CBN and The Nigerian Economy: A Short Story

If you have an M.Sc in Finance or a degree in economics, you can skip this piece. The point of it is to try to explain what the CBN did today at the MPC meeting and how it all relates to the wider Nigerian economy.

The communique they released is here

Larry Summers, I think it was, who once said that it is not so easy to understand how the economy works. And Summers has more than one brain. Everything below is a simplification to get the basic points (as I understand them) across.

Increase the MPR by 100bps from 12% to 13%

First thing to know – 100 basis points equals 1%. It really is as simple as that – the CBN increased the Monetary Policy Rate (MPR) by 1%. But what is MPR anyway?

Every Central Bank in the world has a broad goal that it seeks to achieve. For most central banks, this goal is controlling the rate of inflation usually around a certain target. This is known as – wait for it – inflation targeting.

If there is only one guy in a village with enough money to buy a motorcycle, it’s safe to say the motorcycle seller cannot easily increase the price of his motorcycle. But if a bunch of other rich guys suddenly move to the village and they happen to like motorcycles too, the motorcycle seller now has an opportunity to make more money by increasing his selling price. In other words, there is now more money in the village chasing the same amount of motorcycles. That’s a simple definition of inflation and the downside of it is that it makes people poorer. If the motorcycle seller increases his prices overnight it means you could possibly afford the bike yesterday but not today.

It’s possible that those new rich guys in the village borrowed money from the bank which they are now flashing in front of the bike seller and turning his head (making him increase his prices). This is where the central bank can tackle inflation – by increasing the MPR – which is the interest rate at which the central bank lends to other banks – it can set off a chain reaction that means those new money miss road guys have less money to throw around. CBN lends to the banks, the banks lend it to money miss roads, money miss roads flash it in front of bike seller i.e. CBN is at the top of the food chain, in theory and is throwing meat down at everybody else. The economic principle at work here is the simplest one – if the price of something increases, people will demand less of it (with the exception of a few types of goods). If you think of interest rates as the ‘price’ of money, by increasing the MPR, CBN is trying to reduce the demand for money.

There’s a smaller point as well. If you increase the price of money, obviously it becomes more valuable and anyone who has it suddenly becomes a big(ger) boy. So, if banks were willing to offer you 5% for you to keep your money with them before, they might now be willing to offer you 6% for the same money. All of a sudden, simply keeping your money in the bank has become more attractive than spending it. The new money miss roads in the village won’t be able to buy the bikes anymore and the former local champion will now rather keep his money in the bank given that he will get more for it. And motorcycle seller? With no customer in front of him, he has to drop the price of his bikes.

Inflation down.

Increase the CRR on private sector deposits by 500 basis points from 15 per cent to 20 per cent with immediate effect

Imagine you just opened a bank called Dorobucci Bank. You rent an office, buy a generator and hire a couple of staff to run the place. The cost of the office, diesel and staff salaries on a monthly basis is N1,000. The first customer to come to your bank, Mr Jonathan (Jona for short), deposits N10,000 with you in a savings account. You offer to pay him an interest rate of 5%, say monthly. So at the end of the month, if Jona turns up to demand his money, you need to hand over N10,500 to him. Don’t forget your N1,000 for running the bank i.e. in total, at the end of the month, you have to pay out N11,500. Also you have to make a profit to make it all worthwhile so let’s say N500 is a good profit for you. We are now up to N12,000. Jona is your only savings account customer so somehow you need to turn that N10,000 he gave you to N12,000 before he comes back i.e. a rate of return of 20%. One way of doing this is to buy chemical that turns paper to money but this is very risky and it might not work. Luckily for you, just after Jona gave you the money and left the bank, one guy walked in, Mr Bagajan and says he needs a N10,000 loan.

That’s when you remember that CBN says you can only lend out a maximum of 85% of deposits that customers keep with you. You must keep the rest as cash. So now, out of Jona’s N10,000 you can only lend out N8,500 and he’s coming back to ask for N10,500 in 30 days time. Hmmm.

