ALL EYES ON THE CBN
Can Governor Cardoso Resist Political Pressure?
Long time, no post. One big announcement: I am bringing back my course on macroeconomic analysis, check the course to see if you’d be interested.
In this post, I want to share my thoughts on the botched FX reforms, new minimum wage and fiscal policy dominance.
In every transaction, the party with the advantage is the one who collects more information about the other party without revealing too much about themselves. This is called information asymmetry, and it's powerful.
Imagine yourself as a trader in the market, any market, trying to buy a product that is sold by suppliers. You can trade to your advantage if you know the state of their supplies now and in the future. If these suppliers sell yam and you know that yam harvest is going to be bad and the stock of yam is already depleted, there is only one trade: buy early before the price of yam rises. If yam harvest is likely to remain poor for longer, you can keep buying even at higher prices until there is information of a good harvest. Ahead of a good harvest, you can offload your stock and replenish it when prices fall.
This scenario is not so different from trading in the foreign exchange (FX) markets. To keep it really simple, the external reserve of the CBN is the stock of dollars available, and oil exports are sort of the periodic harvest. When the reserve is depleted and oil exports are weak, the exchange rate is likely to depreciate or the price of a dollar rises.
Analysts and people who paid attention to the CBN suspected that the external reserves balance of the institution was overstated. But these suspicions could not be confirmed because the CBN never published proper financial accounts. This information asymmetry helped the CBN manage the exchange rate even though it had massive short-term FX obligations that would render the reserves inadequate and the CBN “insolvent”. Most of the analysts and the general public did not know this, so the exchange rate was broadly stable in the official and parallel markets.
Some analysts who were deeply connected to the people who knew knew. The people who tend to know these things are the bankers, because they were effectively dollar lenders to the CBN. Analysts who were tracking the monetary financing provided to the FG (reflected in rapid money supply growth) and the dysfunction in the domestic oil market also knew that trouble was coming.
Most of the general public, including businesses, were unaware of the trouble looming, and went on with their business as usual. The banks hedged their positions by having more dollar assets than liabilities and speculating on a devaluation with derivatives.
In May 2023, a new president came into office with the intention to clean up the mess at the Central Bank. In June 2023, the CBN moved to a more market determined pricing and the exchange rate sharply lost value in the official market while holding steady in the parallel market. These moves and the outcome were expected.
In August 2023, the CBN surprised the market by releasing its audited financial accounts from 2016 to 2022. This was initially a welcome surprise, because a month prior I wrote about the absurdity of CBN and AMCON not publishing audited accounts.
But the suspicions of an overstated reserves were confirmed from the financial statements, with some analysts estimating net reserves to be negative or too small to cover even a month’s imports. The CBN made a grave mistake. It lost its information advantage over the market by opening all its cards without any backstop.
News of the CBN failing to meet obligations on FX swaps (contracts to supply dollars) started circulating. Financial markets hate and punish negative surprises. Chaos ensued, and the market is yet to recover until today.
The banks profited greatly because they knew. Non-financial corporations with huge dollar liabilities, from Telcos to FMCGs, suffered massive losses that destroyed their profitability and balance sheets. Individuals who were hoping to purchase dollars at a discount to fund Japa ambitions were wiped off.
What went wrong? The first big mistake was the lack of sensible leadership at the CBN after Godwin Emefiele was removed. The first task of the new leadership should have been to wait: assess the state of the reserves and seek financing to shore it up before making its accounts public and implementing the FX reforms. That way, danger would have been averted while maintaining transparency to the public about the CBN’s finances.
The second big mistake was failing to align monetary policy to the new reality. If investors are spooked, and rightly so, and they are rushing to the exit to avoid the impending devaluation, it only makes sense to make the Naira worth holding again. The CBN failed to raise interest rates to a level that would have supported the strength of the Naira. This was a concern I shared in June 2023 in a Twitter thread.
Governor Olayemi Cardoso resumed office after these decisions and I am not sure that he led those decisions. But he is a long time member of the President’s inner circle, so maybe he was, I don’t know.
I am writing this because a friend once asked why there was such a strong volatility in exchange rates, and this, in my view, is the strongest argument. Unfortunately, many spectators would think that “FX market reforms are not working because Nigeria is different.”
Beyond the hastily put together FX reforms, the fiscal policy actions taken subsequently have inflicted severe damage.
Spending like it is the ‘70s!
I have written a detailed post about fiscal policy in Nigeria, so please read it if you have not as this will be short.
I have long suspected that the candidates who contested the 2023 elections had a poor grasp of the scale of Nigeria’s fiscal troubles. It was obvious in the manifestos I read, with only one candidate promising fiscal discipline beyond the removal of petrol subsidies.
The new government rushed to pass a supplementary budget of N2.1tn, increasing the 2023 spending plan to N23.9tn (2015 budget was N4.5tn). This is a staggering amount by all standards, and it made no sense that the government was being frivolous while asking Nigerians to tighten their belts by removing petrol subsidies. It essentially meant that the early gains from subsidy removal were captured by the political elite, especially since their spending never serves the public. The supplementary budget was partly meant to finance renovations of residences for the new government.
The point of removing petrol subsidies was that it had become unsustainable because the FG was borrowing too much to run its other, more important priorities like funding education, healthcare and other public goods which had better long term benefits.
The government could not afford to continue such borrowing and needed to be more disciplined. The clearest sign of this was high interest payments, which were consuming 80% of government revenues (vs a threshold of 50%). And Debt to GDP, which used to be a source of comfort about the debt burden, had almost breached the 40.0% threshold set by the Debt Management Office (DMO). The deterioration in these debt indicators came with consequences. Investors in the Eurobond markets asked for higher interest rates to lend to the FG. Credit rating agencies downgraded Nigeria to its worst rating since the debt crises that ended in 2006. Effectively, it had become more expensive for every Nigerian institution to borrow outside the country.
