GLOBAL ECONOMIC RECESSION AND CHALLENGES FOR NIGERIA: AVOIDING THE WRONG LESSONS AND TAKING THE RIGHT LESSONS Mike I.

1. GLOBAL ECONOMIC RECESSION AND CHALLENGES FOR NIGERIA: AVOIDING THE WRONG LESSONS AND TAKING THE RIGHT LESSONS Mike I. Obadan, Ph.D, FNES

2. Presentation Outline I. Introduction • Dimensions of the crisis • Impact of the crisis on the Nigerian economy • What do we learn from the crisis? • Conclusion

3. I. Introduction • The world capitalist system has been greatly stressed by financial and economic crises, which have threatened the foundation of the system for about two years now. • The resultant global economic recession was triggered by financial crisis originating in the US mortgage sector. • However, financial crises with global dimension are not new in history. • A major one occurred 1928-1933 culminating in the Great Depression. • The Great Depression occurred after a dramatic expansion in debt and money supply, first in the 1920s, and later in 1929-1933 due to debt default.

4. I. Introduction • Latest financial crisis similarly originated in rapid risky debt accumulation and loss of investor confidence in the US sub-prime mortgage market. Result: liquidity crisis. • In September 2008, the crisis deepened, as several stock markets crashed and many banks, mortgage lenders and insurance companies failed. • Spread of the crisis worldwide is due to the linkages of the world economy arising from economic globalization. • Implications tends to be alike in crisis-affected economies: - economic recession, output losses, higher unemployment and poverty; - reduced capital inflows including aid, and increased capital flight; - exchange rate and balance of payments crisis. • Adoption of expensive rescue packages to bail out troubled financial systems.

5. 2. Dimensions of the Global Economic Crisis Causes of the Crisis • US mortgage crisis triggered the crisis which affected the entire financial sector and led to serious economic recession. • Use of financial instruments such as securitization. • Role of policy: Clinton govt. pressurized Freddie Mac and Fannie Mae to increase mortgages to low/moderate income people. • Other factors: - Limited regulation/supervision amidst careless financial liberalization. - Fragile and vulnerable U.S financial system. - Widespread miscalculation by banks and investors on the risk inherent in the unregulated collateral debt obligations and Credit Default Swap markets. • Boom and collapse of the shadow or “parallel” banking system. • However, the financial crisis could have been a symptom of a deeper crisis.

6. 2. Dimensions of the Global Economic Crisis Spread and Effects of the Crisis • The crisis spread to Europe through the channels of financial globalization. • The crisis rapidly spread into a global economic shock and crisis, resulting in: - A number of European bank failures, - Declines in stock market indices, and - Large reductions in the market values of equities and commodities like oil. - As the currency crisis developed, investors transferred vast capital resources into stronger currencies

7. 2. Dimensions of the Global Economic Crisis • The problems have been so severe that the following happened: • Some of the world’s largest institutions have collapsed. • Some have been bought by their competitors at low prices • Governments have resorted to extensive bail-out and rescue packages. - U.S targets $1.5 trillion to recover. Congress already approved $800 billion. - U.K – about $692 billion of fresh funds - France – Euro 360 billion - Germany - $670 billion. • Growth has slowed considerably in most developed countries. • U.S economy, many Euro-zone, Japan, etc, officially in recession. • Stock markets are down with about 40% reduction in the value of the world’s companies.

8. 2. Dimensions of the Global Economic Crisis • Even banks with large capital reserves needed funds and sought government bailout though businesses and individuals that rely on credit find it harder to get. • Specifically, the following have occurred: • U.S economy lost 2.5 million jobs in 2008; lose 500,000 jobs a month; has another 3.4 million who have gone form full-time to part-time, has high under employment rate; and growth has slowed considerably. • In U.K, the Bank of England cut its interest rate to an historic low of 1.5% from 2.0 (Mid-January 2009) to 1.0% by February, 2009.

9. 2. Dimensions of the Global Economic Crisis • The World Bank has warned that: • Some emerging market economies (EMEs) may face serious challenges like bank failures and currency crises even if global bail-out plans start restoring confidence in financial markets. • There would be a significant decline in global economic growth in 2009 for developed countries and EMEs. • Deep global recession could not be ruled out and world growth per capita could be negative in 2009; • Following the insolvency of some large banks and financial institutions, capital flows to developing countries are drying up and huge amounts of market capitalization have evaporated. • Dwindling capital flows to developing countries reduce their investment level while slowdown in world trade tends to cut into their export markets.

