The US FED’s hawkish stance to stamp out rising inflation is likely going to cause some trouble for emerging markets like Nigeria.
The US Federal Reserve hiked its benchmark interest rate by three-quarters of a percentage point this week. The rate hikes mean a stronger dollar against most of the world’s currencies including Nigeria.
As a result, a stronger US dollar, backed by higher US interest rates, tends to reduce emerging market currency values at a time when many emerging markets (EM) economies are already struggling and their currencies have already fallen against the greenback.
Nairametrics took a cursory look at how the surging dollar could impact Nigeria’s economic prospects.
Higher cost of external debt for Nigeria
A major consequence of the strengthening dollar is that emerging market economies will have to pay a higher interest rate to entice people to acquire dollar-denominated bonds issued by EM sovereigns and corporations.
- If existing dollar-denominated loans in Nigeria are not hedged, they may be subject to rate spikes. A government that intends to fund a large portion of its budget through deficit spending will almost certainly have to borrow at a higher rate.
- Higher borrowing cost is troubling particularly when you take into consideration that Nigeria spent about 96% of its revenue on servicing debt obligations in the year under review. Compared to the previous year, Nigeria’s debt service-to-revenue ratio increased from 81.1% in 2020 to 96% in 2021.
- This is particularly worrying because an anticipated fall of the local currency as a result of a reversal of capital flows could make servicing the dollar loan more difficult. Corporations and institutions that borrowed in dollars may be put under extra strain if their earnings do not rise in lockstep.
Pressure on the Naira despite an uptick in exports
- Given the hawkish stance of the US Federal Reserve, a stronger dollar could signal trouble for the Naira, as it is likely to rise above N620/$. Furthermore, the International Monetary Fund (IMF) has warned that improving trade balance will have a modest influence on FX strains, with parallel market exchange rate premiums remaining in the 35-40% area since October 2021.
- Total imports in Q1 2022 totalled N5.9 trillion, down 0.67% from Q4 2021 (N5.94 trillion), but up 21.04% from the comparable period in 2021. (N4.88 trillion). Nigeria’s export income in the first quarter of 2022 was N7.1 trillion, up 23.1% and 137.9% from N5.77 trillion and N2.98 trillion in the first and fourth quarters of 2021, respectively.
- The Fed’s rate hike might exacerbate the EM currency woes, possibly leading to a full-fledged crisis. Nigeria does not currently have a free-floating currency. Naira has been under pressure on the black market and is currently trading at N607/$1 despite the Uptick in the trade balance
- Nigeria, which historically has been reliant on foreign investment from the United States and other developed countries, may continue to face a severe shortage of direct investment from overseas.
- This is because higher rates in the US would entice investors to return to the US capital markets, due to the widely held views about the relative safety of investments held in the United States, thereby accelerating capital flows out of emerging nations and making the cost of sourcing USD more expensive via exchange rate depreciation.
- This issue of reducing capital inflows aggravates the already existing problem as Nigeria’s capital inflows hit a four-year low of $9.66 billion in 2020, before dropping to $6.7 billion in 2021.
What experts are saying
Dr Godswill Osuma, a researcher and lecturer in the Department of Finance, Covenant University stated the US hawkish stance is expected to put more pressure on the Naira and increase importation costs.
He said, “As a result of this interest hike, I predict adverse contagion effects on countries Highly integrated with the United States such as Nigeria which could lead to currency depreciation, high cost on borrowing and high import prices.”
He added that “To buffer this intending shock, the government should revamp the countries manufacturing sector especially the ones engaged in the production of fast-moving consumer goods that constitutes a large volume of import into the country.”
Samuel Oyekanmi, Research Analyst at Nairametrics stated that “with the aggressive move by the US fed in raising interest rates, it means that the interest paid on Nigeria’s external loans will rise. Already, the federal government is spending as high as 96% of its retained revenue on debt servicing, this could surge significantly in 2022, which would open the government to more borrowings and hinder its ability to fund capital projects.”