Naira and Tenge: The limits of correlation

Forex
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Wednesday, August 26, 2015 5:14 PM

The speculators are at it again! An army of foreign portfolio investors, financial analysts, and financial media is determined to ensure further capitulation of the Central Bank of Nigeria (CBN) on precipitous devaluation of the naira. Remember The Economist’s toothpick article of a couple of months ago. A vast armada of financial analysts and commentators including from ratings agency, financial media, foreign and domestic financial institutions have also been putting pressures and speculating on naira’s devaluation.

The latest episode in the relentless attempts by the short-term foreign exchange speculators to force the hands of the CBN on the naira came on Thursday, 20th August, 2015 with the 22% plunge in Kazakhstan’s tenge, the currency of this central Asian country and a former part of the Soviet Union. Tenge’s devaluation followed from the decision to allow the currency to trade freely as a reaction to weaknesses in China’s remminbi and Russian ruble, its two major trading partners, declining oil prices, and looming increase in U.S. interest rates.

In the same week, a chart showing the correlation between the tenge and the naira has been published showing the currencies of the two oil exporters moving in lockstep together since 2008. RenCap, an investment banking firm has also noted that in the global financial crisis of 2008, “the two currencies were devalued within a week of each other and by a similar magnitude, both triggered by a fall in the oil price. Following the recent devaluation of the tenge, the valuation gap between the tenge and the naira has diverged considerably. As a result, the naira needs to be devalued by as much as 20%.”

An understanding of the two economies suggests that there are limits to using correlation between the two currencies to elevating naira’s devaluation as the key solution to what plagues our country. Nigeria’s economic challenges are rooted in wrong incentives, weak institutions, fiscal leakages, and poor infrastructure contributing to high cost, low productivity and competitiveness.

Devaluation works by altering relative prices and provide incentives to shift resources towards non-exports and away from imports. But wait a minute. According to IMF, in 2014, both countries exports were about $90 billion, but Kazakh export to GDP ratio is 40% compared to 17% in Nigeria. While non-oil exports constitute 4% of Nigeria’s exports, they are 40% for Kazakhstan. Oil exports are 96% of our exports relative to 40% of the comparator.

How about imports?  Nigeria’s oil imports to total imports ratio is 25%, quadrupling that of Kazakhstan at 6% with non-oil imports at 94% of total imports. As a result, devaluation, at least in the short time, is likely to stimulate non-oil exports and depress non-oil imports better in Kazakhstan than in Nigeria.

Low non-oil revenue mobilization and fiscal leakages and mismanagement are manifestations of our weak institutions.  Total revenue and non-oil revenue to GDP ratios in Kazakhstan are two and a half times those of Nigeria which are 10% and 4.5% respectively. Non-oil revenue as a ratio of GDP is five times that of Nigeria.

Another round of naira devaluation will pass-through and feed into inflationary expectations with Nigeria’s inflation and interest rates of 9.2% and 13%  already more than twice those in Kazakhstan. Unemployment rate is 5% in Kazakhstan, much lower than in Nigeria. The Government of Kazakhstan has a history of cushioning the effects of the devaluation with countercyclical fiscal stimulus plan. In 2008, a $10 billion fund was targeted at such goal. In 2014, the negative impact of a new round of devaluation on real incomes was mitigated by a 10% increases in public wages and social benefits.

A $5.4 billion was also used to support diversification and industrialization plan. Nigeria lags behind Kazakhstan on key measures of competitiveness, ranking 127 and 50 respectively, while the ease of doing business is rated 77 and 170 respectively. Competitiveness has been hampered by poor infrastructure which raises cost to firms while lowering labour productivity.

A more flexible exchange rate within the framework of a managed floating regime remains essential for Nigeria. Naira’s devaluation in tandem with tenge with free floating, however, is not the panacea for addressing the country’s competitiveness, fiscal, structural, institutional, and infrastructural challenges. There is a limit to naira and tenge correlation.

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