funds to
20% from its initial 15%.
 Ban in the sales of dollars to importers of telecommunication
equipment, power generators and finished products at the CBN foreign
exchange auction.
 Restriction of lenders and discount houses from placing more than N7.5
billion as deposits with the CBN.
 CBN moved the mid-point of the official exchange rate to N168/US$
from N155/US$ and increased the band around the foreign exchange
rate to +/-5% from 3% signaling a devaluation of the naira by 8 percent.
 The closure of the Retail and Wholesale Dutch Auction System of the
foreign exchange market signaling a further devaluation of the
exchange rate from N155/US$ N168/US$ to N199.7/US$.
Implications on SME,s and the
Current Structure of the Economy
 The current structure of the Nigerian Economy is such that Nigeria
currently is the largest economy in Africa, and the 24th economy in
the world in terms of the country’s output.
 With the conclusion of the rebasing exercise, there was a notable shift
in the structure of the Nigeria from the dominance of Agriculture to
a Service Sector -driven economy.
 Service Sector accounted for the largest share in GDP in Q4-2014 and
was the fastest growing sector in the economy.
 The current structure of the economy shows a declining output
between Q1:2013 and Q4 :2014.
 Real GDP growth of 5.94 % in Q4: 2014 dropped below the
corresponding growth of 6.77% in Q4: 2013 as shown in the figure
below.
Implications on SME,s and the
Current Structure of the Economy
Real GDP Growth (year-on-year)
8
7
6.77
Growth Rate (%)
6.54
6.21
6
5.4
5
6.23
5.94
5.17
4.45
4
3
2
1
0
Q1
Q2
Q3
2013
Q4
Q1
Q2
Q3
Q4
2014
 In terms of the current sectors driving economic growth and sectors driving GDP the
service sector which houses most of the SME’s and micro enterprises sits on the drivers sit
 Question : What does this sector produce? How does the increased demand for import
by this sector affect foreign exchange market? Where does the current exchange rate
dynamics leave the productive sector?
Sector Contribution to GDP Q4:2014
16.27
8.97
4.34
0.01 0 0.14 0.35 0.71
0.25 0.5
4.44
8.76
3.67
2
2.3
0.35
0.02 1 1.25 0.18
1.03 0.99 0 0.01 0.1 0.08 0.03
0.27 0.07 0.18 0.27 0.25 0.01 0.24 0.08 0.49 0.55 0.1
8.3
Sector Real GDP Growth Rate Q4:2014
32.01
32.92
29.5630.69
30.74
26.59
24.28
23.13
20.17
17.85
5.16
1.18
-25.15
23.37
21.35
17.56
14.1815.6
18.08
13.32
12.79
6.78
27.44
12.66
6.47
2.81
11.43
5.32
5.14
12.05
7.91
2.83
10.98
2.48
8.2 7.76
5.96
3.1
Implications on SME,s and the
Current Structure of the Economy
 In terms of growth and contribution to the Nigerian economy, the
service sector is the most active sector in 2014-2015.
 It is this sector that houses micro enterprises, small enterprises and
medium scale enterprises.
 By definition, the National Policy on Small and Medium-sized
Enterprises categorizes of SMEs into the following groups.
Categorization /Grouping of SME’s
Category
No. of Employees
Assets Excluding Land & Building
(N’M)
Micro Enterprises
Less than 10
Less than N5M
Small Enterprises
10-49
>N5M but <N50M
Medium Enterprises
50-199
>N50M but <N500M
Implications on SME,s and the
Current Structure of the Economy
 In the current structure of the Nigerian economy, micro enterprises,
small medium-sized enterprises and large firms can be found
operating in;
 Wholesale Retail Trading Sector,
 Agriculture & agribusiness food chain sector
 Fast Moving Consumers Goods sector (FMCGs),
 Telecommunication & ICT Sector,
 Health Care, Transport and Construction sector
 Education & Health Care Services,
 Hotels &Hospitality,
 Movie and Motion Picture Industry.
