The Economist and the Central Bank - In Plain English


Monday, July 13, 2015 2.35 PM / By Temitope Oshikoya**

The Economist is a well respected international magazine both for its substance and style. It provides with clarity authoritative insight and opinion on economic issues that favour free trade and free market.  The Economist, however, can be very cynical and condescending especially when it puts on its pontificating hat. One vivid example was in May 2000, when on its cover page, it dubbed Africa as “The Hopeless Continent,” characterized by corruption, crime, and civil war leading to despair, destruction and death. A decade later, in December 2011, The Economist, in a patronizing manner and as if trying to remorsefully purge its soul, has a front cover page titled “The Hopeful Continent: Africa Rising.” It was noted that since The Economist regrettably labeled Africa ‘the hopeless continent’ a decade ago, a profound change has taken hold.”

The Economist’s recent article on “Toothpick Alert,” will no doubt count as one of the Magazine’s cynical and condescending moments. While the article favours market determined exchange rates for the Naira, it portrays the Governor of the Central Bank of Nigeria (CBN) as an economic illiterate, who should be sacked!  The CBN has actually played into the hands of The Economist and that of speculative foreign portfolio investors. In an article titled “Central Bank’s capitulation” in The Guardian of December 2014, this writer has noted that the CBN is capitulating to financial dominance by foreign portfolio investors and the financial markets.


Specifically, it was noted that “the insatiable appetite of the markets and foreign portfolio investors for higher MPR and further exchange rate depreciation will be difficult not to satisfy and meet.  The MPC threw itself under the bus to be crushed by the financial markets going forward.”


Putting the issues in perspective, the halving of oil prices in the past one year meant that Nigeria’s terms of trade has declined significantly and any given volume of exports pays for a smaller volume of imports. In the face of fiscal leakages and mismanagement, and lower foreign reserves, the burden of adjustment fell upon monetary and exchange rate policy. However, the CBN keeps churning out circulars upon circulars that appear to be uncoordinated and an ad-hoc monetary policy reaction, suggesting panicky measures instead of a well-thought out comprehensive package of policy mix and direction based on sound economic principles. As a result, the Governor of the CBN appears to the foreign portfolio investors and The Economist as a schizophrenic rabbit that does not know where to turn to after finding itself in the middle of the road at night facing a full-light beaming truck.


The CBN’s initial attempt to impose capital controls has been constrained by J.P Morgan’s threat of ejecting Nigeria from its bond index. But the CBN puts itself between the hard rock and the deep sea as it has always been beholden to speculative foreign portfolio investors.


In particular, over the past five years, CBN policies have been characterized by incentives for short-term portfolio capital inflows with persistent high interest rates, with relatively low controls on short-term capital movements and heavy intervention in the foreign exchange market.


The CBN has also tried to increase monetary policy rate to 13% to placate foreign portfolio investors. Nigeria’s nominal policy rate, real interest rates, and bond yields remain some of the highest among its BRICS and MINT comparators. Yet, foreign portfolio investors are not rushing back to Nigeria in droves.


The CBN then allowed the Naira to depreciate officially by 22%. Economics principles suggest that devaluation has the advantage of efficiency and administrative simplicity as an across-the board expenditure-switching policy.


However, for devaluation to be effective, it must achieve real exchange rate depreciation, and not simply nominal exchange rate depreciation. With a mono-culture export and heavily import-dependent economy, achieving this condition will be a tall order in the short-run. While we export crude oil, raw cocoa and woods without value addition, we import refined oil products, processed chocolate and beverages, furniture and toothpicks; all at a huge cost to foreign reserves. 


Devaluation is also inflationary and a further sharp depreciation of the currency with rapid price pass-through will fuel future inflationary pressure and expectations. Further, devaluation as an across the board policy often ignore income distribution consequences, especially on the poor.


Following initial attempts to enforce capital controls, increase monetary policy rate, and depreciate the currency, the CBN has now embarked on exchange controls on current transaction by restricting importers of 41 items from sourcing foreign exchange from the official inter-bank market, BDC, and export proceeds.  Although the CBN maintains that only 1% of transactions go through the parallel market, it did not initially provide an estimate of the foreign exchange needs of the 41 import items; estimates that now range between $12 billion to $16 billion.


In essence, the exchange controls on the selected items effectively encourage dual exchange rate regimes to increase the prices of these targeted imports by devaluing the exchange rate applicable to those transactions; which explains the widening gap between the parallel and interbank market of about $40.


The second argument often used to support exchange controls on selected imports is the protection of infant industries. It will be good to know the effective rate of protection being provided with this policy to targeted sectors and industries. While attempts to protect local manufacturers should be welcome, some of the items include intermediate goods required for value addition in manufacturing processing.


The third argument for exchange controls is to impose it on luxury goods consumed by the wealthy, while insulating the domestic consumption and production by vulnerable people in order to improve their welfare and income distribution. How does the oil imports and subsidy, which account for a fifth of foreign exchange consumption, fit into this picture? How many low-income Nigerians send their children and wards to schools and colleges abroad or embark on expensive medical tourism outside the country? Why were these items not included in the list provided by CBN?

It is also interesting to note that some of our rich oligarchs that have benefitted tremendously from lack of domestic level-playing field and previous regimes of imports restrictions and that liberally hire expatriates contributing to draining foreign reserves, have been some of the cheer leaders speaking about exporting jobs and importing poverty.

Is the CBN pandering to powerful financial interests and a well-connected clique with sizeable control of wealth in Nigeria in the face of pervasive inequality of economic opportunities, income and wealth? That will turn CBN’s argument about equity, income distribution, and protection of infant industry considerations upside down, while entities such as The Economist attack the CBN on grounds of free trade, efficiency, and effectiveness.

The Economist should, however, be reminded of the words of wisdom of Rudiger Dornbusch, the late MIT economist who was a leading guru on exchange rate management. Writing on balance of payment issues in a small open economy, he noted that “Economics does not require that efficient resource allocation take precedence over social considerations… One of the usefulness of economics is that it helps us understand which tools can be used for what purpose, what their main effect is, and what the side effects are… In economics, as in other fields, there is often more than one way to skin a cat.”
The Economist should also be reminded that Aizenman, et. al (2012), a leading authority on monetary and international economics, has noted that countries occupying the middle ground of monetary policy trilemma, with flexible managed exchange rates, intermediate levels of monetary policy and widespread, but incomplete, capital account transactions, experienced lower output volatility than other countries in the past two decades. In this context, Malaysia successfully managed shocks to its economy during the Asian financial crisis with such a pragmatic approach.

Several other studies have also 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 and structural reforms.

**Dr. Temitope Oshikoya, an economist is the CEO of Nextnomics Advisory based in Lagos.

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