The economic environment, free trade and international institutions

When the Central Bank of Nigeria (CBN) raises its policy rate, a company’s loan gets dearer, its customers spend less and the naira may strengthen or weaken. When oil earnings fall, the naira comes under pressure and a company that imports raw materials sees its costs jump. A financial manager who ignores the economy plans in the dark.

This topic is about the forces outside the company that move its cost of money, its sales and its exchange rate.

It covers the aims of macroeconomic policy, how gross domestic product (GDP) is measured, fiscal and monetary policy and their effect on business, the World Bank, the International Monetary Fund (IMF), central banks (the CBN, the US Federal Reserve and the European Central Bank), and a short note on free trade. The previous topic covered money laundering and directors’ duties.

The next covers government influence and the financial framework. Neither the May 2014 nor the November 2014 Pathfinder sets a stand-alone question on this topic, but it is the backdrop to many scenario questions.

Key terms in plain English

Syllabus check

This topic is in syllabus area A (financial management and the international environment), which carries 10% of the marks. It covers:

• the actions of the IMF, the World Bank and central banks, and their effect on organisations;
• macroeconomic, fiscal and monetary influences on financial decisions;
• the theory of free trade and barriers to trade, in outline.

CAMA 2020 and the economy

The Companies and Allied Matters Act 2020 (CAMA 2020) does not deal with economic policy. It does require directors to report on performance and risk.

The aims of macroeconomic policy

Macroeconomics deals with a country or the world as a whole. In advanced economies there are normally five aims: sustained real growth; full employment (which depends largely on growth); price stability; balance of payments equilibrium; and redistribution of income.

GDP and growth

GDP can be measured by output, by income or by spending, and the three totals should agree. The spending approach is the most useful for analysis:

GDP = C + G + I + (X − M) where C is consumption, G government spending, I private investment, X exports and M imports. (X − M) is the balance of trade.

Growth can come from more consumption, government spending, investment or a better trade balance, but only if a rise in one does not cause a matching fall in another. Higher government spending funded by tax may cut C or I. Higher investment needs savings, which means less consumption.

Inflation

GDP as measured is in money terms. Real growth is growth after inflation. Governments want to limit inflation because it moves wealth unfairly (people on fixed incomes lose, asset owners gain), pushes up wages and costs, and over time cuts real growth.

Fiscal policy

Fiscal policy covers government spending, taxation and borrowing. More spending raises GDP but has to be funded by tax (on income, company profit and sales or value added tax) or by borrowing. In Nigeria the government borrows by:

• issuing long-term sovereign bonds through the Debt Management Office, which account for most public debt;
• borrowing from multilateral lenders (the World Bank, the African Development Bank) and bilateral lenders;
• issuing short-term Treasury bills, normally repaid after 91 days.

Effect on business

• Companies may try to cut tax by moving operations to low-tax countries.
• Tax reliefs and capital allowances affect investment decisions.
• A rise in sales tax or value added tax is likely to cut demand. Higher income tax reduces customers’ spending power.
• Government bonds are treated as risk-free, so companies must offer a higher interest rate than the government to persuade investors to buy corporate bonds.

Monetary policy

Monetary policy covers inflation, interest rates and the exchange rate. In many countries the main tool against inflation is the central bank’s lending rate to banks. The CBN uses the Monetary Policy Rate. Raising the rate works through the economy (the “transmission effect”): banks put up their lending rates, borrowing and spending slow, and inflation pressure eases.

If the economy can grow without inflation, rates can be cut to encourage spending and investment. Inflation also falls only when expectations of inflation fall, so the authorities must be seen to act.

Interest rates and the exchange rate

Higher interest rates attract investors into the currency and tend to raise its value. Lower rates tend to lower it. If the authorities target the exchange rate with interest rates, they cannot also use the same rates to control inflation. In Nigeria a large part of foreign exchange comes from oil, so the naira is largely a function of the oil price.

Higher oil income tends to strengthen the naira, and lower receipts tend to weaken it in the long run. In the short run the CBN may defend the naira from its reserves.

Effect on business

• Controlled inflation helps real growth in the long term.
• Higher interest rates raise the cost of borrowing, cut profit and may stop new investment. They may also cut customer spending.
• A falling currency: exports become cheaper to foreign buyers so demand should rise, but imports cost more, which can start an inflation spiral.
• A rising currency: exports become dearer and demand may fall, imports become cheaper, and competition from imports may increase.

In the exam you may be asked how a company is affected by a change in economic conditions or policy, and how it should respond.

International financial institutions

The World Bank

Many developing countries cannot reach the international capital markets, and foreign companies will not invest unless transport, communications and education are good. The World Bank lends to countries in need, with conditions such as economic discipline. Its aim is long-term development and poverty reduction through projects such as schools, water, electricity and environmental protection. It is funded by rich governments and by issuing bonds. It has two main parts:

• International Bank for Reconstruction and Development (IBRD): repayable loans to middle-income and creditworthy poorer countries for projects that cut poverty and that private companies will not finance.
• International Development Association (IDA): interest-free loans and grants (“credits”) to poorer countries. The loans run for about 35 to 40 years, often with a ten-year grace period, for health, education and infrastructure.

