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Towards a realistic exchange rate for the naira

By Theophilus Kagbare   |   03 April 2017   |   2:45 am

Why has a realistic value of the naira remained elusive since 1986 when the Second-tier Foreign Exchange Market was introduced? Why has the gains of industrialisation not been realised?

Simple and straight forward: it is because we are still hung on the ‘Udoji Award’ mania, the haste to waste away windfall whenever the price of crude oil increases rather than invest in the capacity of the economy. That is what is going on now: precious foreign exchange being used to buy Basic Travel Allowance, Pilgrims Travel Allowance, school fees, instead of being allocated to producers; when governors insist on all foreign earnings to be allocated, just like it happened in 1990 with the Gulf War windfall, practically rolled back and derailed the Structural Adjustment Programme. We have not truly allowed the market to work, because politics always rides roughshod over economics, because we choose instant gratification over sacrifice; because we choose consumption over production.

The question of what is a realistic exchange rate cannot be spoken of in isolation of the potential of the economy, overall economic management objectives as well as the extant economic condition. While no country leaves the determination of its exchange rate completely to the vagaries of the market, every responsible economic management seeks to have a competitively determined rate and manages same within the context of an overarching development strategy. The journey to arrive at a realistic exchange rate for the naira started in 1986, when it was exposed to the elements of the market with the Second-tier Foreign Exchange Market (SFEM). It has been a managed process, through the merged Foreign Market (FEM), the Autonomous Foreign Exchange Market (AFEM)and the Inter-bank Foreign Market (IFEM), the naira has declined steadily overtime from N22 to the dollar through N85, to N150 to the present N300 plus.

All through this process, there has been a haste to artificially prop up the value of the naira, even when the foreign exchange earning was healthy and we were not under serious pressure.

The gains of industrialisation were never realised, because the plan was never followed through. Devaluation cannot be in isolation, it is not a magic wand, it is necessary but by no means sufficient in and of itself. It is but a part of overall integrated plan – as may be spelt out an industrial policy- to effect the necessary changes in the structure of the economy; with requisite leadership and political will to see it through. That has seriously been lacking, through successive regimes. Devaluation of the naira in 1986 was inevitable, and it was a good thing, though the question of whether it could have been better managed is another matter. But devaluation is not by itself sufficient on its own.

If you want to strengthen the value of the naira, strengthen the economy. Invest in infrastructure to expand its production possibilities. We fail to do that when we are in position to do so, when crude oil prices rise, and when crude prices fall, as they are bound to, we waste what little foreign reserve there is in futile fire-fighting

Where there is problem of run-away inflation combined with high unemployment, highlighted by the tumbling of the naira against the dollar, we face a very serious situation calling attention to the structural fundamentals of the economy. These are the issues of power, transportation and general poor infrastructure that undermine economic activity, a stunted industrial sector and minimal production with high consumption, which calls for concerted leadership, beyond propping up the value of the naira.
Is a strong Naira good for the economy?

No. Not if we want to encourage local production of manufactures both for exports and to substitute for imports. A strong naira makes imports cheap making locally made products relatively expensive, encouraging consumption of foreign made goods. Thus jobs are exported. Local producers suffer. A strong naira makes Nigerian exports less competitive abroad, thus the much desired expansion and diversification of the economy is not furthered with a strong naira. The only thing a strong naira does is to encourage consumption of imports. In a liberalised market where imports are freely allowed in, the only protection local producers enjoy derives from a low exchange rate.

Locally produced Abakaliki and Ofada rice varieties practically disappeared with influx of cheap foreign imports from Thailand and elsewhere on the back of a high naira exchange rate. That is a whole value chain with multiplier effect with employment opportunities shut down. The fall in the naira has already seen the emergence of LAKE rice – from the collaboration of the Lagos and Kebbi state governments, opening a window of employment opportunities while conserving foreign exchange. With a low exchange rate, it made economic sense for the Federal Government to procure 50,000 Aba-made boots for the police, instead of buying from abroad, and it did. That will strengthen the capacity of the producers to make even better quality footwear. That should embolden them to think of meeting the footwear needs of the populace.

