The Covid-19 pandemic, which has flattened economic activities around the world and along with its demand and prices for oil, is causing an acute dollar shortage in Nigeria.
Besides the evaporation of the Government’s oil dollar revenues, virtually no one is bringing new dollars into Nigeria, and existing investors in Nigerian bonds are seeking to sell and exit. The problem is that they have to buy dollars to repatriate their capital and profit, but the Central Bank of Nigeria has very little to sell to them or to Nigerian businesses seeking dollars to pay for imported inputs.
Analysts said these trapped investors are reinvesting funds in high-yielding central bank bills while they await enough (dollar) liquidity to get their funds out. The Federal Government Bond Auction for April 2020 was oversubscribed last Wednesday, April 22. The Debt Management Office (DMO) said it offered N60 billion ($154 million) Bonds across three (3) tenors to investors at the Auction – N20 billion each for the 5-Year, 15-Year, and 30-Year tenors. According to the DMO, the total subscriptions received through competitive bids for the 3 instruments were N275.67 billion ($707.8 million), indicating an overall subscription level of 459%. Patience Oniha, the DMO Director-General, said demand was very strong for all the instruments offered at the auction.
EXPLAINER: How Portfolio Investors Help Stabilise the Exchange Rate
As opposed to investors who bring in money to build manufacturing plants or hotels (Foreign Direct Investment), investors who buy companies’ shares or government bonds (Portfolio Investment) usually invest for the short term. Their funds flow freely to anywhere in the world where they can get high returns. For example, the 10% interest they get paid by buying Nigerian government bonds compared to the 2.8% they get on Chilean Government bonds or the less than 1% they are paid on American Government bonds.
That’s why their investment is described as “hot money,” because it easily “rushes” out of a country in contrast to FDI. All they need to do is to sell the shares or bonds. One of the triggers for the exit is any sign that a country cannot or will not be able to supply sufficient dollars when they seek to “repatriate” their capital and profit. That is where portfolio investors are right now – they are stuck here with their profits because the CBN doesn’t have sufficient dollars.
The attempt of portfolio investors to “exit”, which requires buying dollars, can greatly worsen a country’s foreign exchange problems – the rate shoots through the roof as hundreds of portfolio investors try to buy dollars. That is why they have a bad reputation. Yet, portfolio investors are useful in bringing foreign currency into developing countries like Nigeria. For instance, South Africa relies on portfolio investment to finance up to 30% of its imports.
The challenge is how to manage a country’s foreign currency reserves carefully so that the economy doesn’t experience sharp declines in reserves and thus the scarcity of dollars. One of the best ways to do this is not to make the dollar cheaper even when oil prices rise, and the country’s reserves are brimming with dollars. Fewer people holiday or shop in Dubai and London and industries learn to depend less on imported inputs.
Trading at the Lagos-based Financial Markets Dealers Quotes (FMDQ) has reduced to $20 million a day from $400 million a day two months ago. FMDQ provides seamless execution, clearing, and settlement of financial market transactions, across the debt capital, foreign exchange, derivatives, and equity markets. Traders are now hoarding dollars, and no one is ready to sell. The Central Bank of Nigeria (CBN) has suspended its intervention at various market segments owing to a drop in foreign reserves and coronavirus pandemic. Nigeria’s exchange rate waves around N360, N380, and N420 to a dollar depending on the market you are buying.
Checks by Arbiterz last Thursday showed that foreign reserves dropped to $33.6 billion from $38.5 billion in January 2020. This is a drop of about $5 billion. The COVID-19 pandemic has led to a global economic downturn that has triggered a sharp decline in global oil prices. Brent crude, the global oil benchmark, has fallen below $30, putting a big hole in Nigeria’s pockets. Nigeria depends on the proceeds of oil export for 55% of its budget (the money the Federal Government spends to pay workers, on education, healthcare, infrastructure, payback debts, etc. and that it “allocates” to Nigeria’s 36 states to do the same) and for 90% of foreign exchange earnings.
The drop in oil prices and the collapse of Nigeria’s income will not only affect foreign investors. The Federal Government is likely to start defaulting in payments to contractors and even its staff and allocate less money to the states who will also start to default. The Federal Government has already cut the 2020 budget by N312 billion from initial N10.594 trillion to N10.276 trillion.
More Nigerians will have less money to spend because Governments are spending less, and companies can’t get dollars to import inputs. The production of goods and services will decline, and companies will lay off staff. During Nigeria’s last recession in 2016, economic activities declined by 1.15%. It is very likely to be significantly worse this time as economic activities in the major oil importers will not resume fully until a vaccine or treatment is found for the coronavirus. Nigeria will not also be able to borrow as much as it borrowed in 2016 and 2017. Commercial banks will be less willing to lend Nigeria money because of the uncertainty surrounding oil prices.
Also, Nigeria was using more than half of its income, which has now almost disappeared, to service debts. The Government has so far not expressed any willingness to borrow money from the International Monetary Fund and the World Bank, the global lenders of last resort. Nigeria’s debt currently stands at $84 billion. The $3.6 billion that the IMF has approved is akin to humanitarian aid to fight Covid-19. Nigeria could apply for up to $15 billion (our calculation based on the size of the Nigerian economy and the unprecedented demand for IMF funds triggered by the economic impact of Covid-19) under an IMF programme, but this would come with policy reform conditions attached. Nigeria’s Finance Minister, Zainab Ahmed, has said that Nigeria will not apply for funds under an IMF programme. It is yet not clear how Nigeria intends to find funds to fund government obligations and pay for imports.