You already have N1,500 to return to him since you kept it in cash so you need to find another N9,000 for him plus your own N1,500 for running costs and profits. In other words, you need to turn N8,500 to N10,500. You now need a 24% return and not 20% as you earlier thought.

You then tell Bagajan that you can only lend him N8,500 for 30 days at an interest rate of 24%. He’s a bit desperate so he agrees. This is banking simplified. That 15% that the CBN says you must not lend out is what is known as the Cash Reserve Ratio (CRR).

So what happens when CBN hikes the CRR from 15% to 20%? In simple terms, it means you as a banker have to make your money work harder. Now you have only N8,000 to lend out but you still need a total of N12,000 by the end of the month. You now have N2,000 in cash waiting for Jona when he comes to collect his money and you need to find another N8,500 for him plus your own N1,500 to cover profits and running costs. If you lend N8,000 to Bagajan, you now need him to return N10,000 to you – the interest rate you charge him now goes up to 25%.

When you take this hike in CRR together with the increase in MPR discussed earlier you can see what CBN is trying to do – reduce the demand for money.

Why so harsh? Why is the CBN squeezing the money supply from both sides in this manner? Who hurt them? The answer is the banks. They have been naughty and CBN is not happy with them.

By increasing the MPR and CRR, the demand for money will reduce. So Bagajan might get annoyed and walk away when you increase the interest rate from 24% to 25% (and make it worse by telling him you can only lend him N8,000 and not N8,500 as you earlier agreed). As he is walking out, you grab his jacket and rub his head then offer him 22.5% instead. This means he will return N9,800 to you. Now you are short of N200. Where will this N200 come from? Jona will raise hell if you try to give him N10,300 instead of N10,500 as agreed (he knows people in SSS and Police).

Your only option is to reduce your profit from N500 to N300.

Listen to what the CBN is complaining about (Page 14):

However, available data indicates that banking system liquidity has been lavishly deployed in pursuit of speculative foreign exchange trading at the short-end of the market. While the Committee remains fully committed to the goal of promoting inclusive growth through lower interest rates in the medium- to long-term, banks as agents of financial intermediation have a critical role to play in the nation’s development process. A banking system with an overly high profit motive negates the core tenets of banking and purpose of a banking license

In simple English, the banks have refused to fear God and are using all their profits to play lottery. So the CBN has decided that the ‘solution’ to this problem of lottery playing is to punish the banks by squeezing their ability to make profits.

The problem here is that the weapons of CRR and MPR that the CBN is using are not ‘guided missiles’ where you can speak incantations into a ram’s horn and it goes directly to the person you’re targeting. They are grenades, so when you throw it in a room to target one particularly annoying guy, there is no guarantee that you won’t hit an innocent bystander. We see here that the motorcycle seller, the money miss roads and Bagajan have all been affected even though the grenade was aimed at the banks.

Oh well

Move the midpoint of the official window of the foreign exchange market from N155/US$ to N168/US$

The Nigerian naira is not a freely traded currency. If you travel to Australia or Japan or Nauru and you have US dollars with you, you will definitely find someone to change it into the local currency. This means that the US Federal Reserve doesn’t really worry itself about the exchange rate of the dollar. It is traded globally and the price is open. It is hard for one person to control the exchange rate.

On the other hand, if you turn up with Nigerian Naira in Bolivia and demand that they be converted to bolivars for you, depending on the mood of the person you meet, you might either be arrested or slapped. Or both. Outside of Nigeria, you can’t really do anything with the Naira. This gives the CBN great powers to determine the exchange rate of the Naira, afterall it is the one who prints it and controls the supply. The US Fed is also the only one who prints the dollar but the supply is so plentiful across the world that Ecuador and Zimbabwe have adopted it as their currency and they don’t even need the permission of the Americans to do so.

At the beginning we talked about life goals of a CBN. Most of them focus on inflation. But for central banks like Nigeria’s, they have the added work of controlling (or trying to control) the rate at which the local currency trades with foreign currencies. For an import dependent economy like Nigeria’s, this work is quite hard and important. There is no day that people will not want dollars to buy one thing or the other from abroad.