10. 3. IMPACT OF THE CRISIS ON THE NIGERIAN ECONOMY i. Government finances and fiscal operations • This is a most visible area of impact given Nigeria’s heavy dependence on crude oil exports for government revenue and foreign exchange earning. • Reduced crude oil demand due to the recession and the crash of oil prices have negatively impacted on government finances. • Crude oil prices was about US$40.0 per barrel as at the first week of February, 2009 (over $50.00 in May) compared to U.S $147.00 per barrel in July, 2008. • Realized government revenue January-March, 2009, was N353 billion compared to N477 billion expected, implying a short fall of N124 billion. • Though foreign exchange earnings dropped, recent improvements in oil prices, however, have positive impact. • Realized fiscal deficit in 2009 may be higher than what has been projected in the 2009 Appropriation Act.

11. 3. IMPACT OF THE CRISIS ON THE NIGERIAN ECONOMY • Macroeconomic Performance The crisis is already having serious effects on the macroeconomy. Growth: • The economy may not go into recession this year. • Contrary to the optimism of senior government officials, the economy may experience significant contraction and high growth rates recorded in recent years may reduce significantly. Balance of payments and exchange rate • Balance of payments and currency/exchange rate crisis are likely. • There has been higher capital outflow, particularly portfolio investment. • Foreign reserves have largely fallen. From over US $60.0 billion by the mid-2008 to the current level of about U.S $46.0 billion. • Thus, the naira depreciated by 25% early December, 2008.

12. 3. IMPACT OF THE CRISIS ON THE NIGERIAN ECONOMY • Inflation and Interest rates • These are very likely to maintain their upward trend that was observed in 2008. • Inflation may worsen as a result of the “pass-through effects” of exchange rate depreciation and the financing of fiscal deficits. • Interest rates will trend upwards considering the depreciating naira and fiscal deficit.

13. 3. IMPACT OF THE CRISIS ON THE NIGERIAN ECONOMY • The Financial Sector • With the global financial/economic crisis, there has been: • Withdrawal of funds/placements by many international banks/institutions that extended credit to Nigerian banks and businesses. • Intensification of capital flight which is compounding the downturn in the capital market. • Reduction of confirming lines by foreign banks to their Nigerian counterparts. • Belt-tightening measures on the part of some Nigerian banks as part of strategic measures to minimize impact. • The heavy burden of huge lending to the troubled stock market, estimated at N1.2 trillion by the CBN. • Nigerian banks have reduced their lending activities considerably. • Given the high capitalization of the banks, their huge profits and recent strategic moves , they should be able to withstand shocks.

14. 3. IMPACT OF THE CRISIS ON THE NIGERIAN ECONOMY iv. Effects on the Stock Market • The global financial crisis has worsened the crisis in the Nigerian stock market. - Share prices trended downwards mirroring global trends. The stock market lost 45% of its value in 2008 and has lost over 37% since the beginning of 2009. - This had a big impact on banking systems’ exposure to the capital market. v. Effect on the Real Sector • With the global crisis, the industrial sector’s problems are being compounded by depreciating naira, rising interest rate, rising cost of infrastructure services, etc. • Operators in the sector are jittery anticipating more hard times in terms of lower investment, lower profits and possible retrenchment.

15. 4. WHAT DO WE LEARN FROM THE CRISIS? 4.1 Some General Lessons i. Free market mechanism is vulnerable to serious crisis. • The invisible hand of the market is not invincible after all. The promoters of the Washington ‘Consensus’ are now promoting big government to rescue capitalism. ii. Markets cannot be left on their own. • The crisis has shown that markets are not always able to function on their own. • Pragmatic and sensible adoption of market systems is required. iii. Greater appreciation of the significance of government’s necessary role • There is need for pragmatic adoption of the market system in the context of the guiding hand of government.

16. 4. WHAT DO WE LEARN FROM THE CRISIS? iv. Avoid pre-mature and careless financial liberalization. - Careless financial liberalization and the idea of self-correcting markets led to recession, unemployment and poverty. v. More professional supervision of financial institutions - Better regulation required to reign in financial markets and restore trust in the system. vi. Implications for macroeconomic policies being used to stimulate recovery: - increased borrowing, reduction of interest rates, reduction of taxes, spending on public works, etc. appear reasonable under present circumstances. - However, when good economic times return, some of the policies need to be reversed.

