Central banks work mainly to stabilize or strengthen their currencies (to reduce inflation) and create employment by managing interest rates. Your Social Studies junior secondary school teacher explained that in the section on the differences between commercial and central banks; he likely ended the class with “the central bank is the bank’s bank!”
When you reduce interest rates, companies and citizens can borrow cheaply. That triggers more economic activities, enabling the creation of more jobs. But excessive lowering of interest rates can “heat” up the economy and cause inflationary problems in the economy (money does not worth much as it is readily available, cheaply).
The US central bank (Federal Reserve, as they call it) has increased the interest rate. The goal is to dampen and “slow” the economy by making it a little more expensive for companies and people to borrow money. So, right now in America, mortgage, credit cards, car loans, etc will see higher interest rates. As a result of those high rates, many people will think twice, and some will forgo acquiring some avoidable assets. If that happens at scale, you have slowed economic activity.
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By doing just that, you can help the currency: it strengthens by reducing inflation. That strengthening of the currency is where I am interested in this note: Nigeria’s sovereign external loans are mainly in US dollars. If the dollars “appreciate”, it will cost Nigeria more to finance or obtain new loans.
The implication is that the pressure of this stronger US currency in a rising interest rate regime in the US can further cause the Naira to deteriorate; most Nigerian loans are denominated in US dollars and some are not hedged or fixed which means there is a risk for them to float with US prime lending rates. Or even if the rates are fixed, Nigeria needs new loans to fund its budget, implying that next loans will be more expensive.
IMF projects that by 2026, more than 100% of Nigeria’s revenue will go into servicing debts. The debt service-to-revenue ratio has increased from 81.1% in 2020 to 96% in 2021, and continues to rise. A stronger US dollar will worsen the outlook.
Also, with higher interest rates, many US investors will see more avenues to deploy capital. During higher rates, safe assets like treasury bills will become more attractive. That change can affect how capital is allocated for emerging economies like Nigeria.
Watch out for stress on the Naira (more depreciation possible, black market is at N610/$ now). The cost of borrowing, for corporate and sovereign, will also rise. In other words, corporate bonds will be at higher rates; most of these bonds are Euro- or USD-denominated.
For sovereign debts, the government will borrow, even just to service old loans, and that can activate a vicious circle, triggering massive depreciation of Naira. Pay attention to the currency!
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Comment: I think a stronger dollar may not cause much damage to the naira as Nigeria main revenue is also in dollar. Nigeria has no naira revenue to convert to dollar and pay debt, they either utilize the crude oil proceed or refinance through Eurobond. However, a higher rate in the US will reduce FPI. And I do not think the economy depends so much on FPI as Nigeria is not attractive to foreign investors. We also should not forget that OPEC has increased Nigeria’ quota and oil price is strong.
My Response: “I think a stronger dollar may not cause much damage to the naira as Nigeria main revenue is also in dollar.” Interestingly, Nigeria does not earn enough USD when compared to what Nigeria needs dollar for. If that is the case, it needs to find via other means. Your assumption is that Nigeria’s balance of trade and payment is optimal; not so. That is why we now use local tax revenue to service some of those debts.
“We also should not forget that OPEC has increased Nigeria’ quota and oil price is strong.” – Nigeria has not met its old quota due to theft. The issue of OPEC increasing Nigeria’s quota (to 1.772mbpd from 1.753mpbd) is a political statement EU needs to make Russia jealous. Nigeria is doing around 1.1mbpd now.
IMF Warns That Debt Servicing Might Gulp 100% Of Nigeria’s Revenue By 2026
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The people jostling to lead Nigeria come 2023, what plans do they have on these moving targets, and how well do they understand what is in play here, both internally and externally?
We waste a lot of time debating whose turn it is to rule, who has competence, and whose track record shows he can govern Nigeria. The fact is that none of them has been president before, and none has managed volatile currency like naira before, so what will they be bringing that can cushion the blows naira gets from all sides? Nobody has answered that question, but they seem to possess mystical powers when it comes to winning elections and building structures, while the real thing remains vague and untouched.
The economy is shaking and politicians are spending fortunes to become president? That should tell you what the agenda is, any serious fixer will not even bother to contest, because the task ahead can easily keep you dazed for months, if you really have what it takes to turn things around.
If the things we borrowed money for are not productive on themselves, then we are sinking deeper, while looking for more money to service unproductive debts.
Our eyes will soon clear.
Well said sir, is it advisable to hold on to USD this period?
Why Nigeria are not cooperating in foreign currency