Throughout economic history, financial crises have been a constant feature of economic cycles. Though the initial trigger may differ from crisis to crisis, the underlying blend of circumstances are usually similar. From the Great Depression in 1929, to the Asian Financial Crisis in 1998 and the Great Recession of 2008, all these events involved some combination of a rapidly deteriorating currency, a failure to meet sovereign debt obligations or a partial collapse of the banking sector. Ominously, a comparable scenario is brewing in Nigeria and could result in similar chaos if it is not averted.
In most crises, the fault lines exist long beforehand and the seeds are typically planted long in advance. Both remain largely undetected until the crisis is analysed in retrospect. In Nigeria’s case, the cause of the troubling scenario can be traced back to the nation's humble beginnings. Since 1999, the Federal government has predominantly relied on one source of income (oil) to fund the fiscal budget. The recklessness of this decision (or indecision) has various implications and is largely responsible for the current state of the Naira, which for a long time has served as a mere proxy for oil prices.
Ideally, a currency should represent the dynamism and robustness of an economy as it serves as a store of value. However this has not been the case with the Naira as it has plunged by 25% in the past 10 months before showing signs of attaining its true market rate in recent times. The revenue drop has made it increasingly difficult for state governments to meet their budgetary requirements as the amount of their federal allocation has drastically reduced. Although President Buhari has authorized a $2.1 billion bailout for state governments, economic history has made it clear that band aids don't fix bullet holes and there are urgent structural issues related to the cost of governance that are yet to be addressed.
So far, the weak Naira has done considerable harm to the private sector, as many organisations in the oil & gas, power, real estate and manufacturing industries have borrowed large sums to expand their operations. Most of these loans are denominated in US dollars and borrowers are finding it increasingly more difficult to service interest payments off the revenues they receive in Naira. This exchange rate risk has persistently been a problem, but has been made worse by the Naira's inability to find stability. A weaker currency is an advantage when a nation's economic strategy is weighted towards exports. Given that Nigeria largely exports raw materials, the current state of the Naira is of benefit to only a few. Moreover, global commodity prices have been falling, in line with the oil slump.
The falling Naira has had a harsh corollary effect on the banking sector and this is of great importance given that this sector tends to be the main conduit through which most crises wreak economic havoc.
Commercial banks in Nigeria have appeared to perform decently in recent times with banks like GTB and Zenith posting over $500 million in profit before tax (PBT). However, the share of non-performing loans in the banking sector has slowly been on the rise due to structural issues in several core lending industries (i.e. oil and gas, power and manufacturing). Given the total bank lending allocation to oil and gas companies is roughly around 26%, this level of exposure has forced banks to write off several loans.
Going further afield, the lack of discipline in many bank's credit committees gives some cause for concern especially as CEO's have been consistently accused of using depositor funds as a vehicle for personal ventures. Although only the failure of Tier 1 banks (FBN, GTB, UBA, Zenith and Access Bank) could truly pose a systemic risk to the sector, the panic that may subsequently follow a 'run-on-any of these-banks' can be irrational and over-zealous. Many Tier 2 banks (Stanbic, Diamond, Skye, FCMB, Sterling) are beginning to announce their Q2 results for 2015 and the picture is patchy at best with PBT declining by over 20% in two of these banks. This should come as cause for concern as the process of converting a banking crisis to an overall financial crisis is a well-beaten path.
In any given crisis, the loss of depositor confidence in a big bank leads to a frenzy of capital flight. Depositors are quick to remove their funds from banks as the sentiment runs through the system that 'one bad apple spoils the bunch'. Sometimes, the panic comes from not knowing which particular apple is bad. Inevitably, this leads to a credit crunch as banks recall loans and become more unwilling to lend as their balance sheets temporarily shrink. This credit crunch creates liquidity challenges for businesses that rely on debt as a cheap, stable source of funding. From there, the economy grinds to a halt as businesses put their expansion plans on hold and this subsequently leads to a recession. This hysteria of capital flight will also be reflected in the capital markets as investors dump their shares in banks and share prices begin a race to the bottom. Taken in isolation, these factors are not particularly worrying but once viewed as a whole, they offer an ominous warning for the Nigerian economy.
All in all, there is a slight propensity to overstate the effects of these issues on the overall economy. After all, economic doomsayers are as integral to our history as crises themselves. While a financial crisis may not occur soon or even in the near future, the aforementioned factors indicate we are on an unfavourable trajectory.
Nigeria is at a painfully uncertain period in its economic development with the policy direction of the country in a state of limbo. Based on recent history, we are likely to muddle through with a series of haphazard attempts at fixing what is a legacy of dysfunction. If so, we will remain ill-equipped to navigate the economic headwinds on the horizon. It is the responsibility of the current administration and big business leaders to ensure that there is an enabling environment to curb the effects of what would otherwise be ingredients of a perfect storm.
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