Volatile environments test the resilience of firms: The experience of businesses in Nigeria during the 2015-16 FX scarcity


Adapt or leave

Even as most firms found it difficult to adapt to the hitherto foreign exchange (FX) scarcity in Nigeria – eased in June 2016 after the Nigerian central bank floated the naira – others embraced it by adopting innovative strategies to remain in business. Shoprite, a South African grocer, advertised in April 2016, asking Nigerian manufacturers to supply specific consumer goods – it used to import these items. As the sale of FX for the importation of some of its fast moving consumer goods had been banned in the official FX market, the retailer needed to seek local alternatives. There were concerns about quality. Even so, it was the grocer’s brand that assured customers, not where the goods came from. Some South African firms – Truworths and Clover for example – chose to leave the country instead. Their business models, it turned out, were not really adaptable to the new economic realities. As they imported goods cheaply from their home country, Nigeria’s then fixed and overvalued exchange rate almost always guaranteed them a positive FX return and sometimes made up for the occasional negative or meagre margins on goods sold. In spite of the tough economic environment – which remains challenging even after the naira was allowed to trade freely in June 2016 – Pick ‘n’ Pay, another major South African retailer, announced plans in April 2016 to set up shop in Nigeria, evidence it considered the long-term prospects of the country to be still attractive. A view echoed no less by Rich Lesser, global chief executive at Boston Consulting Group, a consultancy, at a July 2016 CEO conference by BusinessDay – the leading business daily in Nigeria.

 

Take short-term losses for long-term gain

Some firms needed to import certain inputs. So, local alternatives could not be sought in their case. Regardless, almost all the major firms were forced to source foreign exchange from the parallel (unofficial or ‘black’) market at a premium of at least 50 percent on the then official US dollar rate of about 200 naira. The views of key executives in Nigeria’s manufacturing sector during that testing period are instructive. They sourced foreign exchange from wherever they could get it, at twice the official rate sometimes. Unfunded clean letters of credit, asking for favourable payment terms from suppliers, and adopting an export focus to generate FX were some of the strategies adopted by Seven-Up Bottling Company Plc, manufacturers of PepsiCo’s products in Nigeria, chief executive Sunil Sawhney says.

 

He was not alone. In a trading update reported by Bloomberg in April 2016, PZ Cussons Plc – makers of the Imperial Leather soap brand in Nigeria – availed investors of its own experience: it did not get as much hard currency as it needed for its operations. And even when it did, it had to pay a premium of 50-70 percent. Inevitably, the much higher blended costs of foreign exchange from these alternative sources were passed on to consumers – not in all cases, according to Mr Sawhney; never mind that his company’s suppliers were able to pass on the increased costs. PZ Cussons was able to transfer some of the costs, however: it made changes to the prices of those products that were elastic – typically the high-end ones – while maintaining the prices of its mass market segment products, the sales of which tend to be extremely sensitive to price changes.

 

Even so, an executive at a competing manufacturer, Unilever Plc, did not hide his frustration. Unilever’s Africa president, Bruno Witvoet, was blunt in an interview reported by Bloomberg in March 2016: “It would be very insane to continue like this for months and months.” Regardless, some firms managed to cope. Nestle, a global foods and beverage manufacturer, for instance. What Nestle did was to widen the number of banks it sourced foreign exchange from – a practice that became widespread amongst other multinational firms thereafter, limiting effectiveness. Additional investments by Nestle – it opened a US$28 million (5.6 billion naira) water factory in mid-April 2016 – amid the myriad of uncertainties at the time, is proof it still saw tremendous potential in the country.

 

Despite the challenges, Unilever continued to make additional investments as well, investing over US$150 million in recent years on its brands and facilities. On why Unilever remained bullish on the country’s prospects despite the obvious constraints, Mr Witvoet put it this way: “Nigeria has a lot of opportunity.” This was the dominant sentiment of managers at multinational companies that endured those challenging times. Since they were in Nigeria for the long-run, they chose to brave the challenges, albeit their pain thresholds were severely tested. Positive measures by the central bank from June 2016 onwards – in addition to floating the naira, the Central Bank of Nigeria (CBN) also cleared pending FX purchase orders of about US$4 billion via spot and forward settlements – were a vindication of their resilience.

 

Return to normalcy can take a while

About a month after the CBN adopted a more flexible FX regime, liquidity was yet to return to the market. This was in part due to the CBN’s continued domineering role. At below 300 naira to a US dollar in mid-July, the naira was believed to be still overvalued. Market participants, especially foreign ones, asserted that the CBN needed to allow the naira to depreciate further – that is, hands off a little bit – if it hoped to restore liquidity and attract much needed foreign portfolio and capital flows. The country’s apex bank finally let go later in July 2016, allowing the naira exchange rate to be determined by market forces. Expectedly, the naira weakened further, albeit boosting confidence.

