March 23, 2009
QUOTE: “As long as Wall Street enhances revenues with leverage to prop up kingly bonuses, as long as there are few personal consequences for CEOs (and board members and other top executives) for shoddy risk management, as long as CEOs are allowed to walk away with millions, nothing will change. The fact that shareholders are wiped out is no deterrent, and moral hazard will live on” – Janet Tavakoli
The Tectonic Plates are Shifting III
Finding a solution to the global economic crisis will not be easy not less because of the widely divergent approach adopted by different nations, the widely disparate solutions profered by experts and the unwillingness of the economic managers to focus on the real cause of the crisis.
At the meeting of G20 finance ministers, the major economies held divergent views on how to dig us out of this mess. There was a debate between those who want more fiscal stimulus and those seeking more or tougher regulation. The US, supported by the UK, was arguing for a co-ordinated fiscal stimulus to re-boot the world economy. The EU, and in particular Germany and France, want nothing to do with such a plan, arguing that since it was a credit bubble that caused this calamity, inflating another one is not a sensible remedy.Are the ‘Economic Wizards’ missing the markIn Nigeria, the recommendation of the steering committee set up by President Yar‘Adua in response to the crisis centered around: 1. Full deregulation of the downstream sector of the oil industry, the privatisation of our refineries and the removal of fuel subsidies; reforming the Petroleum Products Pricing and Regulatory Agency (PPPRA); 2. The adoption of a common year end for commercial banks and the adoption of International Financial Reporting Standards (IFRS) by all banks in the system; 3. The establishment of an Asset Management Company and the setting up of a Regulatory Financial Services Committee to monitor and review developments in the financial system.However much the present administration would have preferred to bury its head in the sand, the above policy decisions was a tacit admission that firstly; things are getting out of hand and therefore tough policy decisions to strengthen the financial services sector in all its ramifications have to be taken; secondly, that the foundation of Nigeria economy is based on the financial and oil sector. With crude oil contributing about 95% of total foreign exchange earnings and the banking sector constituting about 65% of the capitalisation of the capital market, the premise appears to be: get the two sectors right, and other things would follow. This premise is largely correct and if all the proposals are implemented to the letter, it would certainly alter the face of the entire financial system.However, In choosing to concentrate on fiscal measures that ignores the reasons why Obasanjos economic team led by Mrs Ngozi Okonjo-Iweallawas relatively successful, Yar Adua is manifesting either ignorance of or a lack of the political will to take the tough political decisions necessary to support the economic measures. Yar’Aduas economic wizards appear to ignore the imperative of fighting today’s wars while laying a strong foundation for future prosperity; there appears to be an intellectual failure, a fundamental unwillingness to see (or their willful ignorance of) what the Nigerian economy needs in order to produce good outcomes for all and attract international investors looking for a safe haven to invest their funds, away from the troubled western financial systemOur short term solutions would be a disastrous failure without laying a solid foundation for future prosperity and fighting the root cause of the present crisis.Where we areThe cause of our present crisis is not the sub-prime mortgage malaise that precipitated the crisis of confidence and the freezing of credit in the global financial system.The crash in the price of crude oil from its last year high of $157 per barrel to the present $40 per barrel precipitated a fall in the market capitalisation of the Nigerian Stock Exchange by about 60 per cent in local currency terms from its historic high of March 5, 2008.Whereas the Nigerian regulators were quick to blame the collapse of the capital market on foreign investors withdrawing funds as the global credit crisis intensified, that is not the full story. In the preceding articles, I had argued that those hedge funds and other international investors, which never held more than an estimated 10-12 per cent of share capita, played only a secondary role. Prior to the crash, investors were “troubled by high valuations, dubious corporate governance, rampant speculation, and suspicions of market manipulation” in the over-inflated stock market. The sudden collapse was thus rooted in the widespread practice of banks loaning money for share purchases, which allowed soaring valuations to lose touch with market fundamentals.Our economic policymakers could have limited these dangers, but they did not do so. Instead, they ignored all the warnings and allowed the bubble to inflate and let financial transactions become increasingly opaque and ever more leveraged.However, for the foreign investors, with oil prices as high as they were, they ignored their fears about the direction of the economy and their investments. The rising price of oil and increased earnings also blinded the administration and its economic managers to the fact that fast gamble being played on the economy by the Banks has started to give the economy high fevers. But when the price of oil came crashing, the investors took to their heels immediately!
