Minister of Finance, Kemi Adeosun and IMF Managing Director, Christine Lagarde

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IMF on Nigeria’s Net Capital Flows Mirage

By Temitope Oshikoya

On April 8, the IMF publicly released the 2016 Article IV Country Consultation Report on Nigeria and the accompanying Selected Technical Issues Papers. The technical papers are of interest as they provide detailed empirical analysis of the topical issues that we have recently focused on: choice of exchange rate regimes, capital flows, fiscal framework, and productivity, especially of the non-oil sector.

These supporting technical papers cover four key areas. First, Options and strategies for a fiscal rule for Nigeria’s oil wealth management. Second, Enhancing the effectiveness of monetary policy in Nigeria. Third, Capital flows to Nigeria: recent development and prospects. Fourth, Financial deepening and the non-oil sector growth in Nigeria.

Of immediate relevance to the title of this article is the IMF’s technical paper on Capital flows to Nigeria: recent development and prospects. According to the IMF, total capital inflows are defined as net non-resident investment in Nigeria. Similarly, total capital outflows are defined by the IMF as the net investment of Nigerian residents abroad. As such, the values taken on by both concepts can be either positive (increase in liabilities or assets) or negative (decrease in liabilities or assets).

There are some takeaways from this paper, much in line with the key points we have highlighted severally. First, Nigeria’s net capital flows may be more of a mirage. On a net basis, capital flows may have been neutral or negative as both inflows and outflows equally averaged 4% of GDP between 2011 and 2014, about $20 billion per annum.

The IMF notes that Nigeria’s total capital inflows averaged 4 percent of GDP over 2011–14, but fell to 1.5 percent of GDP through the first three quarters of 2015. The IMF also observes that Nigeria has also been characterized by an equal sizable capital outflows of 4 percent of GDP in the same period, which have also diminished recently.

Second, Nigeria has witnessed significant illicit capital outflows. The magnitude of Nigeria’s capital outflows may even be under-recorded due to illicit capital flight, which tends to show up as errors and omissions in the country’s balance of payments data, and averaged another 3 percent of GDP over 2010-2014. This will amount to about $15 billion per annum over this period. Chart 2 below clearly shows that as a ratio of the GDP, Nigeria’s errors and omissions flows are much larger than that of G20, BRICS and other oil exporting countries.

Third, the IMF’s stylized facts suggest that total capital inflows, in particular portfolio inflows, coincided with the period of high oil prices and low interest rates in advanced economies, and the associated search for yield by investors. The IMF’s analysis also demonstrates that the subsequent downturn in these flows in late 2014 also coincided with the decline in oil prices, which also generated higher yields on domestic securities and Eurobonds, and expectations of exchange rate depreciation. Foreign exchange controls also likely had a dampening effect on capital inflows.

Fourth, the IMF further conducts an empirical analysis of the drivers of Nigeria’s capital inflows and outflows, which include pull and push factors. IMF’s empirical quantifications show that Nigeria’s domestic interest rates have typically exceeded ten percent. The pull factors including higher monetary policy rate, yields on one-year and long-term (ten years or more) Federal Government of Nigeria securities, as well as stronger expected economic growth and higher oil prices, all tended to increase capital inflows in Nigeria, especially of portfolio debt securities.

According to the analysis by the IMF, Nigeria’s capital inflows, especially portfolio inflows, have been reduced by push factors of higher yields on the ten-year U.S. Treasury, the VIX volatility index, and the EMBI Global spread on emerging market sovereign debt, which measure the increased risk aversion either in general or toward emerging markets.

The IMF observes that the Consensus Forecast and the non-deliverable forward (NDF) market have tended to expect large naira depreciation. The IMF also notes that while higher expected depreciation of the naira also tended to reduce capital inflows, but the results were not statistically significant. The largest impacts, on Nigeria’s capital flows, however, result from the rising U.S. Treasury yield and the lower oil price, which would continue to exert a drag on capital inflows and the external reserves (Chart 3 below).

Fifth, IMF concludes that its empirical findings point to risks that capital inflows to Nigeria will be lower in the near term than in the recent past. In the short run, Nigeria’s room to manoeuvre in an environment of low oil prices and rising external interest rates may be limited. The IMF concludes that in the long run, removing structural impediments to growth and enhancing the business environment and governance would be more crucial to increasing capital flows.

IMF’s empirical findings on capital flows for Nigeria are much in line with the key messages and perspectives that we have provided in the article on the JP Morgan Index and Collective Self-Delusion published at the time Nigeria was injected from the JP Morgan Emerging Markets Index in July 2015.

We have noted that with a relatively high premium on Nigerian bond yields and loose capital controls, the portfolio investors were making a killing, which explained their relentless media campaign against Nigeria. More importantly, the fickle foreign portfolio traders had perceived Nigeria’s foreign reserves during the financial and economic peace time as ‘nuclear weapons,’ whose mere existence especially in relation to short-term external debts served as deterrents and as a form of protection to them. They, at the same time, expected that the foreign reserves would be deployed as gun powders when financial and economic crisis start to emerge (Bussière, et. al, 2014).

The findings of the IMF also support the theme of the article on Currency Woes and Capital Flows in Emerging Markets, where we have clearly noted that Nigeria was not immune to the capital outflows sneeze that have affected key emerging markets. Although more than 75 countries have devalued their currencies in the past twenty-four months, yet capital outflows from emerging markets, especially from the BRICS, reached $735 billion in 2015, according to the Institute for International Finance, an association of over 500 global banks and other institutions including Citibank, JP Morgan, HSBC, World Bank, and Standards & Poor’s, etc.

The IMF’s findings are also broadly in line with our statement in the article on Devaluing the Devaluation Delusions which notes that “The love affair of foreign portfolio investors will be severely tested even if the country relaxed capital controls and enacted a floating exchange rate. The current spread between rising U.S. interest rates and declining Nigerian rates provides insufficient compensation for the perceived risk of Nigerian investment given rising external current account deficits, rising fiscal deficits and low oil prices. In essence, a much larger depreciation of the exchange rate would be required to compensate them for lower interest rates and bond yields.”

The IMF’s empirical studies of Nigeria’s macroeconomics topical issues show that international financial and development institutions tend to bring to bear intellectual, analytical, and empirical rigour on policy-related issues, especially from their own perspectives, and not just polemics.

This writer knows this for a fact from experience of having served as a Joint Coordinator of the African Competitiveness Report of the African Development Bank, World Economic Forum, and World Bank; and of the African Economic Outlook of AfDB, OECD, and UNDP; and Team Lead for the African Development Report; and having also participated in the Can Africa Claim the 21st Century of the World Bank, AfDB, AERC, and UNECA;