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The challenge of managing excess crude funds

By Udeme Clement

The initiative by the National Assembly to pass the Sovereign Investment Authority Bill, which seeks to invest a portion of the excess revenue generated from crude oil exports in the Sovereign Wealth Funds (SWF) to be managed by the Nigerian Sovereign Investment Authority is a welcome development to many stakeholders in the economy. The authority is expected to invest the funds in a diversified portfolio of medium and long term investments in infrastructural development, capital projects and for the benefit of the future generations of Nigerians. Some experts expressed their opinions as follows:

Efficient management of the country’s reserves  imperative ex-director and head of treasury department, Bank of Ghana, Mr. Francis Andoh:
Foreign exchange management is important because it indicates the value of one country’s currency compared to the currency of another country. And, the value of a particular currency could also be determined by market forces of demand and supply necessitated by trade in export as well as import, investments, tourism, and geo-political risk in the country involving different economies as well as the political activities of the country. This also has effect on trade and impact on the economy of other countries, because instability of a country could also devalue the currency. Sea piracy and inflation, if allowed to occur, could result in increase in the prices of goods and services.

Exchange rate management could sometimes create a problem.  That is why government should fix and manage it to ensure price stability in the economy. On the other hand, the floating exchange rate is determined by the market forces of supply and demand and any attempt to disrupt the floating rate of exchange rate becomes detrimental to the economy and affects offshore transactions, which could lead to inflation. Government should also note that inconsistency in polices could hinder investments in the economy, thereby reducing income flow in the country. For instance, Ghana uses inflations target regime in its economic policies, such that the country maintains floating exchange rate in its currency. There is also the need to ensure efficient monetary policies to facilitate export and reduce the volume of imports in the country. This would pave the  way for the manufacturing sector to thrive instead of the country depending mostly on buying and selling of goods.

In the foreign exchange market, participants such as banks, commercial firms, central banks, investment management firms, retail brokers and investors should be allowed to buy, sell and exchange currencies. So, CBN should not be rigid in its monetary policy control.

The foreign reserve accumulation is important because it serves as a buffer to manage the exchange rate volatility, especially in fixed exchange rate regimes. To prevent foreign exchange crisis, especially in countries having capital account liberalisation, reserves have become buffers against future disruptions of capital flows and the related potential exchange rate shocks. It provides confidence in a country’s currency thereby promoting financial stability and preservation for the economy. Management of foreign reserve is imperative to provide liquidity for meeting payment obligations in a timely manner. Adequate level of reserve must be maintained to conform to the international standard and enhance returns that are consistent with the bank’s risk profile.

The apex bank should also take note of the challenges of excess reserve on its balance sheets. These challenges arising from rapid increase in reserve, especially for oil exporting countries resulting in CBN holding reserves well in excess of what could be considered adequate. The traditional objective of managing exchange rate is more than met with the risk of appreciation. Reserve holding gives rise to opportunity costs, especially if returns on domestic investments are higher than foreign assets and could also lead to considerable risk on CBN balance sheet mainly foreign exchange and interest rate risk. Also, inconsistencies between monetary policy objectives in price and exchange rate stability may arise if reserve inflows, which increases domestic currency market liquidity are not completely sterilised.  Sterilising reserve inflows could be costly, so CBN may have to issue interest bearing securities in addition to regular open market operations to mop up excess liquidity in the country.

The regulators of the financial system have to play their roles  to ensure that robust risk management and regulatory systems are in place  —DG, West African Institute for Financial and Economic Management, Professor  Akpan Ekpo:

Foreign exchange reserve management has gained increased importance in central banks as well as commercial banks’ activities in the recent past due to the lesson learnt from the recent global economic crisis. The experience of the financial market turmoil led to new challenges which are quite formidable. New vulnerabilities and risks have arisen from overall market downturns and increased mortgage defaults in developed countries.  As a result, the vital importance of managing risks associated with reserves has been increasingly exponentially in recent times. In the past, measuring risk was mostly based on credit ratings.

For this purpose, the yardstick for measurement was usually provided by the rating agencies that were supposed to rate countries and institutions in accordance with certain pre-determined norms. It was clear that the rating agencies depended on to provide independent assessments of the standing of institutions and instruments obviously failed to warn of possible weaknesses in the balance sheets of such institutions and investment houses.  Whatever may be the reasons for the failures, the challenge that we face now is how to manage risk optimally, knowing that opinions provided by the rating agencies may not be too accurate.
Another issue arising from the global crisis that is of concern for management of reserves by the central bank is fall in interest rates on fixed income securities and in money markets in industrialised economies to near record low levels.

This situation is as a result of the extraordinary measures taken by various governments through central banks in these countries to inject liquidity to bolster financial markets and aggregate demand.  Because of the prevailing low interest rates on the traditional safe assets which dominate the portfolios of central bank, its reserve managers are facing increasing pressure to find ways of enhancing income, given that income generated by reserves is a main source of revenue for many central banks. As such central banks are beginning to examine whether they need to diversify their reserve asset portfolios to embrace types of financial assets which could offer higher yields without impairing the liquidity and safety of their portfolios.

The monetary authority should ensure timely intervention in the foreign exchange markets to manage the domestic economy. At the national level, exchange rate appreciation benefits the import economy because imported goods become cheaper for domestic buyers. This tends to dampen competitiveness of the domestic products. Alternatively, exchange rate depreciation decreases purchasing power for imported goods but stimulates international competitiveness for domestic goods.

The lesson learnt from the financial crisis shows the need not to undermine regulation, risks control, transparency and full disclosure, particularly in the financial sector of the economy. All stakeholders both institutional and individuals have to rise up to their responsibilities.

The regulators of the financial system as well as commercial banks have to play their roles effectively to ensure that robust risk management and regulatory systems are in place. On continuing basis, macro-economic and financial sector management are being put to test and, this, of course, provides opportunities for stakeholders to gain insights and acquire needed competence in reserves and foreign exchange management.


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