The regulators were not unaware of the risks, but their confidence was based on the faulty premise that the high oil price would continue, things would work out well and no one needs to worry about systemic risk. The great mistake was to rely merely on the higher oil earnings. The huge profits bankers reaped reinforced their collective blindness to the illusory value of the assets they traded.This is an intellectual and moral failure of those who were in charge: a failure for which there is no excuse.Transparency
What is needed then is not just a better or tougher financial regulation or a frantic but so far futile effort to shore up the value of the Naira, but a concerted effort to shore up confidence and credibility in our economy.Every first-year economics student learns that the most important conditions for an unregulated market, in theory, to function efficiently are:1. Confidence; confidence in future values is everything for a financial product: if confidence is lost, the market collapses; 2. enforceable property rights and contracts, and the absence of “externalities” and finally 3. Full information. These conditions are never perfectly fulfilled, but many markets come close enough that participants’ self-interested actions works for the common good.But as noted by the Financial Times, when these conditions are absent, markets malfunction; the way they do so is one of the great topics of economic theory. It tells those who care to listen that when a market is too opaque, or when the effects of market transactions are too inter-dependent, the pursuit of self-interest can make everyone worse off, or unfairly land some with the losses caused by others, or in extreme cases make markets disappear altogether.That is why confidence in your markets, future values and on your currency based on transparent and full information is everything. If that confidence is lost, the market collapses. Nigeria have decided to practice an unregulated capitalist economy but are unwilling to embrace its fundamentals steming from the above three conditionalities - the existence of a virile opposition, a free press, the rule of law, strong and independent judiciary and a functioning criminal justice system. The Nigeria financial market was conducted under seriously non-transparent conditions that today most Nigerians view the market with distrust and see it as a place where a lot of ‘hanky-panky’ takes place.Take statistics for example. Government statistics the world over are notorious for its massaged figures. Governments is always the last to admit a financial mess. But the existence of independent institutions – Universities, think-tanks, Institutes, Chambers of Commerce, Consulting firms, Financially strong and investigative Press, business groups - like the UK CBI – make up for their deficiencies. These dig, research and come up with challenging figures that forces the government to admit them much later.In Nigeria, some of these bodies are non-existent. The available ones still depends on government institutions for their figures, where the government has a strong interest in hiding the true state of affairs.In such non-transparent financial sector, unwarranted valuations will often occur, which, when they fail, can destroy confidence throughout the financial system. And the more implicated the economy is in the financial sector, the wider are the repercussions of such dysfunctions – to the point where financial failures can threaten the economic system as a whole.The same lack of information, accountability and transparency applies to the oil sector. It is sad that not much is known about what goes on inside the most important foreign exchange earner in the country. Observers believe that the majority of the country’s crude oil is stolen by foreigners due to illegal activities going on at the country’s exclusive economic zone. Nigeria produced about 1.9 million barrels of oil per day in January, according to OPEC figures but as many as 100,000 barrels of crude oil are being stolen or smuggled from Nigeria every day, representing 5 per cent of national production, according to estimates from Shell. Shell confirmed that the theft of oil in Nigeria, Africa’s largest oil-producing country, ranged from 20,000 to 100,000 barrels per day but may have peaked at more than this. At today’s price of more than $45 a barrel of benchmark Brent crude, this equates to between $300 million and $1.6 billion (£1.1 billion) a year. Stolen Nigerian crude is usually exported by barge for refining in other parts of West Africa. Local oil smugglers in Nigeria earned up to $2,000 to $3,000 per shipment. Stolen oil was delivered to larger, seagoing barges for onward export. There is evidence that it is shipped to as far as Brazil and Eastern Europe. A lot of people have died in this illegal activity. Nigeria has proven reserves of 36 billion barrels – the seventh highest in the world – but the industry has been wracked by violence, corruption and crime, particularly across the volatile Niger Delta region. Nigeria needs to resolve the social issues in the region and come down heavily on crime. Government agencies cannot claim ignorance of the perpetrators of this crime.The right institutions and transparent policies should be put in place. There was the need for the country to make significant changes to support clear, accountable and efficient development of the oil industry. The oil boom “had bred corruption, underdevelopment, social conflict and environmental damage". There is a need for transparent revenues payment practices, open and competitive contract bidding, active monitoring and participation by civil society. The Extractive Industry Transparency Initiative (EITI) should be re-invigorated so that the government should fully be committed to extend that work to the petroleum sector.CORRUPTIONAll this long talk boils down to one single solution: FIGHT CORRUPTION!Obasanjos relative economic success would not have taken off the ground without the symbolic gesture at fighting corruption. His tougher line on money laundering led to a newly-awarded BB- sovereign debt rating that attracted global funds.President Yar’Adua should commit himself to fighting corruption. Taking away the responsibility of financial services