Weekly Trust (Abuja)

3 September 2006

Nigeria: CBN Seminar: Participants Discuss How Foreign Reserves Should Be Utilised

Kaduna — The Central Bank of Nigeria organised a three day seminar on the dynamics of exchange rate management. The various resource persons argued for the effective utilisation of the current foreign reserve accumulation to launch Nigeria development agenda.

Participants at a 3-day seminar on the dynamics of managing exchange rate in Nigeria have profered workable solution on how the nation's foreign reserve should be proparly utilised to achieve maximum development for the country. Resource persons were drawn from CBN, the University community and international organisation.

The conference which held between 28-30 August 2006 had finance correspondents, stakeholders in the finance sector and resource person as participants Alhaji Mohammed Nda, CBN director of Foreign Operation presented a lead paper on the challenge of effective foreign reserve management. He defines foreign reserve as "consisting of official public sector foreign assets that are readily available to and controlled by the monetary authorities for direct financing of payment imbalances and regulation of the magnitude of such imbalances through intervention in the exchange markets to effect the currency exchange rates and for other purpose. He explained that "The accumulation of reserves is a global phenomenon and not peculiar to Nigeria. Global official reserves increased from about $2 trillion at the end of 2002 to over $4 trillion in January, 2006, with emerging and developing countries accumulating the bulk of the world's foreign reserve.

"The rise in oil prices has now shifted foreign reserve accumulation from Asia (excepting China and India) to the oil producing countries. Many of these countries are accumulating reserves on account of the lessons they learnt during the various financial market crises of the 1990's. They have continued to build reserves to shield them from volatile capital movements."

He noted that Nigeria, like other oil producing countries, has accumulated reserves since 2004 following the upsurge in oil prices occasioned by the general tension in the Middle East, regional conflicts, and increasing global demands for oil, especially from China. Nigeria's current external reserves had reached the unprecedented level of $38.07 billion by July 31, 2006. The big challenge before us is how to manage the phenomenal increase in our foreign reserve that we don't feel the impact when the prices come crashing, as they surely will. How do we manage the investment of this reserve in our microeconomic sectors to diversify the economy?

Dr. Ayo Odusola, UNDP Senior economist argued that the accumulation in the foreign reserve has enable the CBN to harmonise the official exchange rate and the parallel market. He noted that the major lesson we can learn from Malaysia and Mexico in 1998 and 2002 is that we have to be careful the way we handle our capital account. He explained that you don't just open your capital account to all and sundry. It must be a capital account that is what we called guided by the policy directive in terms of agenda of government. He said no country ever leaves it free like that and think it will impact positively on the economy. he further clarified that leaving the capital account open has ripple effect that dislocate the whole economy from getting its own bearing for several years because that exactly what happened in Mexico for several years before they could relocate themselves."

Professor Mike Obadan, of university of Benin in his reaction said that the deregulation of the economy that started with SAP targeted the diversification of the oil sector. That the deregulation since 1985 has failed to achieved the set target of generating 1.0billion dollar from non-oil sector. The challenge of the current accumulation is to see how we can diversify the economy to generate revenue and foreign exchange from the non-oil sector that still remain untapped. That governement has started with cassava which is in serious demand in India and China. That there is the need to focus on other sector. Malaysia has oil but they de-emphasise it and concentrate on real production and manufacturing.

Alhaji Nda observed that Nigeria's dependence on oil for over 90 percent of its foreign exchange earnings, which makes its capital account vulnerable to the fluctuations in crude oil prices, poses a lot of challenges for the management of the country's economy. Nigeria's high level import bills have contributed to the fluctuation of our foreign reserves over the years and consequently rendered its management more difficult.

Certain important measures could facilitate the effective management of our huge accumulation of foreign reserve, the most important of which is the enactment of the Fiscal Responsibility Act to provide for prudent management of the reserve and ensure long-term macroeconomic stability and greater accountability and transparency in fiscal operations within a medium-term fiscal policy framework.

