Have developing and emerging market countries decoupled from the US enough to grow despite significant recession in the US? Using VAR models, this paper addresses this question for Nigeria in the context of the global crisis.
Do Trading Partners Still Matter for Nigeria’s Growth? A Contribution to the Debate on Decoupling and Spillovers By Kingsley I. Obiora
Have developing and emerging market countries decoupled from the US enough to grow despite significant recession in the US? Using VAR models, this paper addresses this question for Nigeria in the context of the global crisis. The results seem to debunk the “decoupling theory” and suggest there are still significant spillovers from Nigeria’s main trading partners, including the US, with trade and commodity price linkages being the dominant transmission channels. Given the sharp fall in trade financing and commodity prices in the aftermath of the crisis, these results provide some explanation to the realization of adverse second-round effects in Nigeria.
A growing consensus was beginning to emerge that the rest of the world could continue to grow despite significant slowdown in the US. In published reports2, books3, and short essays4, proponents5 of this theory, commonly called decoupling”, frequently pointed to the fact that emerging markets now constitute 30 percent of the world economy and contribute 60 percent of global growth. They also argued that consumption in emerging markets has risen to the extent where it can replace consumption declines in the US.
More arguments in favour of decoupling were built around several other factors including shifting trade patterns and demographic changes. Proponents argued that trade linkages with the US was becoming increasingly less important for many countries and that critical pro-growth demographic factors are in favour of emerging market countries. In particular, Garner (2008)6 asserts that while working age population in emerging market countries will rise by one billion people by 2050, the same demographic group will shrink by 120 million in developed countries. In general, the underlying position was that emerging market and developing countries may have decoupled enough from the US such that these countries could continue on the path of economic growth even with a major slowdown in the US.
These conclusions seemed to have emanated from the benign effects of US economic recession which began in December 2007.7 A number of possibilities may have resulted in this outcome.
These banks made huge losses from the crisis and had to either declare bankruptcy (Lehman Brothers), be sold
(Bear Sterns, Merrill Lynch, Wachovia), or bailed out again and again by the US government (AIG). Others
(Goldman Sachs, JP Morgan Chase, etc) survived but not without scars.
The slowdown has been related to specific sectoral developments in the US economy including corrections in the housing and manufacturing sectors, rather than to broad based, common factors such as oil price or equity market developments that were often behind earlier downturns (IMF, April 2007). This outcome may also have been related to the strengthening momentum of domestic demand in emerging markets, and other advanced economies (excluding the US), which made global growth seem more resilient at
However, global reverberations emanating from the sub prime crisis in the US seem to suggest otherwise. With the collapse of nearly all major investment banks in the US8, and sharp decline in equity and commodity prices, anecdotal evidences suggest that the scope for economic spillovers may have increased significantly. While low-income countries had no direct exposure to sub-prime mortgages, there are still significant indirect effects through sharp declines in remittances, trade financing, foreign direct investment, and commodity prices.
Indeed, the crisis is projected to increase the financing requirements of low-income countries by as much as US$25 billion (IMF, 2009).
In the case of Nigeria, the global crisis has resulted in sharp declines in the value of oil exports, rapid depreciation of the exchange rate, and worsening investor sentiments in the banking sector. Given that over 90 percent of Nigeria’s foreign exchange earnings and public sector revenue come from exports of crude oil, the fall in the price of crude oil (probably reflecting projected fall in global growth outlook) resulted in a rapid depreciation of the exchange rate and reversal of the trade balance from a usually comfortable surplus to a deficit. More also, there was a plummeting of share prices and market capitalization of quoted companies as both foreign and local investors divested from the Nigerian stock exchange.
Remittances were also projected to fall by as much as 20 percent given the global slowdown.
TRADE AND FINANCIAL LINKAGES
Over the past two decades, there has been remarkable increase in external trade and openness in Nigeria. The importance of trade in the Nigerian economy has grown rapidly in recent times, especially since 2002. Trade openness, measured as the ratio of exports and imports to GDP, has risen from just above 3 percent in 1991 to over 11 percent by 2008.
The moderation in the growth rate of trade in 2008 partly reflects the unrest in Nigeria’s oil-producing Niger Delta region, which resulted in significant disruptions in oil production and shortfalls in oil exports from Nigeria.
Direction of trade data indicates that the US, the EU, and Brazil are Nigeria’s largest trade partners. Figure 1 shows that the US is Nigeria’s single largest trade partner as it accounts for nearly 45 percent of Nigeria’s exports. Of total exports, oil exports account for the vast bulk. The EU is also a major destination for Nigerian exports accounting for over 25 percent of total exports from Nigeria while Brazil accounts for about 6 percent of total exports.
Trade relations between Nigeria and Brazil were further formalized in 2006 by the Abuja Resolution, which established the Africa-South America Cooperative Forum. Trade statistics show that Nigeria is the fifth largest exporter of merchandise to Brazil after the US, Germany, Argentina, and China.