 These sector required substantial amount of foreign exchange and
current burdened by the high cost of fund and transactions losses.
Implications on SME,s and the
Current Structure of the Economy
 Continuous devaluation of the naira against the UD dollar
implies rising cost of imports at the expense of Exports.
 The current tight monetary policy stance of the CBN also
implies rising cost of borrowing.
 In addition to rising cost of borrowing is the issue of increased
government borrowing which creates two major effects on
SME’s.
- Government borrowing crowds out private sector
investment
- Increased government borrowing increases the risk of
debt overhang
 Both factors constrains the ability of the Government to create
the much needed environment for business to thrive.
Implications on SME,s and the
Current Structure of the Economy
 In addition to tightening liquidity, currency devaluation tends to
create a bearish capital market through rising interest rate and rising
inflation.
 This directly impacts on the capital market through it effects on;
 Fixed income securities
As interest rate rises following currency devaluation , the preferences of
portfolio holders will move from existing bonds and treasury bills to new
issues.
This exist because of the inverse relationship existing between fixed income
securities’ prices and interest rates.
The result is a bearish capital market.
Implications on SME,s and the
Current Structure of the Economy
 Effect on Share Prices
For the domestic companies operating in Nigeria, currency devaluation will
boost export sales but the feedback effect of high cost of imported raw
materials can have a negative effect on corporate profits.
The effect of this changes is usually transmitted into the economy through a
decline in all share price index.
 Asset Portfolio Shift
Currency devaluation usually leads to a shift in portfolio preferences From
the Capital market to the Money Market as a result of the new prevailing
high and attractive interest rate in the money market.
 Shrinking Market Liquidity
A fall out of currency devaluation is shrinking market liquidity usually
triggered my movement of “hot money” in the form of capital flight.
Current Market Reaction to Currency
Devaluation & Tight MP
 The Central Bank appear to be winning the game of currency
devaluation at a high cost of speculative market activities
 At the current crude oil price of US$55/barrel, the IFEM rate
appears to be converging with the BDC to a fair market value.
 Cost of doing business now vary high for SMEs and corporate
firms with firm heavily exposed to dollar denominated debt
resulting to cutting back in production and reducing the size of
their workforce.
 Election cycle further compounding the situation. Government
in the face of dwindling oil revenue will most certainly
embark on fiscal policy restructuring to boost revenue drive
(Contractionary fiscal policy) immediately after the conclusion
of the election .
Current Market Reaction to Currency
Devaluation & Tight MP
Oil Price, IFEM, Naira App/Dep
140
Oil Price, BDCDollar, Naira App/Dep
250
140
250
120
120
200
100
200
100
80
150
60
80
150
60
40
100
20
40
100
20
0
50
0
50
-20
-20
-40
0
Oil Price
App/Dep
IFEMDollar
-40
0
Oil Price
App/Dep
BDCDollar
Way Out for Firms
 Prudent management of cash/during periods of economic
cycles cash is usually described as king.
 Innovation and move away from import dependent
consumables. One interesting phenomenon of the
Nigerian market is that the products are not competitive
in the international market hence do not attract dollar
value.
 Firms should diversify their production base by moving to
value added sectors as opposed to trading in imported
goods and services.
 Currently production base still largely at the unfinished
goods state. Effort should be geared towards goods that
commands premium price in the international market.
Way Out for Firms
 A clear gap in the industry today is the absence of the much
needed skill and innovation to drive productivity.
 To boost productivity, the private sector must play a leading role
in encouragement of research and development by funding
research and linking up with the various institutions in the
country.
 At the beginning of the slide in oil price, government clearly said
businesses should not panic but the reality on ground is that the
government panicked and came up with all kinds of policy
response.
 Going forward, business survival in the current political
dispensation requires continuous tracking of policy and non
policy indicators as well as diversification of production base to
reflect the country’s competitiveness.
Thank You
Any Question?