Last week we focused on budgets, stimulus, deficits, spending reform, innovative approaches to stimulating the economy, and priority sectors-power, transport and solid minerals (add agriculture), and such matters. This week there are more issues-foreign currency management, a return to controlled interest rates and broader issues of economic management strategy that appear more and more mis-directed under this administration.
First the shocker that emerged from the Central Bank mandating banks to take deposits at a maximum of 15 per cent, grant loans at a maximum of 22 per cent interest and 2 per cent per annum fees, with an explicit maximum spread of 6 per cent. With this policy pronouncement, the Central Bank completed an embarrassing descent into economic illiteracy that has been unfolding in the last few months! I was willing to support the banks “temporary” controls on the foreign currency management side. I believed that those were justifiable in the context of an emergency situation of an unprecedented global financial crisis, and economic meltdown. I agree that the lesson from Malaysia’s response to the Asian financial crisis was that in the midst of a crisis, temporary controls may be useful in stemming outward flows and calming the markets.
In spite of agreeing with this broad response on the currency management front, there are actions from the bank itself which appear to have fed the panic in the first place-the absence of policy direction in December/January while market participants worried about foreign currency sourcing in the new year; doubts about the safety and soundness of the banking sector which I believe have been fed rather than assuaged by the regulator’s complicity in the industry’s decision to defer recognition of loan losses, and lack of transparency regarding the extent of individual institutions’ and the industry’s exposure to margin loan losses; the over-celebratory posture of the regulator since the conclusion of consolidation and pushing the industry in the direction of further capital raising rather than the substantive priorities of the industry. The mere fact that there are rumours in fact questioning the integrity of the CBN’s management of foreign currency depreciation whether true or false is itself a comment on the incestuous relationship that appeared to have developed between the regulator and those it was supposed to be regulating.
While the arguments on foreign currency management may be nuanced and debatable, I find nothing whatsoever that can justify the resort to direct price controls as the Central Bank’s strategy for managing interest rates. For one, they will not work. Price controls which run against economic fundamentals (as Nigeria should very well know from our history in the 1970s and 1980s) don’t work. In financial services, they are even more useless in so far as anyone familiar with structuring of financial products knows that they can easily be structured to achieve effective interest rates far higher than the nominal rates stated on the face of the documentation. More importantly, the attempt to regulate interest rates distorts (and destroys) industry structure accentuating a flight to (perceived) safety and making smaller and weaker banks less competitive. Moreover in an environment with 14.6% inflation, a deposit at 15% makes no sense-a sensible depositor will rather put his money in tangible assets that hold value than in monetary assets at a real return of 0.4%.
The international policy analysts Eurasia Group, says our CBN has with this measure cemented “its growing reputation as one of the most erratic central banks in the world”! Ouch!!! The analysts also make the following comments, “Rather than helping to ease the liquidity crisis, the arbitrary imposition of interest rate controls will severely exacerbate it…The profitability of the country’s banking sector will take a structural hit. Nigeria’s Central Bank Governor Chukwuma Soludo (who is tirelessly fighting to be re-appointed to another 5-year term next month) has clearly abandoned all pretences of a basic belief in market-based economic mechanisms…This adjustment process will crowd out the middle-tier and smaller banks…Unless this circular is rescinded soon, Nigeria will soon develop an even more risky unregulated ‘shadow banking system’ where market rates will apply between borrowers and lenders.” I commend these words to our economic and policy managers. A word is enough for the wise!
It has become clear to me that while there are narrow technical reasons for all our current domestic economic challenges-the capital market collapse, financial sector worries, Naira depreciation, rising inflation and rising interest rates, at its foundations what we are dealing with is most importantly a crisis of confidence. That crisis of confidence has aspects that are not within our control-the exogenous impact of the global financial crisis for instance on capital flows and the price of oil. But there are several aspects that are endogenous and we must now begin to deal aggressively with them. There is a lack of confidence in policy direction, governance and leadership. The populace and the markets perceive no sense of urgency in addressing the nation’s economic and policy challenges, and in some cases (such as the unwillingness to implement the Electric Power Sector Reform Act) a case probably of perverse motives. And there is eroded confidence in the transparency and regulation of our capital markets, financial sector and now currency management as well. If we don’t urgently re-instate confidence at all these levels, our crisis may extend beyond the global financial crisis.
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