Govts, Firms Urged to Build Buffers against External Shocks

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Obinna Chima 

Analysts at FSDH Merchant Bank Limited have warned that current developments in the global financial market may lead to rising interest rate and possible capital flight, particularly from developing countries.

Owing to this, they stressed the need for companies and countries, particularly Nigeria, to build buffers to protect themselves.

The bank stated this in a report on its monthly economic and financial markets outlook titled: “Easy Money: Time to Create Buffers.”

According to the report, many central banks in both advanced and developing countries have been adopting expansionary monetary policy stance in order to stimulate economic growth.

For instance, it noted that the Federal Open Market Committee (FOMC) of the U.S Federal Reserve System cut the interest rate in July 2019, the first rate cut since 2008; the Bank of Japan maintains a negative policy rate; the European Central Bank maintains the interest rate at zero; and the Bank of England maintains the interest rate at 0.75 per cent, which is considered low compared with the historical average of 3.89 per cent between 2006 and 2009.

Also, the South African Reserve Bank lowered its interest rate in July 2019; while the Central Bank of Nigeria (CBN) also lowered its interest rate in March 2019 and has indicated its preference for low interest rate, causing yields on fixed income securities to drop.

But commenting on the report, the Head of Research and Strategy at FSDH Merchant Bank, Mr. Ayodele Akinwunmi, said the strategies by central banks across the globe had created easy money (low cost of fund) in the global financial market and by extension, in Nigeria.

“Individuals, companies and governments can now borrow money both from the domestic and foreign financial markets cheaper than in the last few months. FSDH Research has observed that many banks and other credit providers in Nigeria have recently begun aggressively pushing credit to their customers.

“The federal government of Nigeria is refinancing maturing debt obligations and taking on new debt at cheaper rates because of the low interest rate environment.

“Foreign Portfolio Investors (FPI) are aggressively investing in fixed income securities in Nigeria with reasonable yields because of the low interest rates in advanced countries and the expectation of a further interest rate cut, particularly in the US.

“If the current trade tensions between the US and China subside and the economic growth in the two countries returns to an upward trend, there may not be a need for excessive expansionary monetary policy,” he explained.

According to him, the developments in the US and China affect the global economy as the two countries account for about 40 per cent of the global economy in terms of Gross Domestic Product (GDP).

The two countries also account for about 33 per cent of total global demand for crude oil. This also means that developments in these countries may affect the demand for crude oil and lead to a price drop, he added.

“US, Euro Area, China, Japan, UK and India collectively account for about 69 per cent of the global economy. If the economic outlook of these regions improve, the low interest rate may change and there may be capital flight from Nigeria.

“This may hurt the economy and the financial market if there are no buffers in place to counter the negative implications that may follow. The low yield on the fixed income securities in Nigeria is already impacting on the total FPI inflows through the Investors and Exporters’ Foreign Exchange Window. 

“Between January and July 2019, Nigeria recorded the lowest FPI through the I & E FX window in July, both in absolute number and as a ratio to the total,” he disclosed.

Furthermore, the report noted that although FSDH Research always advocates for Foreign Direct Investment (FDI) because FPI may be regarded as hot money, it stated that FPI however helps in a way to increase the stock of foreign exchange in the country.

It stated that companies may wish to issue debt capital at this moment to expand business operations and create additional lines of business that can generate improved earnings for them.

“When the financial market becomes tight again with rising interest rates, companies may then modify their capital structure in favour of equity capital and hopefully their earnings would have grown in order to eliminate the dilutive effect of increased equity capital of return on equity

“In doing this, it may be important to provide forex hedging mechanism for foreign loans. The FGN may also take advantage of the current low interest rate to access long-term debt and channel it specifically towards building the capacity of the economy to generate more revenue.

“Investment in infrastructure, security, education, healthcare and other social safety net will improve the productivity of the country and provide an opportunity for government to generate future tax revenue. This strategy will increase the stock of foreign exchange in the country and may reduce inflation rate.  

“The current low interest rate should not be seen as an opportunity for individuals, companies and governments to increase deadweight debt.

“However, the low interest rate regime should be seen as an opportunity to access long-term funds that can be used to improve the wellbeing of the economy in order to generate increased revenue for all the economic agents,” it added.