THE EMEFIELE TAPE, ANNOTATED- WHAT WAS THE CBN GOVERNOR DISCUSSING ON THE RECENTLY LEAKED TAPE?

The online paper, Sahara Reporters, managed to get its hand on a recording of the Central Bank governor, Godwin Emefiele, discussing how to fill a seemingly large hole in its balance sheet. Also remarkable is that, from the statement the CBN released immediately after the story broke, it did not deny that the recording was authentic – it merely quibbled with the way Sahara Reporters spun the story to be about fraud.

So what was being discussed? The conversation is sometimes hard to follow due to the governor’s liberal use of exclamations and colloquialisms. But some things are clear to work out. Under discussion is the financial accounts for 2018 so we can work out that the tape is from February or March of this year (more on this below).

Also worth noting is that the CBN under Emefiele has stopped publishing its full IFRS financial statements. What we now get is the accounts without the notes making it difficult to work out some large numbers. Still, numbers are numbers and they don’t lie so we can make educated guesses as to what is going on. In that sense, the 2017 accounts published by CBN are central to understanding the tape. The 2018 accounts have of course not been published (and may never be published at this rate).

Annotating the tape

Man: Option of 34 billion but if we put this number there it will change our shareholders’ form to negative which is dangerous.
Edward: Yes, yes. We can’t do that one that will be dangerous, Hmmn!
Governor: What do we do?
Edward: …can we get the finance ministry to take some off? Even if it’s just for the record?
Governor: How can they take it now? Take what now precisely?
Edward: Even if it’s just to do some book work.
Governor: That will expose us to them.
Edward: That’s the only way.
Governor: Okay, what do we want finance to do in this case?
Edward: Well, the thought was that, we do some discussion with them, If they can just write saying the government will but it hasn’t maybe appropriate or something.
Governor: They can’t try that because national assembly and government, they have to go to the federal executive council to do that. 
Edward: They have to go to Federal executive council, wow! 
Governor: Ahhh… damned!
Edward: I even said we should look at the ratio but there’s pretty much nothing we can do here …I don’t have an intervention, that’ll not work and we can’t afford negative… (inaudible) 
Governor: Enn?
Edward: We cannot afford deficit governor, no way!

This first part of the discussion is almost likely about the bailouts or ‘budget support’ given to the states as the CBN says in its statement. However this cannot be taken in isolation. As the governor was heard to say, he did not want the CBN’s books to be exposed to the finance ministry. The way Emefiele has run the CBN has been to use a lack of transparency as a source of his power. Allowing the ministry to look through its books would have damaged him in their eyes severely. As we shall see, to maintain the exchange rate stability that President Buhari demands above anything else, he has slowly but surely boxed himself into a corner that will be incredibly difficult to get out of.

Obviously the budget support given to the states was really a gift no matter that the government called it a loan. After two years, none of it clearly had been paid back so it seems obvious that the auditors were asking for a write-down of the loan. Alas, writing off N650 billion (if we believe the CBN that the N55 billion monthly ‘support’ only went on for one year) would have pushed the CBN’s accounts into negative shareholder funds which would have exposed Emefiele to serious political problems.

But why would the CBN not be able to take a N650 billion hit? The answer lies in the most important part of the tape below.

Governor: How do we get out of this is the issue …because the auditors themselves will be very careful because they have people who redo their account.
Edward: Exactly, they also have their names and their own governance process might not allow them to do some of these things.
Hold on for Ukeji sir.
Ukeji: Governor sir.
Governor: Yeah. I’ve been thinking of all the options because the omo asset which is the box …the money has been paid and bank has recognized that amount in their income and naturally the auditors were also asked for confirmation to confirm. Because initially we had about 150 billion which was what was paid in December then the initial thought was to look at the heavy edge that bought into that but we also realize that they had their end of the year in December  so they would have recognized that and I was just asking Mr Arowosegbe about our ex-Rate gain, the rate they used for this year is said to be already 354 which is already very high.
Governor: Hmmn!
Ukeji: Yes, because if not we would have increased that closure maybe by just 1 naira or 2 naira that will change the whole thing.
Governor: The first time in history…negative shareholder.

This is the big reveal. To understand why the CBN has no space to take a N650 billion hit in its accounts, we have to go to its 2017 accounts.

Central Bank of Nigeria 2017 Accounts

It barely managed a profit of N107 billion for the year. The big damage came in the second line – Interest and similar expense. An astonishing N1.3 trillion – three times what it spent in 2016 – went on this. On the tape, Emefiele talked about the ‘OMO asset’. This is of course referring to the Open Market Operations tool which he has ramped up since 2017 (Professor Soludo never used the OMO tool in his time as governor and Sanusi Lamido Sanusi only used it very minimally).

From OMO to OMG

As President Buhari wants the exchange rate of the naira to the dollar to be stable, no matter what happens elsewhere, and also will not countenance a devaluation, it fell to Emefiele to come up with a way to guarantee an inflow of dollars into the economy since oil prices were still low and foreign investment was nowhere near enough.

To entice foreign investors, Emefiele thus came up with one of the sweetest carry trades in the world. An investor shows up with some dollars. Emefiele buys those dollars from him and hands him the naira equivalent. He then sells an OMO instrument to the same investor paying up to 18 percent interest per annum. To make it even sweeter and remove all risk, he commits to selling dollars back to the investor in one years time at an agreed rate. Thus, an investor could simply park money in Nigeria – risk free – for one year and earn a double digit return on it – something practically impossible to find anywhere else.