 

Not that there were no immediate gains from the liberalisation move hitherto. There was less uncertainty, for instance. And long-running negative views by prominent economists and development partners like the International Monetary Fund (IMF), the World Bank and the United States (US) became positive by and large afterwards. The US government, in particular, hitherto implored President Muhammadu Buhari to reconsider his intransigent stance on the naira. Still, the country’s leader did not conceal his continued scepticism of the naira float move thereafter. It was later revealed that Mr Buhari’s reluctance was a major reason why the CBN sought to support the naira at below 300 to the US dollar after it announced its flexible stance. When it became clear that foreign investors were still being cautious, Mr Buhari had little choice but to see reason.

 

In the period prior to its adoption of a flexible FX regime in June 2016, the CBN insisted it could meet genuine and productive requests for foreign exchange. Its assertion was in the face of obvious constraints. Quite naturally, it couldn’t keep its word. Dwindling foreign exchange reserves – US$26.6 billion (5 months of imports) in May 2016, a 10.7 percent year-on-year drop then – due to lower crude oil prices was why. An earlier ban on the sale of foreign exchange to importers of some forty-one items – ranging from packed sardines to toothpicks and which remained in place as at July 2016 – was one of a series of measures the country’s apex bank took to manage demand. The evidence from market participants was that even when the CBN approved FX purchase requests, they were not supplied on time – the US$4 billion demand backlog cleared by the CBN in June 2016 was accumulated over months. Consequently, foreign trading partners refused to do business with some Nigerian importers – after letters of credit were not being settled on time and foreign banks increasingly took precautions in their dealings with Nigerian banks. Inflation rose consequently, to double-digits: the annual headline rose to 16.5 percent in June 2016 from 9.6 percent at the beginning of the year.

 

Fuel shortages hitherto were due to foreign exchange scarcity as well. As fuel marketers no longer received subsidy payments from Nigerian authorities, there was not much incentive for them to import products if they couldn’t also secure foreign exchange from official sources in a timely manner – the official fuel pricing template assumed the overvalued official exchange rate: this was eventually reviewed upwards in May 2016 to reflect the higher blended cost of acquiring FX from the official and parallel markets. Consequently, the retail price of petrol was capped at 145 naira per litre, a 67 percent increase. With the exchange rate now ‘market-determined,’ it is expected that this would be reviewed as needed.

 

To get an idea of the extent of the FX scarcity back then, consider this: half of Nigeria’s crude oil earnings of US$550 million in April 2016 was required to meet fuel import requirements in that month alone, an all too risky move the authorities chose not to make in light of other very important obligations – foreign debt service, for instance. Until the two-third price increase in the retail pump price of petrol, marketers were not able to transfer the higher FX costs to consumers. The upward price revision was forced when the national oil company could not meet demand fast enough, as it became the sole importer of petroleum products in the absence of private sector participation. Add to that power shortages on the back of gas supply shortfalls due to vandalisation of pipelines – incidents have increased due to renewed agitations by aggrieved residents of oil-producing areas who feel marginalised by the central government and then low water levels at rivers – due to inadequate rains – that fed hydroelectric dams. Businesses had to deal with a myriad of constraints.

 

With hard times also come opportunities

More fundamentally, Nigerians started changing their tastes to suit the hard times. Those who would only consume foreign goods hitherto were forced to seek cheaper local alternatives. Retailers such as Shoprite – who in any case used to mix their foreign stock with local varieties – had to sell more local goods, as foreign alternatives, even when allowed into the country, became prohibitively expensive. (The strategy paid off: in July 2016, Shoprite reported annual sales growth of about a third for its stores outside South Africa.)

 

The adaptive strategy instigated a new challenge: inadequate supply. Even as demand rose, local manufacturers did not adapt fast enough. With their goods ordinarily not cost-competitive, most of them incurred losses. As the new machinery local manufacturers required to meet increased demand also needed to be imported, they were caught in the vicious cycle as well. Smugglers filled the gap. With ample capacity at the sea port in neighbouring Benin republic, smugglers imported goods from there and got them into the country illegally, paying no import duty.

 

The loss in revenue to Nigerian customs authorities was huge – with a continued FX sale ban for the importation of some 41 items (as at mid-July 2016 at least), this continues to be the case. Incidentally, these banned items still find their way relatively inexpensively into the Nigerian market. Barring that, there was another reason local firms were being cautious: if they ordered for machinery to cater for increased demand for locally manufactured goods, there was the fear that the increased capacity, when fully functional, may become redundant due to likely policy changes in the future; when a new administration takes over for instance. In sum, the uncertainty that these cocktail of policies created hitherto, stymied investment, production and economic growth. Growth contracted by almost half of a percent in the first quarter of 2016, the first in more than a decade. Only two years earlier, the Nigerian economy sped at about 6 percent. For resilient local and foreign firms operating in the country, this is no matter: expensive imports mean opportunities for local manufacturing.

Dr Rafiq Raji is an adjunct researcher at the NTU-SBF Centre for African Studies at the Nanyang Business School in Singapore. He is also managing director and chief economist at Macroafricaintel, a Lagos-based research company. Dr Raji was previously an Africa economist at Standard Chartered Bank in London. He has a PhD in finance from the University of the Witwatersrand, South Africa.


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