US Fed Rate Hike and Options for Nigeria

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With Wednesday’s hike in interest rate by the United States Federal Reserve, Ndubuisi Francis examines the options open to Nigeria to insulate the economy from the adverse effects

The United States Federal Reserve on Wednesday raised its key lending rate by another quarter-point — the second time in 2018 – in an attempt to stay ahead of growing inflation amid strong growth and robust employment. Following two days of deliberations, the members of the US Fed’s interest rate-setting Federal Open Market Committee decided to lift the target range for the federal funds rate to between 1.75 and 2.0 per cent. Being the second interest rate increase this year, it brings the total of US Fed hikes in the current monetary tightening cycle to seven.

The US central bank began pushing rates higher at the end of 2015, following more than half a decade of ultra-low rates as a result of the 2008 financial crisis. Indications are that besides Wednesday’s hike in benchmark short-term interest rate, two more increases are likely this year.

Effect

The hike may trigger an adverse effect on capital flows to Nigeria and may compel the Central Bank of Nigeria to maintain its tight monetary policy stance.

THISDAY had reported on Monday that Nigeria’s external reserves had maintained a sustained decline in the past few weeks as foreign portfolio investors continued to weigh the possibility that the US Fed would raise interest rate at its meeting Wednesday.

Now that the rate hike is already done, it would mean an increased return for investors in the US and declining interest in overseas investment. This is besides political risk considerations in Nigeria.

Global Repercussions

Already, there are global repercussions on the Federal Reserve’s rate hike. Some of the most dramatic effects of higher US interest rates have appeared in emerging markets, as this lures back investors who had turned overseas in recent years in search of returns.

The retreat from emerging markets so far remains relatively modest, with weekly flows to bond and equity funds down less than 10 per cent from their peaks.

But the trend coincides with a stronger US dollar and is contributing to currency crises in countries, such as Argentina, Turkey and Brazil. It has also prompted central banks elsewhere, including in Indonesia, Malaysia and Hong Kong, to raise their own interest rates to stem the outflow of foreign capital they need for investment and growth.

Options for Nigeria

Head of Department, Banking and Finance, Nasarawa State University, and Nigeria’s first professor of capital market, Professor Uche Uwaleke, said it was important to recognise that the protectionist policy of President Donald Trump will help to strengthen the US dollar. Uwaleke said this was consistent with the normalisation of interest rates by the US Federal Reserve, which has led to a spike in interest rates and attendant capital inflows into the US, especially from frontier and emerging economies, including Nigeria.

According to him, “Therefore, the options open for the government to insulate Nigeria from the adverse effects of these developments in the US, in particular, capable of eroding external reserves include the sustained implementation by the CBN of the restrictions to forex access in respect of certain items in order to conserve reserves.”

He said another option was the maintenance of the current tight monetary policy stance, which ensures controlled liquidity in the system that, otherwise, would put pressure on forex reserves.

“Given retreating inflation, the retention of the Policy Rate at the current 14 per cent, at least, in the near-term would minimise the rate of portfolio investors’ exit since the real rate of interest in Nigeria would still be positive. On the fiscal side, the government should continue to source for more of cheaper external loans than costly domestic debts to finance budget deficit as doing so will support the level of forex reserves,” Uwaleke said.

The government, he added, through the Presidential Enabling Business Environment Council, should continue to work on dismantling barriers to foreign investments and intensify campaigns for patronage of locally made goods to conserve foreign exchange

Another option, the university don said, is to reduce uncertainties in the investment climate by squarely confronting the challenges posed by insecurity and budget delays as well as intensifying effort to diversify the export base to reduce the country’s vulnerability to external shocks.

Uwaleke stated that in view of the fact that the exit of foreign investors impact negatively on the capital market, the government should begin now to engage the capital market authorities on how best to help the market withstand any shock triggered by the exit of portfolio investors to the US following a rise in interest rates.