Rescuing and defending the naira – Part 1

This contribution has been triggered by several considerations, including the following: the urging of a long-standing friend who thought that I had something worthwhile to contribute towards the ongoing efforts to stabilise the Naira exchange rate. Second, it is in memory of the late maverick, Egheomhanre Emmanuel Eyieyien, fondly called ‘Ëghes’, a great patriot and close associate. He died on Christmas Day last year, barely three days after publishing an article entitled Emefiele is Not the Problem, in which he lamented the travails of the Naira and, inter alia, advocated its devaluation as a realistic step towards restoring exchange rate stability in the country. Third, the timing has been informed by the recent phenomenal crash of the Naira in the free foreign exchange markets, with the Naira crossing what might be called the “bar lev line’’ of 400 Naira/Dollar.

Indeed, until that point, I was of the firm view that the devaluation of the Naira, as urged by many experts, including those of the IMF, was not, per se, the solution to our country’s foreign exchange crisis. Now, however, I firmly believe that Naira devaluation is inevitable and, indeed, mandatory. The real debate now should not be over whether or not the Naira should be devalued, but when and by how much and the elements of a strategic policy framework to make the emerging exchange rate regime stable and sustainable. It should also be clear that failure to act now will merely postpone the evil day and exacerbate the prevailing foreign exchange crisis.

In this connection, it is instructive that three past Governors of the Central Bank of Nigeria (CBN) have spoken out in favour of Naira devaluation. Furthermore, some oil-exporting countries, whose economies have been mired by the collapse of international oil prices, just like Nigeria, have been obliged to devalue their local currencies to ease the unrelenting pressure. For instance, the Russian rouble has officially devalued by over 50% since July 2014 while the Venezuelan Bolivar was officially devalued by 37% last February for the same reason. So, Nigeria is not alone on this devaluation issue and the authorities need to recognise that it is inevitable, and the earlier it is done the better for the country.

It should be recalled that our country faced a similar dire situation some 30 years ago. Then, in mid-1986, after conducting a long-drawn-out and heated national debate whether to devalue or not to devalue, the Military Government under General Ibrahim Babangida mustered the will to devalue the Naira. That was a matter of last resort and a key element in the nexus of economic reform measures introduced under the auspices of the Structural Adjustment Programme (SAP). Although the outcomes of the SAP were mixed, they were, on balance, highly beneficial. Thus, although the SAP is nominally dead, its spirit prevails till this day. Indeed, the SAP ideology of guided market capitalism has continued to inform and inspire policy-making and management under successive administrations ever since. The learning point here is that we had faced a similar situation before as we are in now and that there is a viable option available if the required political will could be summoned to do what is inevitable and unavoidable. We believe that this Government is not lacking in the courage to devalue if it is clear and persuaded that there is a compelling case for it.

After work on this contribution had virtually been concluded, news came that a currency swap deal had been signed between Nigeria and China. Details of the arrangement, in terms of coverage, transaction dynamics, documentation requirements and take-off, etc., have not yet been provided. Accordingly, only tentative comments on the deal are warranted here. In this connection, it is important to state that any arrangement such as the one referred to above, that seeks to relieve the prevailing pressure on our external reserves is welcome, provided the terms are right and the benefits are sustainable. Nevertheless, even with the most favourable terms available, the above initiative, which is analogous to a clearing-house arrangement, should be seen as merely complementary to, and not a substitute for, the existing payment arrangements for the settlement of international transactions. Indeed, the U.S. Dollar still looms large in our external transactions and payment obligations and this dominance will remain for long. Thus, the need to deal with the current exchange rate misalignment and the case made for it here remain valid.

The exchange rate, in general, reflects the underlying health or otherwise of an economy, particularly the economic fundamentals of foreign exchange demand and supply, interest and inflation rates, balance of payments position, and growth prospects. The psychology of the market (expectations and speculative activity) and socio-economic and political factors also exert a significant impact on the exchange rate. The following factors have, to varying degrees, been the driving forces behind the persistent depreciation of the Naira exchange rate since the last quarter of 2014:
The collapse of oil prices which started in June 2014, resulting in the sharp decline in petrodollar receipts and depletion of our external reserves.

Gross inadequacy of supply relative to demand for foreign exchange. This has been exacerbated by the removal of 41 items from the list of imports eligible for foreign exchange sourcing from the official market, with those affected being left with no choice but resort to the bureaux de change and parallel markets to meet their otherwise legitimate needs.

The increasing incidence of hedging and speculative transactions which have swollen an already bloated demand for foreign exchange.

With the persistent Naira weakness and the spectre of imminent Naira devaluation, there has been increased incentive to hold foreign currency rather than the Naira. Thus, while investors and other potential suppliers of foreign exchange withhold their funds in order to make more profits (gains) later, foreign exchange users are desperate to buy now before the Naira depreciates further or is devalued. This “Naira pessimism” or preference for dollars is a major factor in the continued slide of the Naira in the free segments of the foreign exchange market in recent times.

Hence, increased “Naira pessimism”, severe supply constraints in the face of unrelenting heavy demand, the ensuing huge and increasing backlog of unsettled past-due import bills and invisible trade transactions, a large and widening parallel market premium, etc., have all engendered increased uneasiness about Naira exchange rate stability and the well-founded view that the prevailing official rate cannot be sustained for too long, without depleting the external reserves. Consequently, there has been a huge speculative attack on the reserves. Furthermore, the lingering insurgency in the North East and socio-political unrest and violent crimes in some parts of the country, coupled with weak near-term growth prospects, have all induced increased capital flight, thereby exacerbating the woes of the Naira.

In making a case for rescuing and defending the Naira, we should stress the critical role of the exchange rate in the economy. For a country, such as Nigeria, with an open economy where foreign trade accounts for a significant proportion of the Gross Domestic Product, the exchange rate links the domestic economy with the outside world. Furthermore, it is the most important price which influences most other prices and, indeed, the general level of prices. Consequently, exchange rate levels and movements have far-reaching implications for inflation, price incentives, fiscal viability, export-competitiveness, efficiency in resource allocation, international confidence and balance of payments equilibrium.

•To be continued

•Odozi, Financial Consultant and company Director, is former Deputy Governor of the Central Bank.