analysisBy Festus Akanbi
That the Nigerian economy has benefited from the inflow of foreign portfolio investments following the country's robust foreign exchange reserves is not in doubt, but experts in money and economic matters say the short life span of such investments underscores the vulnerability of the Nigerian economy to turmoil in other lands, reports Festus Akanbi
The major issue in business and economic circles in the country today is the ongoing delay over the 2013 budget. This is due to the fact that the signing of the financial document will set in motion economic and business activities.
However, as the waiting game continues, some analysts have described as fragile the seemingly impressive foreign exchange reserves on which the budget fundamentals are anchored.
Government officials, including members of the National Assembly, had at various times played up the prevailing favourable conditions, which were said to have informed the $79 oil benchmark price adopted by the lawmakers. These include the comfortable price level of crude oil in the international market and the attendant rise in the nation's external reserves.
For instance, as at Tuesday last week, a barrel of Bonny Light, Nigeria's oil export, was sold at $117 dollars while the foreign reserves hovered around $45,569 billion. However, information and data recently made available by experts in the financial sector and the Central Bank of Nigeria (CBN) showed that apart from the forex exchange haul made through oil sale, the sustained inflow of foreign portfolio investment is another major source of Nigeria's impressive foreign exchange position in recent times.
Foreign capital inflows into the country rose 77 percent from the previous three months to $6.07 billion in the third quarter of 2012, according to a CBN report on some major developments in the nation's economy for quarter three (Q3) 2012 in comparison with the preceding quarter (Q2) and the corresponding quarter of 2011.
Portfolio flows or "hot money" accounted for 76 percent of total inflows during the period, with foreign direct investment accounting for the remainder.
Foreign portfolio investments represent the passive holding of securities and other financial assets, which may not entail active management or control of the issuer. They are usually positively influenced by high rates of return and reduction of risk through geographic diversification.
The return on FPI is normally in the form of interest payments or non-voting dividends.
Chief Executive Officer, NSE, Mr. Oscar Onyema, recently acknowledged the growing appetite of foreign investors, saying they had continually been showing interest in the Nigerian market due to the various reforms carried out in the Exchange in the last few years.
But informed sources said the apex bank had cautiously embraced 'hot money' flows into the country, as it only recently (in 2011) lifted the one-year minimum hold period on Nigerian bonds by foreign investors, leading to an increase in such inflows into Nigeria.
The bank pushed up short-term interest rates through the hike in its Monetary Policy Rate (MPR) to 12 percent, a move designed to improve the incentive for local and international investors to hold NGN-denominated assets.
The CBN puts the total hot money in the system at about $5 billion, with a further $1.5 billion expected to flow into naira denominated assets from the addition of Nigerian bonds to JP Morgan's emerging markets bond index.
Allure of Nigerian Stock Market
On the situation of things on the Nigerian Stock Exchange, findings have shown that the status of foreign portfolio investment is determined by trading figures polled from custodians and market operators on their foreign portfolio clients from time to time.
For instance, in January 2012, the exchange reported that foreign investors accounted for 81% of total inflows (purchases) on the market during 2011. During the same year, foreign investors accounted for 53% of total outflows (sales) recorded on the market. Consequently, total transactions by foreign investors were N847.9 billion or 67% out of total transaction of N1.3 trillion.
However, because of the transient nature of foreign portfolio investments all over the world, there are growing anxiety that the current confidence on the Nigeria's foreign reserves could be short-lived should the investors decide to take their luck elsewhere.
The fear informed the suggestion of experts that the apex bank might be considering policies to discourage capital flight from Nigeria.
One of the financial market players that expressed worry over the growing trend is the Managing Director/Chief Executive, Cowry Asset Management Limited, Mr. Johnson Chukwu.
Risk of Capital Reversal
In his response to THISDAY enquiries, Chukwu said: "The heightened patronage of Nigerian securities by foreign portfolio investors has had the effect of triggering market rallies in equities and debt instruments with attendant appreciation in stock and bond prices (with attendant decline in bond yields). These inflows have also contributed significantly to the build-up in Nigerian foreign reserve, which appreciated by over 34% in 2012."
However, the financial analyst said, "The challenge with the huge presence of foreign portfolio investors in the country's capital market is the heightened risk of market reversal and possible market crash should these portfolio investors have any reason to exit the market.
"Beyond a capital market crash, their exit would also lead to a sharp depletion of the country's foreign reserve and possibly exchange rate devaluation with the attendant inflationary impact."
The Cowrie Asset boss explained that, "The fact that our foreign reserve is presently over $44billion, which can cover 10 months of imports as against the standard three months, is worth celebrating. The country should, however, be mindful of the composition of the reserves particularly the proportion which inflows from foreign portfolio investors or hot money account for. The higher the proportion of hot money in the country's foreign reserve, the higher the risk of sudden depletion of the reserve. Our economic managers should strive to build up other components of the reserve to ensure that hot money does not ever account for more than 20% of the nation's foreign reserve."
But he maintained that the attractive nature of the nation's capital market instruments would continue to draw inflow of portfolio investment. "There is no alternative to hot money, as long as Nigerian capital market instruments remain attractive. For instance, Nigerian fixed income instruments currently earn returns of above 12% per annum and the equity market returned over 35% in 2012. With improving international risk rating and stable exchange rate, these high returns will remain attractive to discerning foreign portfolio investors, hence the rush for Nigerian instruments.
"One thing that our economic managers should do is to avoid policy decisions than can trigger a run on Nigerian instruments. Such policies include imposition of foreign exchange control measures, fixing bond yields at below market rates and currency devaluation. The second factor is for them to moderate the possible impact of sudden exit of the foreign portfolio investors by diversifying the sources and composition of the foreign reserve. This can be done if we are able to grow our export earnings as well as moderate the rate of withdrawal/monetization of excess crude earnings.