So what the CBN has been doing is to set a ‘band’ at which it will buy or sell dollars to banks and others. For a few years the middle of the band has been N155 to $1 with a 300 basis point ‘slack’ around this. This means that the CBN will allow the Naira move between N150.35 and N159.65 to the dollar i.e. 3% up or down around the midpoint of N155.

How does this work? Quite simply in theory. If people start demanding a lot of dollars and are willing to pay more for it, the price will obviously go up. Once it hits that N159.65 upper limit, the CBN will release more dollars into the system to calm everybody down. If you have been hearing the CBN ‘defending the Naira’ in the papers, this is it. When Nigeria sells oil, we get paid in dollars for it. These dollars flow to CBN. The Nigerian government spends Naira so the CBN gets to keep these dollars and gives naira to everyone instead. When the time to defend the Naira comes, it starts to dip into those dollars until the naira falls below that upper limit of N159.65.

Recently this defence work has been harder than that of a San Marino defender facing Lionel Messi. Our stock exchange is dominated by a lot of foreign investors. Recently they have been selling their stocks and running away because they are worried that you people will break bottles during the elections (and also the US Federal Reserve ending QE…ignore this for now). When they sell their stocks, they need to take their money back to their countries of course. As we have said above, they cannot take the Naira outside Nigeria so they need to change it to dollars in Nigeria before running off with it. More and more people thus need to buy dollars from CBN.

If CBN does not do anything, people will get desperate and will be willing to pay whatever it takes to get the dollars they need. In no time, the upper limit of N159.65 will be broken and the CBN will lose control totally. The investors are attacking, CBN is defending. This thing is tiring and after a while you are bound to concede a goal.

So today, the CBN allowed the attackers to score. At least, in the time it will take to remove the ball from the net, attackers celebrating the goal and getting the ball back to the centre circle, the CBN can rest small before the game starts again.

Now the mid-point is at N168 to $1 and instead of 3% ‘slack’, the CBN will now allow a 5% slack. So the naira will be allowed to move between N159.65 and N176.40. As you can see, the (former) end is now the beginning. In short, the CBN has devalued the Naira by 8.4%.

Going back to the CBN’s complaint quoted earlier, it accused the banks of ‘speculating’ against the naira ‘lavishly’. What it is saying is that banks know that when the pressure gets too much, the CBN will concede a goal. So in simple terms, if you bought dollars last week, you can sell it this week for a sweet 8.4% profit. The banks bet has been proved correct.

Of course, the other action film that is going is that oil prices are falling. Imagine that CBN used to spend $2bn a month on this defence work. Also imagine that when oil was $100 per barrel, $4bn was flowing to CBN monthly. This means that the reserves will still manage to increase by $2bn monthly. But then things have suddenly reversed. All those foreign investors running away (plus the banks speculating ‘lavishly’) have caused the CBN to increase the amount it spends on defence to say, $3bn. Meanwhile oil prices have dropped to $75, meaning that the money flowing to CBN monthly is now $3bn. The reserves are no longer increasing. So imagine what happens if say oil drops to $70 and people are still running away and are now asking for $4bn monthly. The situation will completely reverse – $2.8bn coming in, $4bn going out. The CBN will now need to dip into the reserves to withdraw $1.2bn monthly. If you had only $10bn to begin with, it means you will run out of money in about 8 months if things continue this way.

One is reminded of the ‘Micawber Principle‘ as revealed by Wilkins Micawber in Charles Dickens David Copperfield:

Annual income twenty pounds, annual expenditure nineteen pounds nineteen and six, result happiness.

Annual income twenty pounds, annual expenditure twenty pounds nought and six, result misery.


Nigeria has managed to find itself in an almost perfect storm where practically everything that can go wrong is going wrong. These days the world produces roughly 90 million barrels of oil. But of that amount, only about 30 million barrels are produced by OPEC members. So the weapon of cutting supplies that OPEC used to use to raise prices won’t really work anymore. It’s a bit hilarious to hear the CBN accuse someone of spending money ‘lavishly’ given that this is what the Nigerian government has done for the past 4 years when oil prices have been high.