17. 4. WHAT DO WE LEARN FROM THE CRISIS? 4.2. What can be considered as Specific Right Lessons for Nigeria? • Contingency Plan for possible bail-out of Banks needs to be in place to contain the macroeconomic implications of possible distress in the banking system. • Regulatory institutions, e.g, the CBN, SEC and Nigerian Insurance Regulatory Commission appear weak and ineffective, especially the SEC. • Promote vigorous tax collection to provide sustainable revenue. • Return non-oil tax as the pivot of national development as it is consistently reliable and predictable. • Use oil revenue to strengthen the non-oil sector base of taxation. • Bring all taxable adults evading /avoiding tax into the tax net. • Improve efficiency of collection and administration of existing taxes. • Prudent fiscal policy is required more than ever. • Bloated budgets, like the 2009 budget, portray a penchant for profligacy and corruption which makes public spending inefficient and ineffective.

18. 4. WHAT DO WE LEARN FROM THE CRISIS? • Stimulate aggregate demand through private and productive public spending with supportive anti-cyclical fiscal and monetary policies aimed at stemming recession. • Greater urgency to diversify the economy. • Government needs to sincerely focus on developing/strengthening agriculture, manufacturing and other sectors that can drive the economy and provide alternative sources of revenue on a sustained basis. • Resuscitate national development planning • Planning permits a systematic, disciplined and coherent management of the economy. • Use NV2020 document as framework for national development plan. • Vision 2020 document should provide the framework for preparing a medium term development plan containing programmes and projects for realizing Vision 2020.

19. 4. WHAT DO WE LEARN FROM THE CRISIS? • Macroeconomic management – interest rates and exchange rate. • This is not the time to raise interest rates. They are already too high. • Interest rates should not be relied upon for foreign exchange management. Other strategies should be explored. • Confidence building measures. • There is need for confidence building measures in the Nigerian stock market. • Transparent management of excess oil revenue. • A formal oil revenue stabilization fund, endorsed by all tiers of government is imperative. • Fund should be properly managed as a cushion to the type of internal and external shocks currently been experienced by the country. • Cooperative fiscal federalism. • This is important particularly in view of the last point on management of excess oil revenue and the need for macroeconomic coordination and stability.

20. 4.3. What can be considered as Wrong Lessons to Avoid? i. Ostrich Behaviour. Government cannot afford to behave like an ostrich. A more purposive management of the economy is indispensable. ii. Pro-cyclical IMF policies and lending. • The Bretton Woods Institutions’ usual pro-cyclical policies of raising interest rates and taxes and lowering expenditure are not helpful in the prevailing circumstances of recession. • Such policies had failed in the past. Rather, Keynesian anti-cyclical policies would be in the right direction. iii. Fixing or freely floating the exchange rate. • There is need to continuously manage the exchange rate. • Formal or informal bands may be adopted in this regard.

21. 4.3. What can be considered as Wrong Lessons to Avoid? iv. Printing of money to increase liquidity and ease possible cash crunch. • As Nigerian governments are not known to use deficit finance judiciously, printing of money and borrowing from banks are not advisable. • Safer to borrow from the non-bank public through the floating of long-term bonds and development stocks rather than short-term instruments. v. Succumbing to pressure to bail-out the stock market. • Stock market should be allowed to sort out itself through the market mechanism.

22. 5. CONCLUSION • The global economic melt-down has had far-reaching impact on and implications for both developed and developing economies, Nigeria included, depending on their level of openness and interconnectedness with the global economy. • In dealing with the crisis, the inevitable role of government in complementing the market has come to the fore very strongly. • Important lessons in economic management have also been thrown up. For Nigeria, some of such lessons relate to the avoidance of IMF type policies and conduct which portrays the government as an ostrich.

23. 5. CONCLUSION • Others to avoid are: printing of money, fixing or freely floating the exchange rate, and succumbing to pressure to bail-out the stock market. • Well thought-through strategies and policies are required. Some of them relate to the following: vigorous promotion of non-oil tax collection and prudent fiscal policy and management of available resources. • Others are diversification of the economy and various confidence building measures to restore trust and stability to the financial sector. • Robust regulation and more professional supervision of financial institutions and strict enforcement of regulatory policies and measures is indispensable.

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