Yet the spending party, funded with debt, continued. Another record breaking spending of N28.7tn was planned for 2024 even though the FG earned less than N10tn in revenues in 2023.
The markets paid attention as the FG was heading towards bankruptcy (it was effectively bankrupt already). The only saving grace the FG has is that its debts are mostly in local currency and mostly owed to the CBN which did not care about repayment.
If business was going to continue as usual, then it made no sense to destroy value in Nigeria. Existing investors rushed to the exits and prospective investors remained on the sidelines.
What will the CBN do about the Proposed New Minimum Wage?
Borrowing as an individual or a business is hard. If you need loans for whatever, be it to buy groceries or to start a small business or build a new factory, you must make a strong case to the lender that you can and will pay back.
But sometimes, it can be easy. You could borrow from a lender that does not care about repayment. Or a lender that will not punish you when you default, maybe because seeking repayment is not worth the effort or they do not have the capacity to enforce repayment.
In Nigeria, it is both hard and easy. The difficult part is getting loans, but there is hardly strong enough punishment in the event of a default, whether you are a billionaire or a low income earner. What’s the worst that can happen? Well, the lender will not lend to you again.
Unless you are the Federal Government.
The FG as a sovereign issues currency backed by nothing but its laws. The power to issue a currency backed by nothing is dangerous in the wrong hands, especially in the hands of politicians who do not think beyond the short-term. This responsibility shifted to Central Banks all over the world, with the laws giving them independence from the government. They have a responsibility to earn and maintain public trust in the currency.
In reality, Central Banks rarely operate outside the influence of the government in developing countries, and some Central Bankers like Emefiele willingly subject themselves to them. This was the Nigerian story between 2015 and 2023. When this happens, the Central Bank can fund the government endlessly, at least until it becomes unsustainable.
It seems we have reached that point. Governor Cardoso has promised to stop advances to government after his predecessor, Godwin Emefiele, loaned the government over N23tn which remains unpaid.
With the FG having an unsustainable debt burden and running large deficits, there will be political pressure on Cardoso to finance deficits and make debt cheap.
His stance is going to be further tested as the FG and Labour Unions are negotiating a new minimum wage, which will only increase spending. With lacklustre revenues, the FG will have no choice but to borrow to pay for the wage increase.
By my calculations, the minimum wage should be at least N80,000 if we adjust the existing N30,000 minimum wage set in 2019 by inflation. The FG’s proposal of N60,000 has already been rejected and I suspect the final agreement will be close to N80,000. This means we can expect at least a 165% increase in the minimum wage.
What makes a new minimum wage an expensive adventure is that it will disrupt the existing salary structure. In fact, the more aggressive the increase, the more aggressive the rise in wages across the board because existing salaries across levels are not far apart.
For instance, if the minimum wage increases to N80,000 for someone on Level 1 currently earning N30,000, then it must increase significantly for someone on Level 9 currently earning N77,415.
With the implementation of the new minimum wage, salaries must increase by more than 100%, which means that FG’s wage bill will more than double by 2025.
In the past, it took 6 years for FG’s personnel cost for MDAs to more than double from N2.3tn in 2018 to N4.4tn in 2023 and N5.5tn in 2024. The 2024 figure includes a wage award of N35,000/month for six months announced by President Tinubu in October 2023. Beyond that, I suspect the increase in the wage bill has been driven by promotions and hiring.
Beyond personnel cost, the FG’s expenditure on debt service and statutory transfers has increased aggressively over the past eight years. President Buhari’s debt binge is responsible for the high debt service costs, but nothing explains the aggressive rise in statutory transfers. Why do the legislature and judiciary, who I believe receive most of statutory transfers, suddenly need such a spending boost? The chart above shows that personnel cost has seen the slowest growth, further strengthening the case of Labour Unions.
Based on the 2023 figure, we can expect the wage bill of the FG to double to at least N8.8tn in 2025. This will raise the planned deficit of N10.2tn in 2025 (3.9% of GDP) to at least N14.6tn (5.7% of GDP), unless the FG is able to raise revenues aggressively. That can hardly be done in an economy that is barely growing.
Neither will there be a decrease in spending to fund the minimum wage, especially as debt service is the largest component of spending and it is sticky (unless the FG defaults). Since fiscal discipline is not on the table, the FG will need to borrow to finance its wage increase.
If you read my article on “Nigeria’s Fiscal Imperative”, you would know that the FG cannot afford more deficits. They actually need to reduce primary deficits (non-debt spending) to make the current debt burden more sustainable. As at 2023, debt service was already consuming more than half of FG’s total expenditure.
Borrowing at the current interest rates of more than 20%, which is still significantly below the current 34% inflation, will be devastating for FG’s debt sustainability, hence there will be pressure on the CBN to keep rates even lower than it currently is. If interest rates remain high for longer, I expect the FG to go back to the CBN for cheap advances. If the CBN agrees to either or both, then we should expect further exchange rate depreciation and high inflation.
Instead the CBN must force fiscal discipline by refusing to grant more advances to the FG, and maintain high interest rates to keep inflation and exchange rate depreciation in check. In this scenario, the FG will have no choice but to cut its spending, raise taxes or default because it will lose access to the debt markets and not be able to meet its debt obligations.
This is the best case scenario for the economy, and it is what the CBN must seek. After every unsustainable debt binge, there must be a deleveraging. Otherwise, let us all just keep buying dollars.
The message is clear - the FG must cut wasteful spending and get up its revenues through taxes by encouraging businesses to invest (ease of doing business)