Explaining Nigeria’s Missing Dollar Inflows Despite Naira Float (I)

The Theory of Rational Action claims human beings are abstract symbol manipulators that seek to maximize their self-interest.  The basic premise of this theory is that aggregate social behaviour results from the behaviour of individual actors, each of whom makes individual decisions.
This theory laid the foundation for most of the major institutions of society today, from stock markets to government agencies. One of the most difficult things to change is the human behaviour. According to experts in corporate leadership, there are basically two kinds of change: evolutionary and disruptive. 
Whilst evolutionary change is more gradual, calmer and less destructive, it takes a long time for the results to take effect. Disruptive change on the other hand is immediate and fast – but extremely destructive. For instance, an organisation that seeks to change its corporate culture to a more customer friendly one will have a hard time getting its personnel to align with this change using the disruptive approach.
 It would be best to adopt a more evolutionary approach that would require training, exposure and constant communication on the reason why the change is necessary. In order words, the personnel must be made to buy-in to the new vision and strategy.
Bringing these principles back home, Nigeria has a lop-sided consumption pattern. The country consumes more than it produces. Nigerians have an insatiable appetite for quality products despite the fact that poor infrastructural development has prevented us from being able to produce at this level.
It is for this simple reason that the country finds itself in the current economic dilemma – Balance of Payments deficit. As a consequence of the foregoing, the domestic currency is weakening especially as Nigerians continue to pursue consumption of imported items despite dwindling foreign exchange earnings. Fundamentally, there is nothing wrong with a country having a desire for high quality products/services. However, that country must have the means to pay for these products and services. From education, to fashion; from medical care to consultancy, imported goods and services cost dollars and a nation that desires these products must generate enough dollars to match payments.
When the Central Bank of Nigeria (CBN) re-opened the Nigerian Foreign Exchange (FX) market in June, 2016 and announced a new FX regime, market watchers received the change with open arms and much relief.
This is because many had argued that sequel to the rapid decline in international crude oil prices which significantly dried up the Federal Government’s coffers, the government’s reluctance to devalue the naira was one of the main reasons why foreign investors had continued to boycott Nigeria’s financial markets after their initial exit following concerns over the country’s financial markets status in 2015.
However, 3 months down the line, foreign investor flows have not come in as anticipated. Admittedly, some good volumes have trickled in but certainly not enough to set the inter-bank market awash with liquidity to the extent that the naira would appreciate meaningfully.
It is common knowledge that given the current circumstances of lower to negative yields across global markets (US 10-year Bonds:  1.56%, German 10-year Bonds: -0.008%, China 10-year Bonds: 2.65%), and conversely, higher yields in the Nigerian market (FGN 10-year indicative: 15.5%, 279-day Treasury Bills: 18.50%), a rational investor who is aware of the “carry trade” principle should find the Nigerian market attractive in order to maximize returns on his capital.
Carry trade is a popular trading strategy that involves borrowing money at a low interest rate and investing it in an asset that provides a higher rate of return, usually across sovereign borders.
Since the higher yielding market is in another country/region, currency conversion and its attendant exchange risk must be duly factored into the overall investment strategy. The proceeds of conversion will be either placed on deposit in the second currency if it offers a higher rate of interest, or deployed into high-yielding financial assets such as securities, equity stocks or real estate denominated in the second currency.
Carry trade is a strategy more commonly adopted by deep-pocketed entities referred to as Foreign Portfolio Investors (FPIs) because of their deep knowledge of financial markets and their ability to manage two key risks:
1.      The risk of a sharp decline in the price of the invested assets.
2.      The implicit exchange risk if the second currency devalues significantly against the original currency to such an extent that could wipe away all the gains from investing.
Giving the foregoing, why then are the FPIs not taking advantage of the Nigerian Opportunity as much as anticipated even after the Central Bank of Nigeria has proactively gone ahead to create a hedge product, the Non-Deliverable Futures aimed at addressing (2) above. We will look at the reasons in the second part of this article.
O. H.