New Telegraph

Only Foreign Reserves Adequacy Can Guarantee Stable Exchange Rate –Ayo Teriba

Dr. Ayo Teriba, the Chief Executive Officer at Economic Associates (EA), in this interview with JOHN OMACHONU, speaks about how exchange rate volatility and sundry issues have crippled the nation’s economy

Most people are worried why the Naira continues to depreciate despite a series of policy measures. The governor’s outing in November last year with bankers at the bankers’ dinner seems to be his first major outing where he tried to unfold some of his policy measures such as inflation targeting, exchange rate stability and naira’s fair value, noting that he had seen the issues on ground in CBN and he was going to tackle them headlong, since then there’s no respite, as Naira has been falling as well as other disturbing economic indicators. What’s happening and where did we miss it?

Very good. Your framing the conversation with reference to the CIBN speech last year at the dinner makes it all important and interesting, so that we can benchmark it against six months after the governor made the speech in which he addressed the macro-economic issues.

Well, you said no respite, as the situation with inflation and exchange rates are not any better than the one at the time. I won’t say no respite, rather, I will be specific that the volatility of the exchange rate is not any better than it was then, the inflation keeps rising, so those are the two in spite of series of measures put in place, including measures by the Monetary Policy committee since February resulting in increasing the MPR by first 400 and later 200 basis points, leading to 24.75 MPR and 45 per cent CRR. Those are extreme measures, which produced only temporary respite with the exchange rate appreciation for a few weeks, but then it has begun to depreciate in the last few weeks, showing that those are the temporary effects which is the point that when you are trying to stabilize exchange rate, no one solution is likely to have a lasting effect because if you are trying to use a regulatory solution, and that regulation will produce a temporary effect until the market participants find a way around that regulation.

They will still do what they needed to do but they will find new ways of doing it that doesn’t contradict your regulation. So, you can’t regulate your way out of an unstable exchange rate. You can’t fix the exchange rate and you can’t restrict the transactions that people may do, so if you play opposite in one route, they will bring another route. It’s called financial innovation, you look for ways to innovate around that regulatory obstruction, so the only way out of an unstable exchange rate is foreign reserve adequacy. It’s either reserve levels are adequate and the exchange rate will be stable or they are not adequate and the exchange rate will not be stable.

We should not carry on as if reserve adequacy does not matter. It is the lesson we are learning in the last six months. The essence is that at the end of the day efforts and results should be seen in foreign reserve accretion and the trend of the reserve should be evident for all to see. But for us to be looking at our reserve levels which are very low, even getting lower should be a matter for concern.

How can we shore up the reserves?

To shore up reserves, we should remember that Nigeria’s equity issuance headroom is likely to be more than a hundred times larger than our debt issuance headroom. The efforts the government has exerted like in the case of $3.3 billion from Afrexim Bank, $2 billion from world bank, for instance, are all debts and not equity. Similar effort should be directed in the way of trying to issue equity to increase the foreign reserves.

What I should add is that this involves the whole government and should not be limited to the Central Bank. The point is that the real reason that reserves are low is that the global reality that income levels, output levels, and export levels are declining, our exports revenue has been declining since 2015, so debts anchored on declining GDP or exports are not sustainable. So, when your income outlook is not very bright, you will not be able to get sufficient foreign exchange inflows from debt, because your debt issuance headroom is very small. Indeed, these are some of the decisions we needed to have made since 2015 as we have not switched from depending on debt related to our weakening GDP and exports prospects to depending on equity related to our corporate, real estate and infrastructure assets, which give a bigger equity issuance headroom.

There are two ways you can survive economic crises, either you adopt the outputcentric strategy, if you have the capacity to rev up the growth of your output and everyone can see that your future growth output is very bright, you can borrow, Creditors will give you money because your future growth is certain, so output centric strategy is debtfinanced. But everybody can see that our output has been stagnant, our exports have been declining, and we have run out of honorable debt issuance options. So, we should seek for asset-centric strategy, which means we are offering our real estate, infrastructure, and corporate assets to raise equity at home and abroad like India, Saudi Arabia, UAE among others.

How do you see our equity issuance headroom?