The banks also now know that if you apply pressure, the CBN will concede a goal and devalue again. It is a matter of when, not if. Within a few weeks, the new trading band for the Naira will be blown apart (if it hasn’t already as we speak). Cost of borrowing will also go up for everyone else due to the MPR and CRR squeeze. Things are going to be a bit rough for the next few months and if you have cash or better still, forex, you’re the (wo)man right now.

As bad as things were for Wilkins Micawber, he never stopped living in hopeful expectation. Indeed he lived by the maxim – something will turn up. 🙂




On That Price Crash

Alhaji Putin surprised his friends and haters alike on Sunday with a 40% drop in the price of his flagship Dangote Cement product:

In a move that will raise the stakes in the rapidly evolving Nigerian cement market, leading cement manufacturer, Dangote Cement Plc, has announced huge cuts in the price of the essential product.

In a step that will make cement cheaper than it has ever been since 2005, the new price regime announced by the Group Managing Director of Dangote Cement, Mr. Devakumar Edwin, said the company has pegged the Dangote 32.5 cement grade at N1,000 per 50kg bag, while the higher 42.5 grade is to sell for N1,150 per bag.

The new prices exclusive of the Value Added Tax (VAT) represents about 40 per cent discount on the prevailing market price of the product which is currently sold for N1,700 irrespective of the grade, across the country.

I didn’t see that one coming and annoyingly, I am now at risk of having nothing to complain about on this blog. As you know (or don’t know), I am an Adam Smith Stan and one of my favourite quotes of his was from his Magnum Opus, The Wealth of Nations:

Consumption is the sole end and purpose of all production; and the interest of the producer ought to be attended to only so far as it may be necessary for promoting that of the consumer. The maxim is so perfectly self evident that it would be absurd to attempt to prove it. But in the mercantile system the interest of the consumer is almost constantly sacrificed to that of the producer; and it seems to consider production, and not consumption, as the ultimate end and object of all industry and commerce

Given my almost religious belief in the above statement, it is hard to complain about this price drop – cement is not an accoutrement of garri or rice. It is produced to build houses and infrastructure and the cheaper it is, the more of those things get built.

Given his dominance of the Nigerian cement industry (among others), this move has naturally generated a lot of chatter and analysis online, in what is perhaps somewhat commentary on Nigeria. Almost all the points people have raised as to why he may have made this move have merit – from him wanting to eliminate competition in the market to it being an election gimmick to aid the reelection of Goodluck Jonathan.

So what is it? Why did he do it? I can assure you, I have absolutely no idea why. It could be one thing, it could be a number of things.

But what I would say is that the rules of analysing a ‘normal’ market don’t work in this case. Given that the Nigerian government is a big player in the cement market – by way of banning imports – it is difficult to properly account for that factor, let alone analyse it. The quote below explains why:

ABUJA — PIQUED by the soaring prices of cement in the country, President Goodluck Jonathan, Monday, summoned the Chairman of Dangote Group, and other cement manufacturers with a directive to crash the prices of the product within 30 days period or face the wrath of the government.

Presidential spokesman, Mr Ima Niboro, who announced Jonathan’s decision after a meeting in the President’s office, said the manufacturers had agreed to do all that was necessary to meet the one month time frame.

Remember that? That was in May 2011 (so not exactly an election gimmick) and in the end it turned out to be an elaborate ruse. If prices were indeed ‘crashed’ back then, it must have been a blink-and-you-miss-it type of crash.

The point is that in a market where the President can ‘order’ manufacturers to ‘crash’ prices, you might as well throw away all your analysis textbooks. All we know is that Dangote Cement has said prices are coming down by 40% – it still needs to happen as distributors can claim they are still going through their old stock and thus refuse to lower prices. To further drive home the point that the Nigerian cement market is a market in name only, one of Alhaji Putin’s competitors, Alhaji Rabiu (shall we christen him Alhaji Medvedev going forward?) had this to say yesterday:

What Alhaji Dangote has done today is significant. I am very pleased about it because it would make the cost of the product more easily affordable to Nigerians. With this price reduction, more consumers will be able to buy the product and subsequently drive up demand and in turn increase market share for industry players.