We cannot expect to grow our local manufacturing capacity, quality and productivity without patronising them, can we? With a strong exchange rate it does not make sense to buy Made In Nigeria. Instead we’ll travel abroad for vacation without even thinking of places like Obudu Cattle Ranch; it will be cheaper to attend schools abroad and even do regular training abroad. All of which translates to export of jobs, waste of scarce foreign currency that should be invested in local infrastructure, for example. With a strong naira, it made more sense for a foreign investor to set up a trading post to import and distribute rather than establish a factory here.

Also a strong exchange rate discourages and reduces the impact of remittances – a vital sustaining factor of the Nigerian economy in terms of production and purchasing power.

What about inflation, given that the economy is import dependent?
Yes, we are determined to remain import dependent as revealed by our choices and actions, though we state the opposite. Our idiosyncratic notion of the value of the naira, in the determination, over the course of the years, not to invest in real assets to strengthen the economic base, is palpable.

The economy is import dependent, but you certainly don’t want to keep it that way. We must not surrender to that situation. That is the essence of leadership. A high exchange rate perpetuates a consumerist culture, discourages entrepreneurship and local production. Local producers must be made to source raw materials locally as much as possible not by appealing to their intentions but the economic conditions must motivate them to do so. With a strong exchange rate, they are not so encouraged. With a strong naira, even where theyare able to import raw materials and other inputs relatively cheaper, they are faced with uphill competition against cheaper imports from superior factories abroad.

However, local producers deserve special attention, with an industrial policy. An industrial policy is what is needed to address the needs of local producers’ need for vital imports such as machinery and spare parts. Importation of vital machines, spare parts and vital raw materials may be facilitated through the Nigeria Export-Import Bank, through a special scheme arrangement, taking into consideration the export potential and import substitution of the product, for example.We can decide to spend all our energies on downside of a weakened naira or exploit opportunities it presents. A weak naira strengthens our export potential, to earn more from export. Let’s expand our exports.

What is therealistic exchange rate for the naira?
Now, we must realise that the exchange rate of any currency is a composite index or indicator – it summarises a lot of vital information about its economy, such as productivity, international competitiveness, industrial capacity, business friendliness, cost of doing business, balance of payment, foreign reserves, etc.

A currency is said to be over-valued or under-valued vis-à-vis the underlying economy as reflected in the factors highlighted. Thus, an exchange rate of N1 to USD suggests the Nigerian economy is as productive as the economy of the United States of America, for example. That is lie, of course. That is a distortion of the real situation that may have been brought about by high foreign exchange reserves – a fleeting measure. If those reserves are as a result of real production taking place in the economy, i.e. accumulated from sustainable export of value creation in diverse manufactures as opposed to export of primary commodities, subject to unforeseeable shocks not within your control, then you should wait with bated breaths; the day of reckoning is around the corner.

We may decide to simply fix the exchange rate by legislation or seek to determine it by calculation to arrive at a rate that equates a basket of goods in two countries – the purchasing power parity (PPP) exchange rate. In both cases, we take leave of reality, of those telling factors – until the judgment day. Alternatively, we may seek to arrive at a competitive exchange rate by subjecting it to the dynamics of the market- in which case all the above composite factors will come to play, giving some view of the real, underlying economy.

For a developing economy, economic theory agrees with economic history that a low exchange or under-valued rate is an integral part of any overall economic development strategy. The tiger economic growth rate of Korea, Malaysia, Hong Kong, which saw those economies transformed within two decades to developed countries status, were achieved at the back of deliberately under-valued rates. If we want to follow their example, to evolve an export driven economy, as we do avow, a low exchange rate comes with the territory. These countries reformed with the end in mind, refusing to swallow market fundamentalism hook, line, and sinker; each of those countries, like Japan before them and China after them, had an industrial policy in place, purposely accelerate productivity and graduate the economic profile through increasingly value creating stages.

It is for the same reason that Donald Trump rightly accuses China for currency manipulation: China deliberately keeps the yuan exchange rate under-valued as the linchpin of its economic development strategy, that has made it set to overtake the United States as the world’s biggest economy in the not-so-distant future.


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