Wednesday, April 8, 2009

Global Economic Downturn - Part 2: Who is to blame?

In the last 18 months we have witnessed increase in number of company closures and rise in redundancy. Analyst and experts have predicted a longest recession in living memory, and confidence in the markets around the world is at the all time low. Everyone including the politicians do not want to take blame for this crisis. This crisis is really not a political problem as it turns out to be, as governments are bailing out big corporations from total collapse. At times like this, finger pointing, name calling, scapegoat are order of the moment. But who should we really blame for this crisis? Some argued that the CEO’s and the management of near-collapse banks should be responsible. Others said that the government should be blamed for lack of regulations. I think there is a fair legitimate argument from both sides.

In this article, I will take each argument in turns: Last week we witnessed thousands of demonstrators plotting a series of protests to exploit the disenchantment with City financiers blamed for dragging the economy into recession. The protesters aim was to show their concerns to world leaders at G20 summit in London that weekend. Their main concern is the excessive performance based bonus/incentive culture of the banking industry, which they argued was the main catalyst that leads traders to be reckless and “gamble” with investors monies. The have taken position in a rather complex financial instrument. These instruments are very difficult to account and report and sometimes do not appear on company’s balance sheet but revenue from these transactions appear on company’s book. It is these transactions that now threaten the entire Western economies and it’s spreading like a plague around the globe.

But why should we make traders a scapegoat in all of this? The executives of these companies are far worse when you look at the average remuneration package of CEO’s of investment banks. An average salary of a trader in the city is around £60,000 to £90,000 but their annual bonus ranges from a quarter to 1 million pounds depending on revenue generated. So you can see why these traders would be motivated to take risk or try to make profit at all costs leaving investors at huge risk. The same argument goes with their executives who received stock options. With stock options to be exercise when top management are leaving the company, there is an incentive for these executives to want to increase the value of the stocks to receive maximum payout when their time in office is over. In 2008, an investment banker Andrea Orcel at Merrill Lynch was paid $38.8 million in cash and stock option.

In the mortgage sector, brokers whose salary depend on the number of property he/she sells also became reckless. They ignore the basic principle of risk management. Mortgage loan were offered to families with no secure job at 3 times their annual salaries. No one seems to care as economy booms, house prices rocketed. Average family in the UK and US has 3-4 credit cards on top of their mortgage loan. Our bank executives for their own greed encourage masses to be indebted.

So why government should be blamed for those actions described above? After all, it all happened in the private sector and we operate in free economy. Let me answer this in its simplest form. The governments are the ultimate beneficial of these malpractices. The economy enjoys the boom period and politicians were given praise for good policy. In the UK under Tony Blair, the financial system was deregulated. Banks became autonomous, the result of this independence we can see clearly today. In some quarters, some argued that government should have clamped down on executive pay and bonus and incentive culture.

From both set of arguments above, it is interesting to see where this debacle will lead us. Some of even suggesting it might be the end of capitalism and free market enterprise. I strongly believe that those who have been charged should look into their closet and decide where to mend what I will call reckless greed of the executives. On the other hand, our governments should also be proactive and vigilant in reading red flags. After all, they the one who have being left to clear the mess with taxpayer’s money.

Sunday, April 5, 2009

NAIRA - The way forward

We have seen a precipitous drop of the Naira in recent months and the problem it has caused policy makers, manufacturers and the whole economy as a whole.

Let’s take a look back and reflect on why the Naira gained strength in recent years.
The Nigerian economy saw a massive inflow of funds from Nigerians in Diaspora and foreign investors into the equity market. Also crude oil prices at record highs provided enough foreign exchange to meet pent up demand. It was boom time and hence the naira strengthened in the process.

However in the history of the world boom times don’t last forever hence with the onslaught of the global recession, there was a massive capital flight from the capital market, the price of crude oil headed south as global demand went into a tail spin and as with anything else, the naira followed suit heading south in the process.

There was absolutely nothing the Central Bank could do to save the Naira, it had to bow to the currents of market forces or else it would have been carried by the currents itself. Just ask the Russians who tried to defend the ruble. They had their fingers burnt. They spent almost half of their reserves in the defence of the ruble but to no avail. They should have lent from the Japanese. In that respect I want to congratulate Prof Soludo for not standing in the way of a fast moving train.

Having taking a bitter pill, what is the way forward for the Naira? Just as boom times don’t last forever, gloom times to last forever as well. How do we place ourselves in such a way we benefit when the naira is strong and when the naira weak?

There should be a massive investment in the non oil export sector. As governments around world increase there fiscal stimulus, I believe there would be an increase in the price of commodities (softs, precious and base). With a weak Naira and a well developed non oil sector we stand the chance of capitalising on this increase and providing employment for the masses in the country.

Policy measures should also focus on infrastructure development to provide a base for the export sector. It should be the government’s objective to bring down the cost of doing business in Nigeria. In so doing Nigeria will be another India or China as we have the resources (natural and human), good climate and a business friendly populace.

It is imperative that the CBN looks into the cost of borrowing in Nigeria. The current rate is a massive disincentive to doing business in Nigeria. While inflation is falling in most countries which are reflected in the long end of the yield curve, inflation in Nigeria has become a monster that successive governments have not been able to tame. Cost of borrowing will continue to be in double digits until this beast called inflation is tamed. I will discuss ways of taming this beast in another article.

Risk management policies are also lacking in the sale of our most precious foreign exchange earner. While well-informed countries with crude oil as Nigeria were hedging their exposure to price movement at $100.00, Nigeria simply sat on its backside, hands akimbo and did nothing. Buying a Put option would have ensured we still sold crude at $100 while the price of crude fell to $40.00. That is $60.00 per barrel more of revenue or the equivalent of $60m dollars a day!!!

In summary the political will and serious policy measures will see Nigeria navigate successfully this difficult period and put us in a better shape when global demand returns.

Mr Niyi Omidire is a global macro player (currencies, interest rate and commodities)