Tied to the issue of fiscal responsibility is the recent call for the establishment of a national investment fund. It is an open secret that the recent build-up in the nation's external reserve has mainly been due to unsustainable upsurges in oil prices, which are however already fuelling the search for alternative energy sources, especially in the USA. The national investment fund is intended to invest excess earnings from oil into projects that could shield the nation from the volatility of oil prices. Countries such as Botswana, Venezuela, Norway, Sao Tome and Principe, to name a few examples, have successfully established such funds. What these countries have done is to secure the proceeds from oil and other minerals and finance their budgets through other sources.

The national investment fund serves the twin objectives of stabilising volatile fiscal revenues and creating a capital pool to provide alternative sources of foreign exchange.

As part of its effort to manage our foreign reserve effectively, CBN has outsourced its component parts to external fund managers in line with the best practices worldwide. A recent survey by UBS Investment Bank showed that 70% of central banks around the world now use the services of external managers. A portion of the reserve would be invested in bonds, which yield higher returns than fixed deposits.

CBN has appointed J. P. Morgan Chase to take custody of all securities purchased by its external fund managers. The apex bank has also come up with the idea of allocating the external reserve to strategic assets, the aim of which is to take its risk tolerance into account in optimising long-term reforms of the reserve portfolio. Strategic asset allocation (SAA) would split the reserve into liquidity, investment, and stable tranches to reflect the capital preservation, liquidity, and return objectives of the bank's reserve management.

Foreign reserve is held by a country for a number of reasons. It supports and maintains confidence in the monetary policy and exchange rate management, including intervention in the foreign exchange market in support of the national currency, naira for example. This is evident from the relative stability of our foreign exchange market since 2004 following the historic merger of the wholesale Dutch auction system and bureau de change rates.

Foreign reserve also services the foreign currency liabilities and debt obligations of country. For instance Nigeria was able to pay the Paris Club $12.4 billion from its foreign reserve to secure a debt relief of $18 billion.

Foreign reserve finances government expenditures abroad, e.g. the import of goods and services for government programmes. It provides a defence against emergencies or disasters and could equally be invested in income generating instruments such as treasury bills, bonds, time deposits, etc.

Nigeria's foreign reserve has grown in leaps and bound in the past three years. The trend started in 2003 after the American invasion of Iraq, which resulted in the escalation of prices as Iraqi oil failed to reach the international markets. Some of the participants argued that the windfall of the 1990's cannot be said to have been judiciously utilised. The surge in oil prices pushes countries like the United States to search for alternatives to oil as their major source of energy. If the US succeeds, Nigeria could be in trouble because the US is our major oil trading partner.

During the oil boom of the mid-seventies which resulted in the build up of external reserves, these reserves were diversified into an array of financial instruments including foreign government bonds and treasury bills, foreign government guaranteed securities, special drawing rights (SDRs), fixed term deposits, call accounts and current accounts, providing significant investment income as well as liquidity. However during the glut in the global oil markets which led to the collapse of prices and consequently depleted the reserves, the reserves were largely held in current account and treasury bills. This underscores the need to diversify the sources of a country's foreign exchange inflow.

Other participants also argue that beyond this, however, the fiscal and budgetary violations of the executive arm of government must be treated with more seriousness.

In the last seven years we have witnessed increasing fiscal rascality in the way and manner that members of the executive arm of government handle the budget. This can no longer be condoned if we are to benefit in the long-run from the accumulation of foreign reserve.

In conclusion, the present level of our foreign reserve is a golden opportunity to launch our development agenda. Much as we appreciate CBN's strategic management however the needs of ordinary Nigerians dictate the translation of our excess funds into meaningful life. That boils down to the issue of diversification. We have noted the efforts with cassava, but a lot more must be done to ensure that a country as blessed as Nigeria does not depend on one single but volatile product.

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