The International Monetary Fund

The IMF was set up in 1944 and is funded by member quotas in Special Drawing Rights. Its role is to improve monetary co-operation, promote exchange rate stability, help countries reach balance of payments equilibrium and growth, and lend temporarily to countries with balance of payments difficulties. Loans usually carry austerity conditions: lower public spending and higher tax to cut demand and control inflation, so that a trade deficit narrows.

The cost can be a lower standard of living and higher unemployment. Critics say its policies hurt lower and middle-income people, hold back long-term growth and can cause a downward spiral.

Central banks

A central bank manages a state’s currency, money supply and interest rates and usually oversees the banking system. The objects of the CBN (CBN Act 2007) are to ensure monetary and price stability, issue legal tender, keep external reserves to safeguard the value of the naira, promote a sound financial system, and act as banker and adviser to the Federal Government. It supervises banks and promotes an efficient payment system.

The US Federal Reserve (founded 1913) keeps the financial system stable, supervises banks, manages the money supply and acts as lender of last resort. Support is not automatic: in 2008 it lent $85 billion to rescue the insurer AIG but declined to save Lehman Brothers. It influences the federal funds rate (the interbank rate) by open market operations, the discount rate and reserve requirements.

The European Central Bank runs monetary policy for the euro area, with price stability as its primary aim. The euro area has 21 members, Bulgaria having joined on 1 January 2026.

Free trade and its barriers

The syllabus asks for the theory of free trade and barriers to trade. Free trade lets countries sell what they make cheaply and buy what others make cheaply, which raises output and choice. Governments limit it by tariffs (taxes on imports), quotas (limits on quantity), subsidies to local producers and embargoes.

The World Trade Organization (WTO), set up in 1995 to replace the GATT, sets rules for trade between nations, runs trade negotiations and settles disputes. For a multinational, barriers raise the cost of exporting, push it to produce locally and affect transfer pricing and dividends.

The rules in more depth

Why real growth matters

A country can show 12% growth in money terms and be poorer if prices rose 15%. Companies and governments plan on real figures.

Why government borrowing affects companies

If investors can lend to the government with no risk at, say, 18%, a company must offer more than that, and its cost of capital rises. Heavy government borrowing can therefore raise corporate borrowing costs.

Why a falling currency is not simply good for exporters

An exporter that buys imported inputs sees its costs rise as well. The net effect depends on the mix of foreign currency income and cost.

Why the IMF is controversial

Its conditions work in the short term but cause hardship. In an exam answer give both the reason and the criticism.

Effect on analysis

In a scenario, state the policy change, trace the channel (borrowing cost, demand, exchange rate) and say what the company should do, for example hedge.

Worked examples

1. Real growth.
   1.03 ÷ 1.02 − 1 = 0.98%, about 1%.
2. With inflation of 5%: 1.03 ÷ 1.05 − 1 = −1.9%, so the economy shrinks by about 2% in real terms.

1. GDP = 60 + 20 + 15 + (12 − 14) = ₦93 trillion.
2. The trade balance is −2, a deficit that reduces GDP.

1. Export income in naira rises by 2m × 200 = ₦400m.
2. Import cost rises by 1.5m × 200 = ₦300m.
3. Net gain = ₦100m. If the company had more imports than exports, it would lose.

1. It raises ₦98.75m and repays ₦100m, so interest is ₦1.25m.
2. Return for 91 days = 1.25 ÷ 98.75 = 1.27%.
3. Annualised = 1.27% × 365 ÷ 91 = 5.1%, about 5%.

How to score full marks

• Name the policy (fiscal or monetary) and the instrument.
• Trace the channel from policy to the company: borrowing cost, demand, exchange rate, tax.
• Show both effects of a currency move on exports and imports.
• Use real and money figures correctly.
• Give the reason for IMF conditions and the criticism.
• End with the company’s response, such as hedging or changing finance.

Common mistakes in the exam

• Treating a currency fall as good for every exporter.
• Quoting money growth as real growth.
• Mixing up fiscal and monetary policy.
• Confusing the IBRD with the IDA, or the World Bank with the IMF.
• Ignoring that government borrowing raises corporate borrowing costs.
• Listing facts about institutions without linking them to a company.

Quick revision

• Five aims: real growth, full employment, stable prices, balance of payments, fair incomes.
• GDP = C + G + I + (X − M). Real growth strips out inflation.
• Fiscal: spend, tax, borrow. Monetary: rates, inflation, exchange rate.
• Higher rates: dearer borrowing, lower spending, stronger currency.
• World Bank: IBRD loans, IDA credits. IMF: balance of payments loans with austerity.
• CAMA 2020: ss. 377(1), 378, 385, 308, 404(7).

Practice questions

These are original questions written in the style of the Institute of Chartered Accountants of Nigeria (ICAN) exam. Try each one before you open the answer. Full model answers follow the written questions.

Recall check: multiple choice

The real ICAN paper has no multiple-choice section. These questions are for quick recall. The written questions that follow are closer to the exam.

Written questions

Model answers

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