Why underdeveloped, developing countries should avoid aligning their currencies to major international currencies – Okoroafor

Dr. Emmanuel Okoroafor is the Managing Director/CEO of Hobark Consultant Management Services Ltd, a business primarily focused on the full-suite of Human Capital Management. He possesses a B.Sc (Hons) in Physics, University of Ife, Nigeria; Dip d’Ing Nuclear Engineering, Institut National des Sciences et Techniques Nucleaires, Grenoble, France and PhD in Materials Science, Universite Denis Diderot, Paris VII, Paris, France.

A director in RUTA E&P Ltd and FACEATO E&P Ltd, he has worked for 33 years in academia and industry in Nigeria and overseas. Okoroafor is the Founder of MEPON Ltd, a company that provides online platforms for global equipment and facilities rentals; the Founder of Frempi Spring Water Company Ltd; and also the Founder of IExport Afrique Ltd, which specialises in providing and exporting locally sourced food products from regions around Nigeria and the entire African Continent.

He is a UK Engineering Council registered Chartered Engineer (CEng), FEANI registered Engineer (Eur-Ing), and Fellow of the Institute of Materials, Minerals and Mines (FIMMM). In this interview with ONYEDIKA AGBEDO, he speaks on the prevailing exchange rate crisis in Nigeria, explaining why underdeveloped and developing countries should avoid aligning their currencies to major international currencies.

There have been debates about whether or not it is appropriate for developing countries to align their currencies with major international currencies. How should Nigeria approach this?
Aligning currencies to major international currencies like the US dollar, euro, pound sterling, or yuan has become a common practice among underdeveloped and developing economies. However, this strategy often undermines economic stability, leading to inflationary pressures, reduced competitiveness, and dependency on foreign economies. Countries such as Nigeria, Zimbabwe, and Argentina illustrate the adverse consequences of currency alignment, particularly how it distorts local markets in ways that defy economic logic.

But most countries in the world align with stronger economies. What are the pitfalls of currency alignment?
When a country pegs or heavily aligns its currency with a major international counterpart, it effectively relinquishes control over its monetary policy. This significantly limits its ability to respond to local economic conditions. For instance, in Nigeria, the naira’s value is heavily influenced by its exchange rate with the US dollar. Consequently, economic decisions made in the United States — such as interest rate hikes by the Federal Reserve — directly affect Nigeria, despite the stark differences between their economic realities.

How does that affect locally produced goods?
One perplexing consequence of currency alignment is its inflationary impact on locally produced goods that do not rely on foreign inputs. In Nigeria, vendors frequently cite the dollar-to-naira exchange rate to justify price hikes, even for goods entirely produced domestically.

For example, agricultural products like yams, maize, and cassava are cultivated locally without imported materials. Yet, when the naira depreciates against the dollar, the prices of these goods often rise dramatically. This occurs because sellers preemptively increase prices, assuming that higher exchange rates signal broader economic instability or rising costs. This psychological inflation creates a ripple effect, eroding purchasing power and exacerbating poverty.

Secondly, currency alignment can lead to overvalued currencies, making exports less competitive while encouraging imports. In this way, it distorts trade dynamics. In Nigeria, where oil is the primary export, efforts to maintain a favourable dollar exchange rate for oil revenues have overshadowed the need to diversify the economy. As a result, non-oil exports struggle to compete globally due to high costs, deepening dependency on imported goods and external financing.

Speculative behaviour further exacerbates the problem. In Nigeria, for example, the black market exchange rate often diverges sharply from the official rate. Businesses and individuals hoard foreign currencies, anticipating further devaluation, which accelerates the naira’s depreciation and fuels economic instability.

What are the empirical examples of these currency alignments?
In 2009, Zimbabwe adopted the US dollar as its de facto currency to combat hyperinflation. While this temporarily stabilised inflation, it made Zimbabwe’s goods more expensive compared to those in neighbouring countries with weaker currencies. Local industries, such as textile and food processing, struggled to compete with cheaper imports, leading to widespread factory closures and job losses.

The reliance on dollarisation also drained foreign currency reserves, as the economy depended heavily on imported goods. Instead of boosting local production, authorities implemented measures such as bond notes and currency controls, eroding trust in the monetary system and deterring foreign investors.

Another example can be made of Argentina and its failed experiment at currency pegging. Argentina’s history of currency pegging during the 1990s highlights the risks of aligning with a major currency. By pegging the peso to the US dollar at a one-to-one rate, Argentina initially stabilised prices. However, the fixed exchange rate overvalued the peso, making exports expensive and imports cheaper. This devastated local manufacturing, leading to factory closures, unemployment, and a dependence on foreign goods.

When the system became unsustainable, Argentina abandoned the peg in 2001, triggering a debt crisis, capital flight, and a collapse in investor confidence. Throughout the peg, the central bank prioritised exchange rate stability over structural economic reforms, ultimately deepening the crisis.

Generally, what are the broader impacts of currency alignment?
From the experiences of Nigeria, Zimbabwe, and Argentina, we can see several common consequences of currency alignment.

The first impact is often inflationary pressures, whereby local goods experience price hikes due to perceived economic instability, even when production costs remain unaffected.

Secondly, it stifles innovation. How? Overvalued currencies make imports cheaper, discouraging local industries from innovating and competing.

Thirdly, it leads to monetary policy constraints, whereby the central banks focus disproportionately on maintaining exchange rate stability, neglecting pressing domestic needs such as unemployment reduction and infrastructure investment.

It also deters foreign direct investment. While currency alignment may initially attract foreign direct investment, long-term instability and unpredictable devaluations dissuade investors.

What alternatives to currency alignment can developing countries explore?
Developing countries can adopt several strategies to mitigate the risks associated with currency alignment. One such strategy is to strengthen local economies by investing in infrastructure, agriculture, and technology. Doing these will reduce reliance on imports and build economic resilience.

Another strategy is to diversify reserves. In this way, holding reserves in a basket of currencies and commodities like gold can minimise exposure to any single currency. The country can also float its exchange rates. Allowing market forces to determine currency values ensures a better reflection of domestic economic conditions.

Additionally, establishing regional currency unions or trade agreements can provide stability without over-reliance on major international currencies. For instance, the proposed West African Eco offers a potential model.

In the same vein, creating a stable, predictable business environment through transparent governance and infrastructure development can attract investors without relying on currency alignment.

Overall, it may be said, while currency alignment may offer short-term benefits, such as stabilising inflation or attracting FDI, the experiences of Nigeria, Zimbabwe, and Argentina highlight its long-term consequences. These include the erosion of local industries, imported inflation, loss of monetary sovereignty, and economic instability. To ensure resilience in the face of global economic uncertainties, underdeveloped and developing countries must prioritise policies that strengthen their domestic economies, enhance competitiveness, and promote sustainable growth.