“I hereby urge all cement producers to emulate Dangote and bring down the cost of cement. There is absolutely no reason for a bag of cement to cost so much.

“Despite the infrastructure challenges being faced by the manufacturing sector of the Nigerian economy, it does not justify the high cost of cement.

“On our part, I have already directed all our plants to follow suit and implement the new price regime. We still believe that more can be done to bring down the price even further for the benefit of Nigerians,” Rabiu stated.

This is comedy in its purest form and when supposed competitors are behaving in this manner, you know  FF’s Law of Nigerian Business is in operation. To wit; where 2 or 3 Nigerian businessmen are gathered, a cabal is soon formed. You’re welcome.

All of this means that we can’t really rely on these guys to drop prices when they like or when a game is being played. It is better to have a decent market operating where consumers always have as many choices as is reasonably possible. There is no meaningful reason to continue banning imports anymore – Dangote and co should now be able to stand on their feet, not just in Nigeria, but in Africa and then the world. It is time to take away the feeding bottle of government protection so they can start eating meat.

As for the announced price crash – apply C Caution.


On Cement: ‘Culled’ From The News Magazine

Is it possible to cull one’s self? Well, I don’t know. But I wrote this piece for The News magazine ’bout a month ago (month ago). They are not online as far as I can tell.

I saw this tweet this morning from my friend and I thought to share the article here. The full thing is below. I was constrained by a word limit but maybe that’s not such a bad thing. Enjoy.


In May this year, at the World Economic Forum in Abuja, I was in the audience at one of the sessions where President Goodluck Jonathan said ‘look at Dangote who is now the richest black man in the world…if not for our policies, he could not have achieved that’.

This was a remarkable statement that might get a leader kicked out of office in some other countries of the world. It is true that Dangote is now the richest black man in the world worth over $20bn. It is also true that much of his wealth is linked to his cement business, which has around a 70% market share in Nigeria and is now trying to expand across Africa. What is also true is that cement prices in Nigeria are around $263/tonne when the same product can be obtained only a few hours away from Nigeria at $67/tonne.

Why is this case? Why is the Nigerian President openly boasting about a policy that is enriching one man by causing Nigerians, the people who elected the president, to pay 3 times what they can pay elsewhere? To answer these questions, it is important to understand the nature of cement as a product and a market.

Cement is a vital input especially in fast growing economies that need a lot of infrastructure; there is almost no way around it. It is also a bulky product, which means that it is almost always produced close to where it is consumed. Indeed, only around 3% of current global cement production is traded across borders. Finally, the hardest part of cement production is starting a new plant – it is expensive. However, once a plant has been built, it is much cheaper to simply continue expanding production to meet demand. What this means is that there is a heavy advantage for those who enter the market first – that is to say, there is a tendency for a few players to dominate the market for a long period of time and you end up with an oligopoly.

Given the above, it is not hard to see how Dangote is able to get away with a 70% gross profit margin. Consider the numbers – the world’s largest cement manufacturer, Anhui Conch of China, produces 217MT of cement annually and generated roughly $8.9bn in revenues in 2013. Dangote Cement produced less than 1/10th of Anhui Conch’s cement output at 20MT but generated $2.4bn in revenues. The end result was that while Anhui Conch ended with 18% margins at the net profit levels, Dangote Cement ended with an astonishing 52% net profit margin – the highest profit margins, by far, of any major cement manufacturer in the world (Anhui Conch is the next closest in terms of profit margins).

A few weeks ago, all the newspapers were awash with stories about how Dangote Cement had ‘slashed’ cement prices by between N100 and N300 per bag. To avoid charges of gross exaggeration, none of the papers who reported the ‘slashing’ mentioned the actual price of the product that was being ‘slashed’. Of course they couldn’t because a headline that read ‘Dangote slashes N100 from N2,600 bag of cement’ would look completely ridiculous. For every $10 Dangote Cement makes, $7 is profit i.e. the limestone, the costs of energy and salaries directly related to the production of the cement only cost $3. It is true that cost of doing business in Nigeria is very high but how does the happily coexist with world record profit margins?

