Can Nigeria float the Naira now?
The cacophony of jargons, mantras, singsongs and mere slogans that formed the electioneering messages of political parties in the build-up to the 2019 general elections in Nigeria, were anything but enlightening and informative.
In not a few cases, in fulfilment of all righteousness, obviously ill-digested policy materials, especially as regards the economy, were hastily churned out and widely put across to the unwary and largely ‘uninformed’ public. But on a close scrutiny, some of the key contents of these ‘beautifully packaged’ documents could end up doing more harm than good to the economy, if implemented.
Yet, many of the political parties and their presidential candidates paraded these policies as their unique selling points (USPs) and magic wands for Nigeria’s quick journey to an economic Eldorado.
Take the floating of the Naira exchange rate, for example: this prescription featured very prominently in the economic policy documents of one of the major political parties.
Indeed, the authors of the economic blueprint of the party ended up saying that the Naira floatation would be among the party’s first set of economic policies to be implemented, if they won the election and formed the government at the centre.
Floating exchange rate, also called a fluctuating or flexible exchange rate, is a type of exchange-rate regime in which a currency’s value is allowed to fluctuate in response to foreign-exchange market mechanisms (largely, demand and supply). A currency that uses a floating exchange rate is known as a floating currency.
According to Wikipedia, floating currency is contrasted with a fixed currency whose value is tied to that of another currency, material goods or to a currency basket to keep its value within a narrow band and provide greater certainty for exporters and importers.
In the modern world, most nations’ currencies are floating; they include the most widely-traded currencies: the United States dollar, the Swiss franc, the euro, the Japanese yen and the British pound.
However, central banks do participate in the markets to attempt to influence the value of floating exchange rates.
The degree to which countries’ central banks intervene varies. This gives rise to what is better referred to as ‘managed currency’; that is, one whose price and exchange rate are influenced by some intervention from a central bank.
In reality, truly floating currency exchange often faces a high degree of volatility and uncertainty. For example, external forces beyond government control, such as the price of commodities like oil, can influence currency prices.
A government will intervene to exert control over their monetary policies, stabilize their markets, and limit some of this uncertainty.
However, a government’s ability or capacity to intervene to stabilize the market is a function of several variables including the volume or stock of foreign exchange reserves at its disposal, the volume and pace of foreign exchange earnings/inflow, the extant foreign exchange management regime, among others.
For Nigeria, whose almost sole foreign exchange earner is crude oil, the vagaries and volatility inherent in the floating currency are too disruptive for any meaningful economic progress. As of today, Nigeria neither determines the price nor the quantity of crude oil it supplies to the market.
While so many factors play out in determining prices of oil in the global market, quantity supplied is fixed through the quota structure of the Organization for Petroleum Exporting Countries (OPEC) of which Nigeria is a member.
No substantial foreign exchange earning comes to Nigeria outside oil proceeds. The much touted and bandied diversification of the Nigerian economy is at best at a rudimentary level, with no sector yet making tangible addition to foreign exchange earnings from oil.
This milieu has all along dictated the import substitution (industrialization) strategy of successive governments in Nigeria, including the extant ‘banning’ of 41 or 42 items from access to the foreign exchange market by the Central Bank of Nigeria.
Apparently, with the ban placed on the producers of these items, the pressure their demand for forex would have brought unto the foreign exchange market is deemed to have been eliminated.
The apex bank is therefore using this trade or monetary policy to ‘manage’ the value of the local currency in the foreign exchange market.
So, were the market to be truly left to the full play of market forces (as a largely import-dependent economy, including rabid taste for imported consumer goods), implying fully floating Naira—the local currency would crash irredeemably.
This is why the prescription by authors of the economic blueprints of some of the political parties, calling for immediate Naira floatation, is patently dangerous, to say the least. The prescription has every capacity to inflict what is called the ‘Cobra effect’ in Economics.
The cobra effect occurs when an attempted solution to a problem makes the problem worse, as a type of unintended consequence. The term is used to illustrate the causes of incorrect stimulation in economy and politics.
According to Wikipedia, the term ‘cobra effect’ stems from an anecdote set at the time of British rule of colonial India. The British government was concerned about the number of venomous cobra snakes. The government therefore offered a reward for every dead snake. Initially this was a successful strategy as large numbers of snakes were killed for the reward.
Eventually, however, Indians began to breed cobras for the income. When this was realized the reward was cancelled, but the cobra breeders set the snakes free and the wild cobras consequently multiplied. The apparent solution for the problem made the situation even worse.
A similar incident occurred in Hanoi under the French colonial rule. The colonial regime created a bounty program that paid a reward for each rat killed. To obtain the bounty, people would provide the severed rat tail.
Colonial officials, however, began noticing rats in Hanoi with no tails. The Vietnamese rat catchers would capture rats, lop off their tails, and then release them back into the sewers so that they could procreate and produce more rats, thereby increasing the rat catchers’ revenue.
Similarly, in Fort Benning, Georgia, a bounty was offered for pig tails, being a nuisance in the region. This led to people ‘bounty hunters’ feeding the existing population of pigs, therefore increasing their numbers. Net result: lots of pigs were killed, even more were born. (From Freakonomics: The Cobra Effect: A New Freakonomics Radio Podcast) Therefore, for Nigeria, a highly import-dependent ‘mono-product economy’, it will be suicidal to make the Naira a floating currency (whose exchange rate would almost entirely depend on market forces).
This would imply an accommodation of all foreign exchange demand pressure—through unrestrained importation. In consequence, this would lead to further crisis and deterioration in local production/manufacturing, especially given the subsisting poor business environment.
Poor infrastructure, weak judicial system, general insecurity and prevailing socio-political uncertainty. Usually, the primary argument for a floating exchange rate is that it allows monetary policies to be useful for other purposes.
Under fixed rates, monetary policy is committed to the single goal of maintaining exchange rate at its announced level. However, the exchange rate is only one of the many macroeconomic variables that monetary policy can influence.
During an extreme appreciation or depreciation, a central bank will normally intervene to stabilize the currency. Thus, the exchange rate regimes of floating currencies may more technically be known as a ‘managed float’.
A central bank might, for instance, allow a currency price to float freely between an upper and lower bound. Management by the central bank may take the form of buying or selling large lots in order to provide price support or resistance.
For Nigeria, the subsisting feature of the market where the Central Bank often intervenes to provide ‘price support’ under a ‘managed float ‘has largely bode well for the forex market and Naira value.
This, from all indications, has to a large extent, contained and curtailed Nigeria’s exposure to ‘financial fragility’ and high ‘liability dollarization’; thus, underscoring the rejection of a free floating Naira.
In the final analysis, foreign exchange rate management is not an exercise in political party manifesto crafting and packaging. Policy prescriptions must incorporate deep consideration of certain economic fundamentals and uniqueness of the polity.
• Okeke, a practising Economist and Consultant, wrote from Lagos