How to survive these turbulent times

A very good friend of mine and fellow alumnus of the Lagos Business School recently wrote an article on the Nigerian economy which he shared amongst a small group. I believe this article is worth sharing with our readers due to its invaluable insight. My friend works with one of the banks and does not want his identity revealed hence I am constrained not to mention his name here. His piece goes thus:

With respect to the economy and how it affected the middle to upper class particularly in 2014, what dominated the debate in 2014 was the plunge in the price of crude oil and the possible impact it was going to have on macro economic stability. Towards the end of the year, the CBN responded with a cocktail of monetary policy tightening initiatives which do not need elaboration now.

A wholesome view of the year 2015 presents an overall difficult year, which will be very tough in quarters 1 and 2 as a result of elections and post-election litigations both of which will slow government down. Without government spending within these quarters, tough times loom. Quarter 3 will see the newly elected governments at the federal and state levels begin to spend even though a lot of government vaults will be empty because of the drop in government revenues arising from the crude oil price plunge. Currently, over 20 states are struggling to pay salaries which is really very symptomatic of how dysfunctional our federal system is. Quarter 4 will likely witness growth.

The CBN is in a long drawn battle to defend the naira. I have always been of the opinion that the naira is over-defended. This is more to do with my belief that defending the currency too much is not sustainable than the fact that I have anything to gain from a weaker naira. Generally speaking, defending a currency too much weakens the position of exporters and this is another reason why we should not defend the naira too much since we seek an export-led growth.

To make matters worse, while one may argue that the measures being taken to stabilise the currency are okay in themselves, the way they have been ordered and implemented leaves a lot to be desired. To this effect, it has done an almost equal job of defending the currency and making the market nervous. When the market is nervous, it speculates.

Just to share a bit of my first hand experience with this whole scenario. From my functional desk in the office, the volume of credit to Nigerian banks is shrinking because this whole situation has dampened the appetite of foreign banks. This arises mostly out of CBN’s disorderly handling of RDAs allocations. When bid results are published, you hardly see any systematic basis for allocation. Across products, particular banks win their bids while some others don’t. Across customer segments, particular banks win their bids while others don’t. This sets off the following sequence:

  1. The banks go to the CBN because they have maturing obligations in the form of matured letters of credit or import bills to settle
  2. They lose their bids without any suggestion of the real reason why and what they need to.
  3. The bank resorts to a cocktail of options to settle these obligations including short term foreign currency (FCY) borrowings, refinancing extension requests etc but may or may not succeed in settling this obligation and when it fails, it defaults.
  4. The rate of default at the industry level rises and therefore lenders mark down credit ratings which show up in either of three ways – increase in interest rates, decrease in bank credit limits and shrinking of supplier credit terms.
  5. Ultimately, this leads some people to opt for cash-backed letters of credit (LCs) at the point of issuance or where they even cross over to the black market and pay for their goods in advance.
  6. When they cash back LCs at inception, their cost goes up and they transfer it to you and I.
  7. Then they cross over to the black market, they under-invoice, take a hit on FX but cut down duty payable to government  – government revenue takes another plunge and on we go.
  8. The wheel keeps turning.

Back to the naira saga; one of the indications of the fact that the naira is not near its fair rate of exchange to the dollar is the widening gap between the official and the parallel market. This gap represents a huge arbitrage opportunity which many will continue to chase. Without any deep analysis, it is easy to imagine that the naira will still be devalued. A 5 percent devaluation is possible in my view and that will take the naira to a mid-point of $/N176.4 which will effectively leave the official exchange rate at $/N178.66. This can happen as early as March 2015, which will be the next MPC meeting, and after the elections. In fact, baring a rebound of crude oil price to somewhere near $70pb, our dear naira may trade at circa $/N200 before the end of 2015.

What to do?

•       Make all your savings in FCY. Every naira you have which you do not have immediate need for should be converted and held in FCY.

•       If you have kids in school overseas or in schools in Nigeria where you pay school fees in FCY, negotiate a discount from the school now and pay in advance even if it is part. For those overseas, you can buy interbank funds with minimal documentation.

•       Rein in spending; there will be a massive price correction in the price of finished goods in the market. Therefore the price of goods will rise as inflation is set to rise. If you have liquidity, you can stock essential goods. They will definitely cost more in a few months.

•       If you trade and have a wide war chest, import (even buy locally) now and stock if your underlying margins can absorb your additional working capital cost till such a time in the near future when you can sell at higher prices.

This will not last forever. We surely will get out of it before the end of the year. We’ll possibly see growth in quarter 4 of 2015. The good side of the bad story is that the naira has performed better now than in other commodity price crashes in the past.

You may recall that in 2008/2009, it was so bad that the CBN just shut down the market when the price was $/N117 and by the time we returned from the Christmas holiday, it went as high as $/N180ish before it settled at $/N142 thereabout. We are here because while we are not there yet, non-oil sector has fuelled economic growth in Nigeria in about the last 10 years. Therefore one can argue that the susceptibility of the currency to crude oil price shocks is lower than it has ever been. 

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