September 09 2012 / Bismarck J. Rewane
As a protagonist of general dynamic equilibrium, I have been an open critic of a monetary policy framework that is based on static analysis. In other words, I disagree with any answer to the question of whether the Naira is overvalued or undervalued. Many Nigerians are asking if the Naira is overvalued at N152/$. This question becomes more pertinent, when you consider the fact that the Naira lost 35.5% of its value in 2009 when it fell from N118 to N160/$. The answer to the question is that even if N152 is the fair value or real equilibrium exchange rate, it would have changed by the time I finish answering the question. What is really important in exchange rate management is not the rate or any rate, but it is the framework for and the process by which the rate is determined.
Since every Nigerian is a practicing economist in the day and dreaming economist at night (Whilst asleep), the question of the value of the Naira continues to dominate the national debate. This national discussion has made some multinational companies in fear and anticipation of a Naira devaluation to pay hefty sums as hedge premiums on forward forex positions. This shows that the value of the Naira is not only of domestic and indigenous interest but of great concern to international investors and portfolio managers. Therefore this article sits squarely in the centre of the national business and economic discourse. However, I will like to make a few comments which will help put this discussion in context and make my perspectives less controversial. The first is that historically two factor prices in the Nigerian economy have been heavily subsidized i.e. refined petroleum and the exchange rate value of the Naira. Two, is that the distributors (Banks & downstream companies) or transmission channels of these two products or factors have extracted substantial economic rent or supernormal profits for extended periods. In both cases, in times of shortage the market structure has been easily converted into price discriminating oligopolies. That is to say they buy in the official spot market and sell at a higher (true market) price in the parallel or black market. Round tripping is the lexicon for describing this creative way of taking advantage of the regulatory arbitrage.
In macroeconomics, subsidies are considered as reverse taxes. It means the government is using its revenue to subsidize citizens rather than collect taxes. In theory the government is responsible for provision of social and economic infrastructure and effective governance. Subsidies on the other hand distort the allocation of resources and leads to sub-optimality at the macro level and under performance in terms of productivity, output and investment. However, we live in the real world and the vested interests and beneficiaries of subsidies of which I am one, will not give up these goodies without a fight. Therefore, rather than eliminate subsidies, a realistic approach is to adopt a system which reduces subsidies. The system should recognize the parameters that define the boundaries of subsidy levels and adjust flexibly whenever those parameters change.
In the last month, and ever since the IMF article IV Consultation with Nigeria report was released, the question of the true value of the Naira became heightened and has taken a professional, political and atimes emotional dimension. The CBN governor as the defender of monetary policy in Nigeria, expectedly stood up to the defence of a strong Naira. What else could he have said or done? His personal view or intuitive feelings are not important at this time. What is critical is the position of Governor. He therefore had no choice but to stand firm in defence of the strong currency.
What are the facts?
Nigeria’s imports and payments in 2010 rose to $41bn from $30bn in 2009, and its exports also surged by $20bn to $79.4bn. Its trade balance was $38.4bn. Therefore apart from invisible payments, the Nigerian external account should be robust enough to support the Naira at an artificially determined rate of exchange. However there has been significant depletion in the External Reserves position by 38% since 2008.
The depletion of the External Reserves in spite of higher oil prices and strong production figures has become a source of national and international concern. There are a few obvious explanations for this hemorrhage of Reserves which has only recently stopped. There has been a consistent shift in the external payment structure of Nigeria in the last decade. The ratio of invisible payments to total payments has increased significantly. The invisible payments in the 1990’s were usually below 10% of the total import bill. In the last few years this figure has increased to approx This means that investment flows are increasing relative to trade flows. The difference between these two components is that investment flows are both exchange rate and interest rate sensitive. They are also a function of policy consistency. Investment flows are also allergic to uncertainty i.e. when there is a perception of uncertainty; investors become overly cautious and short the currency or market. Trade flows on the other hand are more inelastic in its reaction to some of these variables. Therefore, slowly but surely the Nigerian economy by becoming more integrated with the global economy has began to enjoy the benefits of an open market. On the other hand its markets and its currency has become more vulnerable to policy and market changes.
The IMF wades in
That is why the IMF and some other economists have called for a more strategic approach to exchange rate management in Nigeria. One can argue easily and justifiably that there is no reason to adjust the Naira downwards, when all that the country exports is oil. This commodity is priced in dollars and the quantity produced is inelastic to price because of OPEC quotas.
The question again therefore
1. Do we want the economy to remain this way or do we want a structural change
2. What happens if the price of oil declines to $50pb or $30pb
3. Most importantly, what happens if production is disrupted and falls to 500,000bpd.
Nigeria’s lucky Break (Tunisia, Egypt & Libya)
The exchange rate is a strategic tool for altering national behavior and consumption patterns and not only a tactical tool for satisfying the addictive propensity of Nigerians to import. Therefore the adoption of a flexible exchange rate mechanism which happily the CBN is likely or beginning to implement will help in making our non-oil exports cheaper and competitive. For example, ever since the Ivorian crisis, the world price of cocoa has surged by The Nigerian farmers have not been able to respond to this opportunity by increasing supply. The relatively overvalued exchange rate over time had made Nigerian cocoa more expensive relative to Ghanaian cocoa where the Cedi has been subject to a more flexible exchange rate mechanism.
Today Nigeria is a triple beneficiary of a surge in oil prices, increase in demand for LNG (courtesy of the nuclear reactor problems in Japan) and an increase in oil production. The export revenue picture is very robust and strong. There is the temptation to ignore the structural problems of the economy and continues the addiction of a import consumption binge, with a subsidized currency. However, this is the time to step back and take a more measured and strategic approach to exchange rate management. It is time to allow greater flexibility and reduce the frequency of intervention. The CBN happily also had commenced a forward market, which in the fullness of time should help smoothen out the exchange rate volatility, which in reality is not high in Nigeria.
Plough for the future or rest on your Oars
The 100 basis point increase in the MPR will go some way to bridging the gap between short term rates and the rate of inflation. This gap when it was widened in 2010 to its peak of 10%, was a recipe for internal financial imbalances and planted the seeds of capital flight. In 2010, for example no less that twelve countries including China, Vietnam and Brazil have tacitly adopted a strategy of competitive devaluation, to gain market share and catalyze their export-led recovery from the global economic crisis. The current steps adopted by the CBN, especially increasing interest rates and flexible exchange rates should be strengthened and accelerated, so that Nigeria can take advantage of the temporary (short term) surge in global oil prices and not live to regret this as another in a string of missed opportunities for the aspiring Giant of SSA.