However, most of Nigeria’s trade with the EU is concentrated in a small number of countries. Within the EU, Spain is the largest market for Nigeria’s exports as it accounts for over 30 percent of exports to the EU (Figure 2). France, Germany and The Netherlands are also prominent export destinations for Nigerian goods.
These trade linkages are reinforced by fairly close cooperation between Nigerian banks and their foreign counterparts. Characterized by aggressive competition and accelerated expansion, the Nigerian banking system underwent a major restructuring and recapitalization in 2004 which resulted in 24 commercial banks in the country.
The sector was largely shielded from direct effects of the sub-prime crisis as they were mostly involved in traditional banking (receive deposits and give loans). However, the top 14 banks have strong ties to foreign asset managers who may have had direct exposures to the subprime crisis.
One such tie is encapsulated in the central bank of Nigeria’s decision (in February 2006) to award the management of Nigeria’s external reserves to only foreign asset managers who had local partnership agreement with a Nigerian bank.
Table 1 presents a list of the pairings.
Access Bank PLCABN Amro (The Netherlands)
Bank PHBFortis (Benelux)
Diamond Bank PLCCrown Agents (UK)
ECOBANK PLCING (Belgium)
Fidelity Bank PLCInvestec (SA)
First Bank PLCHSBC (UK)
Guaranty Trust Bank PLCMorgan Stanley (USA)
Stanbic IBTC Bank PLCCredit Suisse (Switzerland)
Intercontinental Bank PLCBNP Paribas (France)
Oceanic Bank PLCCommerzbank (Germany)
Union Bank PLCBlack Rock (UK)
United Bank for Africa PLCUBS (Switzerland)
Zenith Bank PLCJ.P. Morgan (USA)
Table 1: Partnership between Nigerian Banks and Foreign Asset Managers
Source: Central Bank of Nigeria Press Release, October 2006.
Net foreign direct investment (FDI) has soared over the past eight years, but there was a sharp decline in 2008. Reflecting increased investor confidence following Nigeria’s return to democratic rule and political stability, net FDI increased steadily from 2000 with a peak of about $8.7 billion in 2006 (Figure 4). While the decline in net FDI began in 2007, it may have been intensified by the current global crisis.
Nigeria’s linkages with the rest of the world are also evident in the country’s remittance receipts (Figure 5).
Nigeria is the single largest recipient of remittances in Sub-Saharan Africa and accounts for about 65 percent of total remittances in West Africa (Orozco, 2003a, 2003b).
This represents about 7 percent of the country’s GDP (World Bank, 2007). Given that the current global slowdown has resulted in massive job losses in developed countries, it expected that remittances to developing countries, including Nigeria, will decline sharply.
Given these linkages, business cycle correlations shows fairly similar turning points between Nigeria and her key trading partners (Figure 6)
10 Data for the EU covers the EU-15 countries including Austria, Belgium, Denmark, Finland, France, Germany, Greece, Ireland, Italy, Luxembourg, the Netherlands, Portugal, Spain, Sweden, and the UK.
Did the world really decouple from the US?
Using Nigeria as a case study, I have adopted a combination of a base and extended vector auto regression (VAR) models to provide a sufficiently unambiguous answer to this question. Results from both models debunk the “decoupling theory” in Nigeria’s case and show that there are still significant cross-country spillovers from US (and other major trading partners) to Nigeria.
Indeed, both models show that the effect of a shock from the US rises over time in Nigeria with peaks around the end of the second year following the shock. I also found that of three potential channels of spillovers, namely trade, finance, and commodity prices, the most dominant channel of spillovers from the US to Nigeria are trade and commodity price linkages.
Hence, it is not surprising that the indirect effects of the current global crisis, which began in the US financial sector, has been quite significant, reflected in sharp fall in export earnings, trade financing, and depreciation of the exchange rate. Given these results, policymakers in Nigeria may have to pay attention to occurrences in the economies of key trading partners. It will also be beneficial to take cognizance of the fact that shocks from the US and the EU may have even larger effects over time as is clearly the case with the results from the variance decomposition in both models.
Two options for further studies emanate from this one. It might be interesting to evaluate the extent of spillovers from the US to regional trading blocs in developing and emerging market countries, and then to major emerging market countries individually.
Findings from these studies are likely to provide us with a fuller understanding of cross-country linkages around the world, and add evidence to the debate on decoupling and spillovers.
© 2009 International Monetary Fund WP/…IMF Working Paper, Strategy, Policy, and Review Department
Do Trading Partners Still Matter for Nigeria’s Growth? A Contribution to the Debate on Decoupling and Spillovers
Prepared by Kingsley I. Obiora1
Authorized for distribution by Ulric Erickson von Allmen
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