surveillance from the Central Bank of Nigeria to enable it concentrate on its core function of monetary policy implementation and setting up of a Regulatory Financial Services Committee to monitor the financial sector are good policies but not enough. It would still be Nigerians that will do the “monitoring”. Recently, the CBN came up with an idea to invite what they called in-house inspectors into banks to properly monitor their activities. One writer noted that it is an idea that looks good “but if you look closely it is like you have come into the house of a thief with the hope to stop him from stealing. He will give you his best room, give you all the food you need, close the door and be doing what he likes”. It may work in other countries but not in the Nigerian cultural context.All the best policies in the world will not work if foreign investors would still look and see Aondoakaa as our greasy-fingered Attorney-General.What is needed is to practice Ribadu’s homily: “I intend to show for example that we deliberately went after grand corruption because that is where the problem is. We interrogated the Governors, the Senate President, and the Vice President. I put a Bank Director, Bulama in handcuffs. The moment we did that, the banks knew immediately that there were no sacred cows. We needed to send a strong signal that corruption will not be condoned and the cleansing process had to start from the stop”.Fighting corruption would engender confidence, in the public as well as investors in the real and financial sectors. Political and economic management should be done transparently and in a way that engenders confidence in the private sector community. Nigerian banks must adopt much more transparent accounting procedures.This could be our chanceWhile fighting today’s wars let’s also build for the future. The global meltdown could be an opportunity to reposition the economy and reduce our overwhelming dependence on oil, to create a diversified springboard for steadier long-term growth. Nigeria must take steps to diversify its economy. The effort to better regulate and supervise the banks and the broader financial system should be accompanied by efforts to address two major impediments to economic growth in Nigeria: firstly, policies that create barriers and disincentives to private sector-led growth; and secondly, lack of transparency and accountability in revenue generation and expenditure at all levels of government.We must look at other sources of income apart from oil; e.g. the agricultural sector, the application of biotechnology because of its potentials in ensuring food security and wealth creation.Because of the rising grain prices behind the world food crisis, Nigeria should embrace biotechnology to help generate employment of the jobless youths, while feeding the hungry masses at fairly affordable prices.The Excess Crude Account should be used to fund the development of critical infrastructure for the economy to grow. Dipping into the excess crude account for high rate of return on public investment projects – especially the energy and power sector - would also provide a fiscal stimulus at this time of crisis. Professor Soludo was initially right to say that Nigeria's economy should not be adversely affected by the global crisis. What he failed to add was: If the authorities have a clear objective that understand the issues associated with running a modern financial market; if the principles of our Nigeria's home-grown, IMF-backed economic reform program remain and “as long as the country's oil revenues and savings are well managed”.The stock market meltdown and credit crunch in the country has not deterred the $20 billion hedge fund company belonging to American billionaire, George Soros from scouting for potential opportunities in Nigeria's banking sector.Nigeria topped a new index of African potential investor destinations recently, with the survey organisers saying the country offers good potential for growth even against the global economic crisis.Interest in Nigeria as an attractive investment would pick up again. Business consultancy African Rainbow's Star of Africa index forecasts that "Africa is going to overtake the Middle East to become the second fastest growing region in the world after emerging Asia. It will be affected by the global financial crisis but it is much less exposed than many places."Nigeria potential for infrastructure expansion in electricity, water, information technology and communications as well as its status as Africa's most populous country were enough to propel it to the top of the list.The theme of this 3 part series- The Tectonic Plates are shifting- is deliberate; the global financial crisis has not only exposed the weaknesses of capitalism and globalisation, there has also been a tectonic shift in banking’s centre of gravity.A decade ago, a list of the world’s largest financial institutions was dominated by banks from the US and UK. Today, just four of the top 20 have their headquarters in the US, the world’s largest economy. HSBC, at heart an emerging markets bank, is the only one from Britain.Names like Citigroup, Lloyds’s, Royal Bank of Scotland, which dominated the landscape for most of the past decade, now languishes at the bottom of the list and is in effect under government control. New names have arrived as if from nowhere. This is partly a reflection of shifting economic power. Today’s league table ranking is dominated by China’s three largest banks: Industrial and Commercial Bank of China, China Construction Bank and Bank of China. Floated on the stock market in 2006 and 2007, their shares have held up better than those of many western rivals.Australian and Brazilian banks have also risen to prominence. But the shifting composition also offers evidence of how well different countries have managed their financial systems. Canada, for example, has been praised for its risk-averse approach to regulation. A decade ago, no Canadian bank made the list. Now there are five in the top 50.Remember Part I of the series? The Tectonic Plates are shifting; but with our huge potentials, where is Nigeria?ConcludedDaniel Elombah publishes www.elombah.comContact him at [email protected]
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