Our equity issuance headroom is huge because Nigeria doesn’t even have any state-owned company that is listed on any stock market. But we haven’t started on that journey. We said we will take NNPC to the market during the Buhari regime, we never did. And since the new regime has come, we are not even talking about it anymore.

So not just NNPC but all our companies use them to raise equity. Use our real estate, infrastructure assets like our airport terminals and rail terminal, among others to raise equities. So, in that case and if we go that route, our foreign exchange would have been bigger, focusing on using assets to generate equity. So, we need to talk very seriously about that as a country, and this is not something that CBN can do alone, it is something that CBN needs to be in contact with all the economic agencies, in a nutshell. The only thing that could change Nigeria’s outlook is to use these assets to generate equity. Adequate foreign investments to shore up our reserves to adequate level and then the Naira will be stable. As for inflation, unless you arrest the exchange rate volatility there’s no premise for you expecting that inflation will moderate because, it will keep being passed through. The primary challenge that Nigeria faces is exchange rate volatility.

We need to solve that before you can start talking of inflation targeting. You have to be careful about how many months of reserves you need to cover imports. It’s a very outdated rule of thumb, which goes back to the days before the 90’s when trade flows were the main mode of international transactions, and capital flows were negligible. Capital mobility was very weak, most countries had closed their capital accounts, so the only external sources of liquidity were your source of exports, but that has changed since dot.com liquidity boom of the 1990s, real estate boom of the 2000s, and the surge in FDI inflows to developing countries in the last decade, capital flows have become the dominant mode of international transactions, so talking about months of reserve to cover imports, whereas what will be adequate to cover imports may be inadequate to cover cexcess of what they may reasonably require for transactions, precaution, and speculation purposes the way countries build up arms and ammunition meant to protect them against any external aggression. So, the bigger your reserve the safer you are, so you can compare favorably well, if you want to acquire fire power, your enemy can out fire you, you can run out of ammunition. Look at Ukraine that is in a war with Russia now, they rely on donations from other countries for them to be able to meet up with Russia. But if she were a super power, no country will attack her. So, the question is what kind of power do you want? If you compare that analogy to reserves, you need to build reserves so much that the question of anybody even exhausting your capacity to defend yourself, like what China has done. Since the mid 90’s they started building reserves and most other countries like Saudi Arabia they all, in one form or the other, have built up too much reserves and they even build up the reserves sometimes by borrowing.

So, we are holding reserves of about $40 billion now, when Saudi Arabia has more than $400 billion. It is smaller in population than us; they have just about 30 or 40 million people, we have over 200 million people. So even if we scale it up to say 600 billion reserves, then the Naira will begin to be stable so we can push up to $80 billion or $100 billion, by leveraging assets to raise equity. So those who look for adequate reserves, do mass privatisation of assets like India, Saudi Arabian are doing. So massive privatisation of assets brings in a large quantum of foreign reserves that will help us moderate capital mobility or exchange rate volatility and then you can expect our exchange rate to be stable, even at a stable price.

What lesson can we learn from this?

The lesson we are learning is what macro economists refer to as the impossible trinity or the monetary policy trilemma, that we can’t have three conditions together. You can’t have exchange rate volatility and capital mobility and then expect your monetary policy to be effective. For monetary policy to be effective, you must ensure either no capital mobility or no exchange rate volatility.

And the way other countries are doing is to build enough reserves to mute capital mobility. So, it’s not that money is not leaving but that they have more than enough reserves for you to even notice that any money is leaving.

If we have such reserves the exchange rate will also be stable and then your monetary policy instruments will become effective, but in a world in which Naira is volatile and capital flows are volatile you shouldn’t expect monetary policy to be effective and that’s the thing we are learning, that you can hike the MPR all you want, you can raise cash reserve requirement all you want, as long as there’s exchange rate volatility or capital flow volatility, they won’t be effective so you must deal with those threats before you now attempt to tackle inflation as a secondary matter. So, the primary matter is that external volatility has to be brought under control.

Once we have stability on the external course then your monetary policy can be effective. In a nutshell that’s how to conclude that we are learning how true the macro policy trilemma is, we are learning how true that impossible trinity is. It is impossible for you to expect monetary policies to be effective in the face of those two external volatilitiesapital flow requirements as most countries build up reserves in

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