Since the middle of last year the price of oil has fallen by 60%, driven down largely by booming shale oil production, sagging growth in developed economies, drop in energy demands from emerging markets, and the strengthening of the US dollar. While oil prices have recovered to around $60-65, this still represents a major adjustment from the $100+ average price levels we have become used to over the past few years.
For major oil exporters like Nigeria, the effect of this price adjustment has been immediate and dramatic. Government revenue has dwindled and foreign investors are either exiting the domestic market or holding off from making major new investments. All of these have placed the Naira under tremendous pressure, forcing the Central Bank of Nigeria (CBN) to draw down on already depleted foreign reserves and hike up interest rates to stem the Naira’s slide.
As Oil makes up about 70% of budget revenues and over 90% of export revenues, the impact of the oil price drop on the economy has also led to downward adjustments of growth expectations. IMF now projects the Nigerian economy to grow by 4.8% in 2015 and 5.2% in 2016, down from earlier projections of 7.3% and 7.2%respectively.
How has Government Responded So Far?
While the falling Naira hasn’t tracked the declining price of oil as closely as Russia’s Ruble (as the image above shows), CBN nevertheless decided to devalue the currency in November 2014 by widening the Naira/US$ band from 150-160 to 160-176 (an effective 8%). In February 2015 CBN cancelled its dollar auctions. The exchange rate in the parallel market that had widened to 200 Naira/US$ in February finally started to realign with the official rate after a peaceful power transition following national elections. The central bank is also actively drawing down foreign exchange reserves to lessen pressure on the currency.
This is likely to be sustainable only as a temporary measure. By 26 June, foreign exchange reserves has dwindled to $29 billion, from $37 billion at the beginning of the year. This is about 5 months of imports. Though above the often cited 3 months threshold but down from 6.5 months at the end of 2013, and down from a peak of 17 months in 2007. Most financial analysts expect the Naira will be further devalued before the end of the year as the pressure on the national currency still persists. Similarly some economists expect interest rates may go higher.
Unless government quickens its pace and unveils a realistic and comprehensive reform programme for how it intends to address the structural blockages in the economy – narrow tax base, huge infrastructure deficit, low power generation, high unemployment, corruption etc. – the pressures on the economy and on the naira will persist.