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Devaluation, productivity and recession

By Temitope Oshikoya
13 June 2016   |   3:10 am
As the irrational exuberance and euphoria following the announcement to move towards a flexible exchange rate regime subside, we can now focus on the key fundamental ...


As the irrational exuberance and euphoria following the announcement to move towards a flexible exchange rate regime subside, we can now focus on the key fundamental productivity issues confronting Nigeria’s economy. We do this by examining global and Nigeria’s economic data, which enable us to separate empirical evidence and analysis from sensational polemics and rhetoric.

Devaluation and Recession in Oil Exporting Countries
First, there is no discernible empirical evidence to suggest that operating a free floating market exchange rate or a rigid fixed exchange rate would have prevented a recession in oil exporting countries. The following countries have not depreciated their exchange rates by much and some even maintained fixed exchange rates, but still have negative GDP growth rates (in bracket) according to trading economics: Kuwait (-1.6%), South Sudan (-5.3%), Libya (-6.0%), Oman (-14.1%), and Equatorial Guinea (-10.6%).

Russia (-1.2%), Brazil (-5.4%), Venezuela (-7.1%), Kazakhstan (-0.2%), Azerbaijan (-3.5%), and Kyrgyzstan (-4.9%) have significantly depreciated their currencies, but still have negative GDP growth rates year on year. With the Russian economy declining by 3.7% in 2015, Sergei Guriev, an economic advisor to former President of Russia noted on CNBC that “the Russian economy is still very dependent on oil prices. Even though Russia’s central bank has moved to a floating-exchange-rate framework, Russia could not avoid the recession, given the 50-percent drop in oil prices. The ruble depreciation buffered the shock but could not have shielded the economy completely.”

Some countries with large oil savings relative to GDP and who pursued counter-cyclical policies have managed so far to avoid a recession irrespective of their exchange rates regime: Norway (0.7%) with a free floating exchange rate; Saudi Arabia (3.6%) with fixed exchange rate; and Algeria (3.9%) with managed floating exchange rate. Their oil savings are more than 50% of their GDP, while that of Nigeria are less than 1% of GDP.

Nigeria had devalued the naira twice in this oil down cycle, but has maintained an official exchange rate since the first half of 2015. Its GDP growth rate year on year of -0.4% in first quarter of 2016, was compounded by the triple calamity of falling oil prices, fuel and electricity shortages, with the latter plunging by two-thirds (65%) quarter on quarter in first quarter of 2016 according to NBS. We all know the critical importance of this factor of production facing serious structural issues on other sectors, especially manufacturing.

Nigeria’s path to recession is paved with the calamitous decline of oil prices, recent drop in oil production by more than a quarter, the lack of oil savings buffer and appropriate counter cyclical policies, as well as challenges of structural productivity. Oil prices had declined by more than 70% prices from about $115 in June 2014 to $27 in February 2016. Since 1973, this reverse oil shock is matched only twice: in the 1980s, when oil prices fell below US$10; and in 2008-2009, when it fell from around US$147 to about US$40, but proved short-lived. The real question to ask is why is Nigeria’s economy so susceptible to the vicissitudes of oil commodity boom and bust cycle in spite of the devaluation of the naira from less than N1 to N350 to the dollar over the past three decades?

Second, will a further devaluation alone by itself address the recession and current account gap? The IMF estimates that Nigeria faces a current account gap of 1.5 percent to 2 percent of GDP and a real exchange rate gap of about 15-20 percent. According to the IMF, over half of the gaps could have been closed if other macroeconomic policies, other than exchange rate adjustment, had been at their desirable settings. “This provides a measure of the component of the estimated overvaluation that would ideally be addressed by other policy levers, leaving the remainder to be addressed through real exchange rate adjustment, or, in the medium term, structural policies to improve competitiveness. These dynamics are illustrated by the inability of the 2014-15 devaluations to significantly alter the real effective exchange rate, which points to the need for a package of supportive macroeconomic policies to restore external sustainability.”

Productivity and Credible Comprehensive Policy Package
Third, the real issue to address is long-term productivity of the Nigerian economy. The exchange rate is ultimately the relative price of an economy’s tradable sector to its non-tradeable sectors, which in turn is determined by relative labour productivity in those sectors and total factor productivity. In this context, why is it that the sectors that contribute 90% of the GDP generate insignificant export earnings and revenue? The IMF 2016 Article 4 Consultation Report notes that Nigeria’s exports of non-oil goods and services amounted to just 1.2 percent of GDP in 2015, and have remained in a narrow range below 2 percent of GDP over the past decade. Performance has lagged that of other African oil exporters, who in the last five years have experienced some gains in their world market share and increases in the ratio of non-oil exports to GDP.

In an article on “Towards a social democratic welfare state,” in The Guardian in June 2015, we made a case for a comprehensive policy package. We noted that with the high rate of unemployment and jobless growth, it is safe to state that the economy is already below its potential output; and added to it are the potential recessionary gaps from realized and emerging shocks. We noted then that pro-cyclical fiscal and monetary measures should be replaced with counter-cyclical measures, as the former would worsen the unemployment situation. We also clearly observed that “Removing oil subsidy remains the elephant in the room, but can be achieved given the current low oil prices and the public trust of the new administration on integrity issues.”

This writer in another article in Business Day dated July 15, 2015, on The Economist and the Central Bank of Nigeria, had essentially proposed that the best policy option is for the Central Bank of Nigeria to pursue a combination of an intermediate regime for exchange rate, monetary policy, and partial capital controls. The objective of an intermediate regime is to avoid the two polar extremes of fixed and free floating while enhancing the effectiveness of other policies. It was noted several studies have shown that countries that do not rely only on a single policy instrument such as devaluation, but implemented a comprehensive policy package have been the most successful in dealing with external shocks and enhancing their competitiveness.  “For long-term productivity and competitiveness, what Nigeria needs is a comprehensive policy package of monetary, exchange rate, trade, fiscal, institutional and structural reforms.”

We are pleased to note that global market-oriented media and institutions such as Bloomberg, Financial Times and the IMF have now been echoing this same message. Financial Times in its editorial on Nigeria observes that “devaluation is not a silver bullet.” In particular, The IMF notes that “In the case of Nigeria, greater exchange rate flexibility cannot on its own increase non-oil exports and thereby “cushion” the size of import contraction as high costs of production (due to domestic supply-side bottlenecks) need to be addressed. Greater flexibility may stimulate non-oil exports to some extent, but the immediate impact would be limited by the narrow non-oil export base. Structural reforms to improve productivity and diversify the export base would have a greater impact.”

Unfortunately, the ideologues within Nigeria have been so fixated on their ideological perspectives on devaluation that the message of productivity challenge is lost on them. It is about time that they have a balanced approach to economic governance.

• Dr. Oshikoya, an economist and a chartered banker, is the CEO of Nextnomics,

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