Is it Eureka for Naira, as IMF doles out $3.35bn SDRs?

The Naira, which has been an Elephant in the room over the past few weeks, perhaps would see some relief now, with the announcement on Monday by the International Monetary Fund that SDR allocations have been made to the country and other members with similar challenges. Besides the exchange rate pressure, Nigeria currently faces a […]

The Naira, which has been an Elephant in the room over the past few weeks, perhaps would see some relief now, with the announcement on Monday by the International Monetary Fund that SDR allocations have been made to the country and other members with similar challenges.

Besides the exchange rate pressure, Nigeria currently faces a high debt service burden, thus taking a regular loan may only serve to compound the already challenging debt service burden, as the country used over three-quarter of its 2020 actual revenue in paying interest on loans.

The volatile exchange rate, especially in the parallel market reflects a weak external sector, as characterised by declining foreign exchange earnings and downward pressure on external reserves, despite initiative of CBN to swap Naira for USD with Nigerian banks and other counterparts. The import bill remains obstinate, notwithstanding efforts to rein-in importation and stimulate local production via import-substitution policies. Paradoxically, non-oil exports remain relatively elusive, undermining the policy goal of diversifying the foreign exchange earnings base and overall structure of the economy from the 5-decade monolithic base that has elevated Nigeria’s vulnerability to global oil market volatilities.

Interestingly, as against the regular loan, such as the Eurobond, another round of which would likely be issued in September, this is not a cash disbursement, rather a liquid instrument that is globally renowned as near-cash and thus acceptable as part of the external reserves of the country.

The USD3.35bn SDR, some 10 per cent  of the country’s current reserve position of USD33.3bn, is like a callable or contingent capital from a reputable “AAA” institution, hence it would form part of the nation’s external reserves, providing a buffer and increasing the net import cover of the country’s external reserves. Hopefully, as the SDR strengthens the reserve position, especially with expected additions from imminent Eurobond proceeds, the Naira should see some relief, as it may become fundamentally justified that some appreciation is expected on the N520/USD rate at the parallel market.

The quantum of SDRs allocated under the current programme by the Fund is said to be the largest in its history, signifying the magnitude of the challenges facing the global economy, especially developing countries, which benefited from this historic monetary support of the IMF.

“The largest allocation of Special Drawing Rights (SDRs) in history – about US$650 billion – comes into effect today. The allocation is a significant shot in the arm for the world and, if used wisely, a unique opportunity to combat this unprecedented crisis,” Kristalina Georgieva, the Fund’s managing director, said in a statement on Monday.

As someone has said, one way to understand the SDRs mechanism is to see it as the whole world or membership of the IMF (its leaders) coming together to print more money and deciding who gets what amount based on certain criteria. In specific terms the money so printed is aimed at boosting global liquidity by providing capital to enhance trade.

This also explains the fact that not all member countries would need to access the $650b SDRs launched on Monday by the IMF. The countries where economies are sound have already pledged to transfer their allocations to those in need.

“To magnify the benefits of this allocation, the IMF is encouraging voluntary channelling of some SDRs from countries with strong external positions to countries most in need,” Georgieva added.

Already, such members have offered to lend some $24 billion, including $15 billion from their existing SDRs, to the IMF’s Poverty Reduction and Growth Trust, which provides concessional loans to low-income countries. Acknowledging that such a gesture was just a start, the Fund assured that it would continue to work with its members to build on this effort.

The SDRs work pretty much like an off-balance sheet financing arrangement in the corporate world. One of its attributes that makes it particularly relevant to Nigerian in the current state of the economy is that it does not add to the public debt level until it is drawn down. The near-term benefit is in its buffer of external reserve and the potential positive impact of global market perception towards Nigeria and implication of such for Naira stability and foreign investment inflows, both FDI and FPI.

In the event that the government needs to draw this down to fund infrastructure projects or its budget deficit, the Central Bank of Nigeria would transparently transfer the funds to the government through the Ministry of Finance, thus adding to the debt profile and increasing the debt service burden, as the full and effective interest rate would kick-in.

So, currently it does not add to the debt profile and it is also not a cash disbursement, rather the IMF gives a paper which qualifies to be seen as the value of the SDR amount in the country’s external reserve position.

The unprecedented allocation of the drawing rights is being made against the background of the COVID-19 pandemic and the dislocations it has wrought on the world economy. More countries, including many from Africa, fell deeper into poverty.

This makes the SDR programme a major tool to manage emerging market currency volatility. These countries have been among the hardest-hit victims of the COVID-19, with disruptions to their financial and exchange rate systems.

“SDRs are being distributed to countries in proportion to their quota shares in the IMF. This means about $275 billion is going to emerging and developing countries, of which low-income countries will receive about US$21 billion – equivalent to as much as six per cent of GDP in some cases,” Georgieva explained.

The IMF would provide a framework for assessing the macroeconomic implications of the new allocation, its statistical treatment and governance, and how it might affect debt sustainability, she further explained.

“This SDR allocation is a critical component of the IMF’s broader effort to support countries through the pandemic, which includes: US$117 billion in new financing for 85 countries; debt service relief for 29 low-income countries; and policy advice and capacity development support to over 175 countries to help secure a strong and more sustainable recovery.”

That said, whether or not the SDR would impact the exchange rate would depend on corresponding policies of relevant authorities. Notably, recent decision to halt CBN sales of FX to BDCs is courageous and perhaps commendable, as it has become a major leakage and rent seeking loophole, although requiring customers with genuine need to redirect their demand to the banks without qualifying such demand as genuine and qualified for FX is perhaps undermining the effectiveness of the new policy and reinforcing the gap the BDCs have partly filled.

For instance, only post-secondary education is qualified for FX in the banks, with a limit of USD15,000. What becomes of FX demand to meet obligations for secondary education? Worst still, importers and end-users of the 41 items, now 43 items, completely exempted from the FX market would not stop going to the BDCs and would not be served by the banks, hence reinforcing the demand/supply gaps driving the volatility of Naira at the parallel market, where price discovery is purely based on the equilibrium set by the forces of demand and supply. Perhaps, the SDR brings a new vista of energy and buffer for the external reserve for authorities to test a new model of exchange rate management, hopefully a new model may give a different and better result.