Traders loved this too-good-to-be-true deal and poured into it. This guaranteed a steady inflow of dollars and thus gave President Buhari the stable exchange rate he dearly loves. But when you look at the accounts, you see how much this stability has been costing the CBN. At one point, the outstanding OMO instruments were larger than the federal government’s total debts. The more the dollars poured in, the more Emefiele binged on it.

While we do not yet know what the OMO damage was in the 2018 accounts, it is safe to say it probably came in higher or the same N1.3 trillion as in 2017.

Back to the Tape

The tape also gives us a very good idea as to how the CBN managed to escape making a loss in 2017. From the accounts we see that the CBN’s escape hatch was the ‘Other operating income’ line of N1.5 trillion. Without this, the CBN’s accounts would have bled red all the way down. But what is this magical N1.5 trillion and where did the CBN find it?

The first ‘option’ discussed by the governor is a suggestion to get the local banks to book a lower interest in their books. This is an incredible thing to even think about let alone say out loud. Essentially, after paying out interest of say 16 percent on the OMO instruments, the governor would have bullied the banks to record it as perhaps 14 percent in their books. This would then allow the CBN to lower the amount of interest it paid in its own accounts. Perhaps this could have knocked off a couple of hundred billion from the N1.3 trillion interest expense thus creating more room to take a hit from the dodgy loans to the states. This is also how we can date the recording to February or March this year because the banks had closed their books at the time (they all have a December year end and report in March), foreclosing this ‘option’.

Back to 2017. The governor then moves on to discuss the ‘ex-rate gain’ as an option. The CBN’s official exchange rate remains at N305 to US$1. This is the rate at which it converts dollar earnings into naira for the government. But in 2017, the CBN pulled off a trick by valuing its foreign exchange reserves using a higher rate. For example, in September 2017, the CBN reported foreign exchange reserves of US$33.2 billion. This should have translated to around N10.1 trillion in its books. But that month, the CBN reported N11.7 trillion on its balance sheet. On the tape Emefiele talks about a rate of N354 which comes very close as the exchange rate.

In other words, to escape out of the ‘OMO box’ it had constructed for itself, the CBN was valuing its foreign reserves at N354 while telling the government the official rate was N305, a secret devaluation trick. By doing that, it was thus able to book a revaluation gain which it then passed through the income statement. It is like being able to eat your cake and still having it. (The explanation the CBN gave to the IMF and others was that it was buying a lot of dollars at around the N360 mark during the year from investors).

The trouble with this trick is that it can only really be used once, unless there is another actual devaluation. But Nigeria’s exchange rate has remained ‘stable’ at N360 since February 2017 and as stated earlier, President Buhari will simply not tolerate another devaluation (or murdering the naira as he famously called it, bless his innocent heart). Since the reserves were already valued at close to the N360 market rate for 2017, there is hardly anywhere left to go. As the governor’s adviser, Emmanuel Ukeji, ruefully remarked on the tape, the ability to do this would have ‘changed the whole thing’. Indeed.

At the end of 2018, the CBN reported foreign reserves of US$43.1 billion. Assuming it needed to close a hole of N650 billion, it would need a N15 adjustment on the exchange rate to close that gap. If we take the N354 it used in 2017 as the starting point, this will imply a rate of N369 to value the foreign reserves. Any rate above N360 would have been an impossibility and no auditor would ever have signed off on that.

While we wait for Part 2…

Sadly, the tape ended without letting us into what trick the CBN settled on to close its books. But from everything we know, it would have taken something close to magic to make this work. This explains Emefiele’s exasperation on the tape. At one point he breaks into pidgin English and declares ‘I don die, where I wan see money?’ Emefiele is evidently still alive so safe to say they did find a way in the end. We will know this whenever the CBN releases its 2018 accounts…if it ever does.

The tape reveals the incredible cost of Nigeria’s ‘stable’ exchange rate which Emefiele has gotten many Nigerians to think comes free. Traders in London who have been participating in the Emefiele Carry Trade sometimes get a bout of conscience and complain that they know this cannot be right for a country like Nigeria. But this lasts all of five minutes and they go back to making money hand over fist. Who can blame them?

The CBN now has two choices. It can begin to unwind the OMO by slowing or eliminating new instruments and simply paying them off when they come due. But this will then create an incredible amount of liquidity in the economy which will then force down interest rates. At the first fall in interest rates, the foreign investors will flee the country, along with their dollars which will return the country to the forex crisis of 2016.

The second option is for another devaluation. As has been stated above, this is not going to fly as President Buhari will sooner pluck out his own eye balls than allow this.

And so the country is stuck in a cycle of low growth and high interest rates. But worse is that the ability of the debt soaked CBN and federal government to do anything useful for the economy is steadily decreasing, further worsening the problem. Even taking the CBN at its word that the problem here was N650 billion, it is remarkable how an amount less than US$2 billion was causing them so much exasperation. So much resources have been taken up repaying debts and keeping fleet footed foreign investors happy just to keep the exchange rate that the president wants.

We congratulate the governor on securing a historic second term in office.

Addendum: Somewhere on the CBN website is its Annual Activity Report for 2018. Inside this report, the cost of the OMO in 2018 is revealed on page 9.

Cost of the OMO in 2018

These are even more astonishing numbers than 2017 – N2.1 trillion (nearly US$6 billion) spent in 2018 to give President Buhari the stable exchange rate he wants, an amount higher than the federal government’s own cost of debt servicing.

Source: Faye & Fraser Briefing Note

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