Unlocking Locally Domiciled Dollars: Opportunities, Risks, and Incentives

 - By Chinedu Okoye 

Summary:

- The government plans to raise capital through dollar-denominated local bonds, targeting $30 billion in Diasporan remittances and locally domiciled US dollars. 

- While economists applaud the potential benefits, challenges such as building investor trust, addressing liquidity concerns, and mitigating economic and exchange rate risks must be tackled. 

- Proposed measures by Zero Equilibrium economists include; reducing monetary policy rates, imposing levies on idle balances, and sensitizing stakeholders. 

- Proactive measures by monetary and fiscal authorities, coupled with incentivization efforts, could attract significant capital inflows, supplying much needed FX, and reducing external debt exposure.

The Hunt for Locally Domiciled US Dollars:

The federal minister of finance, Wale Edun, announced on March 4th the government's plans to raise capital by issuing dollar-denominated local bonds. This presents an opportunity to leverage local dollar holdings from idle balances in domiciliary accounts.

The government is targeting Diasporan remittances as well as locally domiciled US dollars, which are in the tune of $30 billion.

The proposal is deemed fitting by Zero Equilibrium economists and analysts, and there are benefits of raising dollars locally. There are also inherent risks that are not so pronounced.

Potential Benefits:

1. Creates short-term liquidity that is much needed for the Naira to stabilize and consolidate its gains on the greenback.

2. Attracts even more remittances as Diasporans who earn in foreign currency abroad may look to earn higher yields on FG dollar bonds than they would on, say, US Treasuries.

3. Offsets any future flight from Naira assets, as it provides an alternative to US Bonds and Treasuries. The notes would be issued in dollar terms at least 9%, a spread of 4.4% to the US 2 Yr Treasury yield. 

4. Discourages speculation, as dollar holders committing their USD to FG Bonds essentially puts the funds that would otherwise be idle back into the economy.

But there are other concerns that could inhibit the flow of these funds from Domiciliary accounts and Foreign Bank accounts of Diasporans. As a result, the government needs to take these into consideration in order to properly incentivize these inflows and draw market interest.

Potential Risks and Concerns:

As sound as the idea may sound and as attractive as yields may seem, there are several factors that could be taken into consideration which would determine whether these locally domiciled US dollars would be forthcoming.

Perception and trust: Diasporans and local USD holders need to trust that a government with a N9 trillion budget deficit would be able to pay back the returns and capital as and when due.

Liquidity concerns: Diasporans, local high net worth individuals and companies who own the most chunk of these domiciled dollars could need their funds to settle future foreseeable and unforeseen transactions, and so may not be readily willing to commit their dollars in non-cash assets.

Economic factors: Nigeria still has deep-rooted structural issues like the 400k barrel miss in its projected oil production in the budget. Coupled with inflation and slow economic growth, investors could perceive potential headwinds and be discouraged to commit to the scheme. Or do so demanding more yields.

Exchange Rate Risks: Naira is stronger today and has stabilized somewhat, mainly as a result of the recent foreign capital inflows into short-term government securities. This could switch the trajectory of the value of the currency once investors repatriate capital and returns, assuming there is no remarkable chamge in Oil production. 

The NNPCL hasn't been able to supply sufficient crude to Dangote Refineries and may fall further short in supplying the Port-Harcourt Refinery. This creates a need for these refineries to import crude if they are to meet production and supply quotas. 

Incentives for Investors:

The Ministry of Finance and the Central Bank could collaborate on measures that would incentivize this capital move.

The Central Bank could incentivize dollar depositors (individual and corporate) by:

1. Reducing Monetary Policy Rates and Cash Reserve Ratios, to enable banks to commit their retained earnings from FX devaluation to investments in the FGN Dollar bonds.

2. Imposing a levy on idle balances above a particular amount (say the minimum required investment amount) over a specific period of time would mean depositors either invest in these bonds and earn a return or lose a negligible amount (at a rate of 6% annually or 0.5% monthly).

The Ministry of Finance can encourage the above-targeted investors by:

1. Sensitizing Investors: Diasporans, local High Net Worth individuals, and corporates would need to be sensitized on the modalities and offerings of the issuance. This gives an opportunity to address any of the concerns regarding trust and risk perception.

2. To address Liquidity concerns, participants could be offered a dollar credit facility and/or a Naira equivalent credit facility for dollar and Naira transactions, respectively.

The facility should be to the tune of a proportion of the total investment, but it will only be for payment of transactions and not to be paid out in cash.

By incentivizing the target market and addressing viable concerns, the federal government could attract at least $3 billion dollars annually, in a cycle that would go on and could be a major support for the Naira. It also reduces external debt exposure, as the debt is in foreign currency but owed to citizens or local entities, unlike Eurobonds or Concessional loans. 

But certain risks persist on the part of the federal government. Options to supplement dollar shortfalls at maturity with Naira equivalents at discounted rates could be suggested should the nation fall into debt-distress. 

Economic Headwinds:

Exchange Rate Risks: The federal government is already in debt to foreign investors and the fundamentals that support the Naira are fairly unchanged.

Oil production is still artificially low, and the FPIs though issued in Naira and to be paid back in Naira, the foreign investors that sought higher yields could decide to repatriate their capital and returns at maturity flooding the market with trillions of Naira (approximately N5.26 trillion Naira).

Liquidity risks: If crude oil receipts don't increase, and the government is unable to refinance the short-term Bills from Foreign Investors as they mature with more issuance, the Naira exchange rate could deteriorate further making it difficult to service the proposed local dollar bonds.

Insolvency risks: The risk of Insolvency is greater for a country in debt to any investor, individuals, or entity in foreign currency. Without sufficient increases in FX earnings, these debts remain prone to insolvency and possible default in the long term, should the issues persist.

Interest rate risks: If the Federal Reserve doesn't cut this year, as now fully expected given recent rhetoric by Fed officials as inflation stubbornly stays above the 2% target, and the labor market is yet to cool off.

Should the federal Reserve hold for longer, the lesser the yield spread between US Treasuries and FGN Dollar Bonds, tempting down the allure.

Necessary Economic Policy Adjustments:

The Central Bank should revise Monetary Policy Rates and Cash reserve ratio downwards but mandate banks to allocate a stipulated proportion of their cash holdings to investment in FG dollar securities.

This would provide the government with a steady flow of institutional credit. Banks would also be expected to adhere strictly to the loan deposit ratios to encourage lending to the private sector as well.

On the Fiscal side, the Ministry of Finance would need to be more prudent with regards resources allocations by providing a proposal for and a framework to achieve a budget balanced between capital and recurrent expenditure.

Lucrative federal assets in various industries could be revamped, registered and privatized and can be a source of foreign direct investments which are longer-term and would increase foreign reserves from lump sum earnings on the sales proceeds of these assets.

Concluding Remarks:

While the proposal offers promising benefits such as short-term liquidity infusion and a deterrent to speculative practices, it is crucial to acknowledge and address the underlying risks. The above concerns and  vulnerabilities underscore the importance of careful consideration and proactive measures. 

Collaborative efforts between the Ministry of Finance and the Central Bank to incentivize investors through targeted policies and sensitization initiatives can bolster confidence and stimulate substantial capital inflows.

It is imperative that  the government carefully study and consider the intricacies of both opportunities and risks, to ensure sustainability of the scheme as we tow the path towards economic stability.