The question to then ask is what effect all of this has on the Nigerian economy. The justification for the policies that have made Dangote Cement possible are usually that it is our own i.e. Nigerian and it creates jobs in Nigeria. These are valid arguments and would justify granting the company some kind of protection given that we desperately need to develop industrial production capacity in the economy. But these benefits do not exist in a vacuum; there are also costs to them and any honest discussion of the matter must weigh the costs against the benefits and determine whether it is worthwhile. After all, the purpose of all production is consumption – we are producing cement so that it can be used to build things that solve problems and not just cement for cement sake.

The most obvious problem that we need cement to solve is the huge housing deficit in the country. By the government’s own estimates, we need 17 million homes to close this gap. Cement is not the only thing required to build a house of course, but you cant build houses without cement in Nigeria, certainly not on the scale we need to. The more expensive cement is, the harder it is to close that gap. By tolerating expensive cement like we do in Nigeria, we are shooting ourselves in the foot because far more jobs will be created in house building than Dangote Cement can ever hope to employ.

But when it comes to house building in Nigeria, there is an often-overlooked cost. There are no reliable estimates for the number of unfinished buildings in Nigeria. But it only takes a drive around any of our towns and cities to get a rough idea of what the situation – unfinished buildings are everywhere from Ikoyi to Alimosho in Lagos as an example. While familiarity has made Nigerians get used to the sight of unfinished buildings across the country, this is something that is very unusual in developed and even middle-income countries. For one, leaving buildings unfinished for long periods tends to quickly turn them into a den for crime and drug use.

The reasons for unfinished buildings are of course varied – lawsuits might be one. But the overwhelming reason is the cost of completing them. Again, this can be evidenced by the fact that low to middle-income Nigerians who manage to build their own homes hardly ever complete it before moving in. Indeed it is not unusual to find people living in homes that have not been plastered on the outside. These homes are usually self-funded and the owners typically squeeze themselves to do as much as possible to make the building livable before moving in. No great leap of logic is required to say that cheaper cement in Nigeria will move possibly millions of buildings from the unfinished to finished category in the Nigeria, creating plenty of jobs in the process.

This part of the story is very important as we attempt to solve the housing deficit in Nigeria. It is not because people are just sitting around waiting for the government to ‘do something’ that has caused the deficit to rise to 17 million. Nigerians have actually tried and continue to try to solve the problem by building their own homes. We cannot help Dangote Cement at the expense of Nigerians. This is what the current policy, which make it possible to charge very high prices for cement in a captive market are doing. It is helping the producer at the expense of the consumer. And it is causing us to drive the economy with the handbrake on.

The government cannot claim to seriously want to tackle the housing deficit crisis and at the same time the President is openly boasting about a policy that has made a cement manufacturer the richest black man in the world. Dangote Cement is not going to solve the housing deficit problem in Nigeria – it is Nigerians and the government who will solve it. Expensive cement is a needless impediment to getting to where we want to.

We can learn from the Chinese who seem to understand the purpose of producing cement – between 2011 and 2013, China used 6.6 gigatons of cement. In the entire 20th century, 1901 – 2000, the United States used only 4.5 gigatons of cement. And what has this translated to? Today, around 90% of all households in China own at least one home. Further, China’s existing housing stock is enough for every household in the country to own a home but Chinese property developers are still adding around 15 million units of housing every year. This is a country with a population of over 1 billion people. And yet, you will not find a Chinese businessman who made his money from cement on any rich list – indeed, China’s richest man, Jack Ma, is around $7bn ‘poorer’ than our own Aliko Dangote by current estimates.

These things are worth reflecting on if we are really serious about tackling the housing and infrastructure problems we face. The Chinese are producing cement to consume it while we are producing it to make the cement producers rich. Producers have been helped for many years by the government; it’s time for someone to help the consumer.