What rising US interest rates mean for Nigeria

The US Fed’s hawkish stance to stamp out rising inflation is likely to cause problems for emerging markets like Nigeria.

The US Federal Reserve raised its benchmark interest rate by three-quarters of a percentage point this week. The rate hikes mean a stronger dollar against most world currencies, including Nigeria.

As a result, a stronger US dollar, supported by higher US interest rates, tends to reduce the values ​​of emerging market currencies at a time when many emerging market (EM) economies are already struggling and their currencies have already fallen against the greenback.

Nairametrics took a quick look at how the soaring dollar could impact Nigeria’s economic outlook.

Cost of external debt higher for Nigeria

A major consequence of the strengthening dollar is that emerging market economies will have to pay a higher interest rate to entice people to buy dollar-denominated bonds issued by emerging market sovereigns and corporations.

  • If existing dollar-denominated loans in Nigeria are not hedged, they may be subject to rate spikes. A government that intends to finance a large part of its budget through deficit spending will almost certainly have to borrow at a higher rate.
  • A higher cost of borrowing is particularly troubling considering that Nigeria spent around 96% of its revenue on debt service in the year under review. Compared to the previous year, Nigeria’s debt service to revenue ratio increased from 81.1% in 2020 to 96% in 2021.
  • This is of particular concern as an anticipated drop in the local currency following a reversal of capital flows could make it more difficult to service the dollar loan. Companies and institutions that have borrowed in dollars could be strained if their profits do not grow at the same rate.

Pressure on the Naira despite rising exports

  • Given the US Federal Reserve’s hawkish stance, a stronger dollar could signal trouble for the Naira as it is likely to rise above N/$620. In addition, the International Monetary Fund (IMF) has warned that the improving trade balance will have a modest influence on exchange rate tensions, with parallel market exchange rate premiums remaining in the 35-40% zone since October. 2021.
  • Total imports in the first quarter of 2022 totaled 5.9 trillion naira, down 0.67% from the fourth quarter of 2021 (5.94 trillion naira), but up 21.04% from the comparable period of 2021 (N4,880 billion). Nigeria’s export earnings in the first quarter of 2022 were 7.1 trillion naira, up 23.1% and 137.9% from 5.77 trillion naira and 2.98 trillion naira in the first and fourth quarters of 2021, respectively.
  • The Fed’s rate hike could exacerbate the woes of emerging currencies, possibly leading to a full-blown crisis. Nigeria does not currently have a floating currency. Naira has been under pressure in the black market and is currently trading at N607/$1 despite the rising trade balance

Capital outflows

  • Nigeria, which has historically depended on foreign investment from the United States and other developed countries, could continue to face a severe shortage of direct investment from abroad.
  • Indeed, higher rates in the United States would encourage investors to return to American financial markets, due to widespread opinions on the relative safety of investments held in the United States, thus accelerating capital flows out of emerging countries. and making the cost of sourcing USD more expensive via exchange rate depreciation.
  • This problem of reduced capital inflows compounds the already existing problem as Nigeria’s capital inflows hit a four-year low of $9.66 billion in 2020, before dropping to $6.7 billion in 2021 .

What the experts say

Dr. Godswill Osuma, a researcher and lecturer in the Department of Finance at Covenant University, said the US hawkish stance is expected to put more pressure on the naira and increase import costs.

He said, “As a result of this rise in interest rates, I predict negative contagion effects on countries that are highly integrated with the United States such as Nigeria, which could lead to currency depreciation, high borrowing costs and high import prices.

He added that “To cushion this intentional shock, the government should reorganize the country’s manufacturing sector, especially those engaged in the production of fast-moving consumer goods that constitute a large import volume in the country.

Samuel Oyekanmi, Research Analyst at Nairametrics, said that “with the aggressive decision of the United States to raise interest rates, this means that the interest paid on Nigeria’s external loans will increase. Already, the federal government is spending up to 96% of its retained revenue on debt service, which could increase significantly in 2022, opening the government up to more borrowing and hampering its ability to fund development projects. fixed assets.

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