Introduction
The Central Bank of Nigeria (CBN) under its current leadership, has maintained a conventional monetary policy tightening stance aimed at curbing inflation. In the exchange market, it has adopted the complete floating of the domestic currency aimed at exchange rate unification for improved foreign investment inflow, especially foreign direct investment (FDI). These decisions have had serious impacts on businesses and individuals. In this post, we evaluate the positive and negative impacts of the current monetary policies on the Nigerian investment climate and in-bound FDI.
Analysing the Policy Stance
The CBN has increased the monetary policy rate (MPR) from 18.75% to 27.25% between July 2023 and September 2024. Also, the Cash Reserve Ratio has been increased from 32.5% to 45.0%. The Liquidity Ratio (LDR) stands at 30%, while the asymmetric corridor around the MPR has been adjusted from +100/-700 to +500/-300. These policy decisions and indicators reflect the deliberate monetary policy tightening stance of the CBN under its current leadership. In the same vein, the CBN has significantly deregulated the exchange market to reduce pressures on external reserves, improve transparency and enhance the predictability of the exchange market.
The monetary tightening and floating exchange rate policy stance adopted concurrently, has had significant and in some cases, disruptive impacts on Nigeria’s business and investment climate; as local businesses are struggling and in extreme cases, some international businesses are exiting the country while several businesses, especially SMEs in the manufacturing and other sectors of the economy have closed down their operations. These disruptive impacts are due to the triggering effects of the radical policy stance on the already stressed local businesses operating in the harsh Nigerian business environment.
One of the major reasons for the policy revolution of the CBN is to attract FDI Inflows. It thus appears that, excessive focus has been placed on attracting foreign investments with little or no consideration for local businesses in the internal growth-external balance monetary policy objectives trade-off. The international growth objective and considerations for local businesses have been left to fiscal policy (government funding and the proposed tax reforms). The effectiveness of fiscal policy in this context is however, uncertain.
Implications of the Policy Stance on FDI Inflows
International businesses and investors will consider beyond entry strategy. Certainly, they will consider the operating environment and regulatory environment. For greenfield FDIs, potential entrants will consider cultural distance in addition to other elements of the Nigerian market and investment landscape. Therefore, floating the exchange rate is unlikely to attract FDI Inflows without a conducive operating environment. This means that, foreign investors tend to focus on the overall country-risk level induced by political risks, regulatory risks, contract risks (the effectiveness of contract enforcement and independent judiciary), security concerns, policy changes and other risk factors in taking their foreign investment decisions, and will not only rely on floating exchange rate regime to make FDI decisions.
By implication, the policy tightening stance will increase the operating challenges of potential investors as it affects the existing businesses and investors are aware of this. Therefore, the monetary tightening stance will most likely have no significant impact on FDI Inflows. This is evident in the capital importation reports by the National Bureau of Statistics (NBS) for Q4’2023, Q1’2024 and Q2’2024 periods when FDIs were $183.97m, $119.8m and $29.8m respectively. it is noteworthy that the successive decline in FDIs in these periods coincided with monetary policy tightening and significant exchange rate depreciation. Thus, the rationality of the current monetary policy stance for attracting FDI Inflows, is highly questionable. It can only improve foreign portfolio investment (FPI).
Conclusion
Attracting FDI Inflows goes far beyond a mere floating exchange rate regime; it requires a moderate or low country-risk level. Instead of completely floating the exchange rate, emphasis should be placed on medium to long-term drivers of investment such as strong market and political institutions, policy reforms, improvement in ease of doing business, reduced cost of borrowing, optimal exchange rate, reduced logistics and supply chain risks, insecurity, inflation, high energy cost and slowing aggregate demand.
In an actionable manner, the government needs to embark on necessary reforms that reduce different political, economic, regulatory and institutional risks that define the Nigerian harsh business environment and seemingly unattractive investment climate. This cannot be achieved through monetary policy only. It is therefore recommended that the CBN revisits its current policy stance to reduce the unnecessary pains or struggles it has inflicted on Nigeria businesses.
Practically, the CBN should adopt a managed exchange rate system, targeting an exchange rate of between 800 – 1000 naira to a dollar. It should also understand that, the current tightening stance is also reducing aggregate demand and, begin to consider easing up monetary policy to tame cost-push inflation because, excess liquidity in the system is strongly linked to fiscal indiscipline and phenomenal growth in public expenditure, not excess aggregate demand.
Author: Oluwafemi O. Toriola
Monetary/Financial Economist and Lead Consultant at RMBS. He holds Bachelor’s and Master’s degrees in Economics from the University of Lagos. He is currently a PhD student with specialty in Financial Economics. He is also affiliated with leading accounting and management bodies in Nigeria.
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