Financial integration in West Africa
Nigeria’s Finance Minister recently highlighted the important role of the private sector in Nigeria's recovery efforts. Though the private sector's access to finances (capital) is critical for economic development, foreign capital, in particular, could be crucial for Nigeria. Financial integration offers an untapped avenue for realising this potential.
The capital agenda
The two primary avenues for a business to raise capital are through borrowing, i.e., credit and equity, i.e., investors. For Nigerian businesses looking to raise capital, they face two primary challenges: low access to funds and high cost of funds.
In regards to borrowing, less than a third of MSMEs can access loans from financial institutions in Nigeria. Apart from government debt crowding out private credit, the failure to collect credit information has deterred domestic banks from pumping more credit into the economy. Nigeria’s credit to GDP ratio is 23%, considerably lower than Ghana (35%) and South Africa (178%). Even with legislative attempts to rectify internal credit barriers, more can be done to improve access to external credit for Nigerian businesses and reduce their dependency on domestic banks.
Meanwhile, the stock market accounts for 10% of Nigeria’s GDP, well below the 60% benchmark for low and middle-income countries, highlighting the under-utilisation of equity markets by Nigerian businesses. Financial capital in Nigeria is shallow at the moment, but with the support of our neighbours, we can reach the deeper end of the pool.
Why financial integration?
Financial integration refers to the ease in which money can move across borders. A financially integrated Nigeria would see capital moving from Lagos to Accra as easily as it can move to Kaduna. Currently, Nigeria is ranked 13th out of 15 ECOWAS States for financial integration, which highlights the scope for improvement. One notable cause of this is the poor exchangeability of the naira in the region.
Let's imagine a Nigerian shoe manufacturer and consider if Nigeria were more financially integrated into the ECOWAS region. The company would face significantly lower barriers to raising capital outside the country. Particularly, a more exchangeable naira would reduce the cost of financial transactions and free up funds that would have otherwise been used to cover fees and expenses associated with currency exchange. This is one accepted benefit of the common currency of the Eurozone. Linking this with the potential for banks and investors to grow in size and efficiency, ECOWAS would have a larger and more efficient pool of capital to deploy into the private sector. Our shoe company now has access to a significantly larger amount of capital.
Capital markets would also become more competitive – banks in Senegal and Ghana would compete to fund this Nigerian shoe manufacturer, and this process could help bid down notoriously high interest rates in Nigeria and the wider ECOWAS region. Markets could also become more resilient as lending institutions can diversify their risk, for example, by splitting loans across countries or syndicating and selling them across borders. This would reduce the impact of naira depreciation on the banking system as banks would have other non-naira/non-dollar assets. The same applies to investors as more diversification allows them to invest in riskier businesses without having a large impact on their overall investment risks.
Subsequently, a lack of viable investment or lending opportunities in other countries could motivate banks and investors in those countries to deploy their funds in more sustainable opportunities in Nigeria. Financial integration makes it easier for them to do so, and in order to take advantage, Nigerian companies would need to showcase themselves as innovative, efficient, and sustainable. Such an incentive would have an enormous beneficial impact on the real economy.
Why Financial Integration in ECOWAS?
There are many reasons Nigeria would benefit from regional integration, in particular. The chief reason stems from the fact that ECOWAS countries all face similar financial restraints. Financial integration within this region allows for a pooling of efforts to improve financial systems and encourages best practices to be shared across the region. Also, deeper financial integration here would complement other initiatives such as free trade and monetary union, both of which rely on and facilitate financial integration. Nigeria has already made efforts towards further integration in the region, evident in its contribution to the West African Capital Markets Integration Council. However, as highlighted earlier, there is scope for more.
Taking steps towards further regional financial integration is not an African story, in fact, significant resources are being expended in Asia and Europe to unlock regional funding synergies.
As we know, there is no such thing as a free lunch. One drawback of financial integration is that it could increase Nigeria's susceptibility to flows of "Hot Money". A quick injection of capital into the Nigerian economy could bring larger inflationary pressures, while a quick exit of capital could exacerbate any shocks to the economy, such as a decline in the oil price. Additionally, any reductions in interest rate could result in excessive borrowing and lead to a potential debt crisis. However, a crisis is preventable if the proper levels of banking cooperation and supervision are in place to ensure lending rules are robust, and debt capacities sustainable.
Who will seek who?
Both internal and external focus is required for Nigeria to ensure a healthy environment for the private sector to play a greater role in the growth of the economy. Improving the access of external capital into Nigeria from other African states could result in a larger and cheaper financial capital market for our private sector to thrive on. Efforts to further integrate Nigeria into the African financial ecosystem could reduce the time Nigerian businesses spend seeking capital by increasing the time African capital spends seeking Nigerian businesses.
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