Taking Advantage of Arbitrage
A specialist in money and financial matters, Odilim Basil Enwegbara, explained that "The problem with unregulated portfolio investments is the kind of capital market heat up we are witnessing, a false impression that wealth is being created when in reality it is all about taking advantage of a faulty capital market. And this is happening to us because the naira is currently kept artificially high, interest rates equally high in the presence of stable exchange rates; all happening while our economy is highly dollarised as a result of high import dependency.
"Why shouldn't foreign speculators be taking advantage of the arbitrage being provided by the market, especially given the absence of capital gains tax policy in the country?"
According to him, "The truth about these unregulated inflows is that in most cases, it is the same people that are dumping foreign goods into Nigeria that are investing large part of their profits in our capital market, to besides making us continue having an overvalued currency that keeps us consuming foreign products, but also make stupendous gain with government as the major borrower, borrowing at such unheard-of 16 per cent.
"The danger in this economic financialisation is that without having effective measures to quarantine these excessive portfolio investment inflows, they could easily reach our banking sector as they did between 2006 and late 2008, causing bubble burst as they did in 2008 with the sudden pullout of $15 billion from our capital market, which should create another crisis in our banking sector as they did in 2008 given that Nigerian bank stocks represent over 70 per cent of the country's stock market."
Calling for a more drastic approach, Enwegbara said, "To avoid the repeat of this, my advice is that the naira should be devalued, that interest rates should be drastically reduced, foreign exchange rates reasonably made flexible.
"And above all, to keep speculators under control, we need to have in place a sound national policy governing the entry, operations and exit of portfolio investments, including making it difficult for investors to exit at will by imposing a minimum stay of six months and imposing capital gain tax.
"If we proactively do these, I will assure that we should drastically reduce the current flood of hot money since they also reduce the arbitrage in the market. All these we should do, bearing in mind that without being able to control portfolio investment inflows and outflows, especially in the absence of counter-cyclical measures, there is no way we should expect robust and stable capital market."
Stockpiling External Reserves
Speaking on the euphoria trailing the rising profile of the Nigerian foreign exchange reserves, the analyst said, "It is unfortunate that with Nigeria's over $250 billion infrastructure deficit, we have continued to keep such high external reserves, when not more than $10 billion should have been our foreign reserve, since that should be enough for six months imports. But the question is, why have we turned Nigeria into such a dumping ground for all manner of foreign goods when most of what we import could easily be made locally and by so doing save us the ongoing pressure on our foreign reserves?
"At our present stage of development, are we supposed to be spending over 95 per cent of our foreign reserves importing finished goods instead of importing industrial machinery? Is this not a demonstration of our lack of faith in this country's ambition to become one of the world's industrial nations? Or are we expecting to become one of 20 developed nations by 2020 as mere industrial product consumers rather than industrial products exporters? Where is that nation that has developed without industrialisation?
"If Abraham Lincoln was right in warning his compatriots to avoid buying foreign made goods because in doing so they only get the goods and lose the money and the jobs, but should they buy made in America, not only they get the goods but also get the money and the jobs, shouldn't our leader too be warning Nigerians that without patronising Nigerian made goods we are doomed as a nation? Let us agree also that keeping such a high foreign reserves at such ridiculously low LIBOR interest rates (about 0.8 per cent), and then turn around to borrow domestically at such outrageous interest rates (not less than 16 per cent), shows that no doubt, there is conspiracy going on here, and that some people are profiting from this policy arrangement."
Still opposed to the nation's dependence on hot money, Enwegbara said, "If we have generated so much money from pension and insurance, why shouldn't we direct major part of that money into our capital market? As a matter of urgency, deepening and stabilising our capital market should require PENCOM to reverse its current policy that restricts PFAs from investing not more than 25 per cent of their portfolios in equities. The policy should rather be more flexible by making 35 per cent the minimum. If we do not do something to curtail the kind of hot money flooding our capital market, we should not be alarmed when international speculators like George Soros take advantage of our "gung-ho" capital market behaviour," he said.
Similarly, Chief Executive, GTB Securities Limited, Mr. John Ogar noted that when the CBN decided to relax the lock-in period for foreign portfolio investors in Nigerian fixed income securities slightly over a year ago, it opened the door for foreign portfolio investors to come in droves to take advantage of the country's high interest rates.
He, however, explained that, "The intent of the CBN at the time was to defend the Nigerian currency which was under attack from speculative activities and thus stabilise the foreign exchange market. Hot money is the flow of funds across countries when investors seek to profit from interest or currency differentials.
"However, since such capital flows can move quickly, it has the tendency to cause market instability. The CBN estimates that hot money accounts for about 20% of Nigeria's current reserves position. What this means is that if these foreign portfolio investors panic out of the country today, we are likely to see a 20% depletion in the foreign reserves, besides the instability and market shocks it will engender. It will weaken our currency vis-à-vis the US Dollar, leading to other distortions in the foreign exchange market.
"Our money and capital markets will likely take a hit akin to the events of 2008 when foreign investors scurried out of Nigeria, a move that both precipitated and compounded the capital market crash. Whilst capital will chase returns anywhere that provides best returns, it will be pertinent for the CBN and the Nigerian authorities to seek ways of ensuring that these portfolio investments are converted into investments in the real sector of the Nigerian economy, especially in Agriculture, Power, and Infrastructure. If the Nigerian authorities provide a business friendly environment to attract foreign direct investments, it will minimise the disruptive effects of hot money."