On the Travails of the Naira
By Kingsley Moghalu
We must begin with the end in mind: a stable (but not immovable) currency, the exchange rate of which broadly reflects both an approximation of its true market value as well as Nigeria’s broader economic interests. Which raises the question: between a fully flexible exchange rate (full float) and a peg or a managed float of the currency, where does Nigeria’s national interest lie? Answer: whichever will make Nigeria’s economy more efficient and encourages production.
Before we proceed, let’s be clear about two things. First, with extremely few exceptions such as Canada and the United States, the central banks of the advanced industrial economies that mainly use flexible exchange rate policies manage their currencies through occasional interventions in financial markets to stabilise those currencies. They also carry out occasional competitive devaluations, in this case because they are productive, export-oriented economies.
Second, the naira’s (and our economy’s) woes were exacerbated by the Central Bank of Nigeria’s prolonged pegging of the naira to a fixed, artificial exchange rate of 199 naira to the dollar, when all the rational economic factors that previously sustained this exchange rate had collapsed, rendering the peg unsustainable. This contributed to black market devaluation-fueled inflation, and unemployment, as manufacturers could not access forex at the official rate and output productivity dropped sharply. We are now in a recession.
But that is water under the bridge. With its policy decision in May 2016 to move to a fully flexible exchange rate, the CBN capitulated to reality, heralding a more rational policy direction that significantly addressed widely held economic and market concerns. Nonetheless, the naira is not out of the woods. Forex liquidity constraints persist because foreign investors remain on the sidelines, and the gap between the parallel and interbank markets remains wide. Typical of our national patterns, we are seeking “quick fixes” to the currency’s malaise without fully assessing the interlocking challenges that confront it. The naira’s problems are symptoms of deeper economic, governance and institutional malfunctions. Without confronting these problems, our quest for “solutions” may be skirting the real issues. There are eight specific challenges we must address.
The fundamental problem is the absence of a productive economy. Two most important aspects of this challenge are electric power to support the growth of a productive, manufacturing industrial economy, on the one hand, and removing the obstacles international trade policy places on our industrialization prospects by stymying the viability of our local industries, on the other. Cheaper foreign manufactures have easy access to our markets. Conversely, our own manufactures are unable to access foreign markets because value-added goods from our country are blocked by high tariffs imposed by our trading partners (but our raw materials for their own industries are welcome and attract low tariffs!). Quality standardization concerns also dog Nigerian exports.
What is the solution? We need to shift from the never-ending quicksand of gas-based power to a focus on renewable (solar, wind, geothermal and biomass) energy for household consumption and hydro and coal-based power for industrial production. And we need to impose “smart” protectionism through high tariffs that can be justified under the rules of the World Trade Organization, on imports from foreign markets that are snuffing out our local industries in several sectors such as textiles. Absent these two policy approaches, we are treading water. If we combine these policies with a flexible exchange rate policy that makes export-oriented value-added products more profitable than importation, the naira will ultimately realize a beneficial effect from its inevitable devaluation. This is the answer to President Muhammadu’s Buhari’s (and many other Nigerians’) understandable concern about the absence of any benefits from prior devaluations. Those devaluations, though involuntary because of external shocks to which the nature of our economy exposes us, only imported inflation. That reality was not offset by any benefit because of there were no complementary policy actions in other economic sectors outside of finance.
The second problem is the absence of a well-articulated, medium to longer term economic strategy to take us forward in light of new realities. The 2016 budget, or the budget for any particular year, cannot be such a strategic plan. This kind of strategy, which needs to be multi-year and have clear, interlinked components with timelines and accountabilities, would be an ideal backdrop against which the CBN can situate medium term monetary policy thinking.
Third, and related to this, is the evident absence of a strategic linkage between fiscal policy, which is the role of the Ministries of Finance and Planning/Budget, and monetary policy which is the central bank’s domain. A central bank can contribute to national economic policy, but does not on its own make such policy in the holistic sense. Rather, monetary policy complements a robust fiscal policy by maintaining monetary and price stability. This role can be a defensive one where fiscal policy is deficient. For instance, a central bank may raise interest rates if it believes there is excessive, politically inspired “fiscal dominance” that can trigger inflationary trends. The absence of a solid, comprehensive fiscal strategy is one reason why the CBN is overburdened with quasi-fiscal functions and ever-increasing development finance interventions.
Fourth, the CBN itself needs to develop a more strategic approach to monetary policy and financial stability, even within the limitations of the absence of a larger national economic blueprint. The Bank’s responses to the challenges of the past two years have appeared short-term, reactive, episodic and experimental, and without a larger plan of action that is evident to all Nigerians, the financial markets, and foreign investors.
Fifth, adequate understanding of basic economic principles that should inform public policy is lacking in our country’s populace. Populism often reigns as a result, as emotional passions take hold and get translated into the “national interest” or that of “the masses”. Zimbabwe and Venezuela offer sobering examples of this kind of approach to economic problems. Meanwhile, other oil and commodity producers have made (certainly painful) adjustments to their currencies in response to changed fundamentals in the past two years. Even the great British pound sterling sharply lost value as a consequence of Brexit.
Sixth, the modern world and the fickleness of its financial markets requires highly adept communication by central banks. The CBN cannot escape the need to communicate effectively to Nigerians the fundamentals of the naira’s travails, and its plan to meet evolving challenges. The new forex policy is a good basis to build on.
Seventh, the institutional and policy autonomy of the CBN has increasingly become compromised. It is unclear whether these challenges have been self-inflicted or externally induced, or both. There are very sensible reasons why the laws of Nigeria provide for the independence of the CBN in the exercise of its functions, as in the case with the central banks of many nations that are making economic progress. Recent negative trends in the Nigerian economy have borne out the foresight in this principle. It is the duty of a central bank to tell a political leader not necessarily what he or she wants to hear, but rather what the leader needs to know. This is what the national interest and professionalism require. It also is a foundational basis for a serious response to economic crisis.
The CBN should educate Nigeria’s political leadership class, for example and especially in connection with devaluations of the naira since 1985, on the global implications of the evolution of the international monetary system since 1914. Fixed exchange rates worked well only when the whole world used them. Currencies were pegged to gold from 1870 up to 1914, and then to the dollar which itself was backed by gold, after 1945. This was abandoned in 1971 when the US dollar became unable to maintain its value of $35 for one ounce of gold. Countries progressively adopted floating exchange rate regimes of various shades and complexities, and fixed exchange rates were completely abandoned by most countries in 1985. Nigeria’s economy was of course not left untouched by this evolution.
Eighth, as the International Monetary Fund noted in a recent report, investor confidence in the Nigerian economy is low. All the seven factors above have contributed to this reality.
Today, we know that fixed exchange rates, though they may appear to provide an appearance of stability, are largely inappropriate for the nature of the contemporary world economy, and tend to cause currency crises as we saw with Mexico in 1995 and the Asian and Russian currency crises of 1997. Flexible exchange rates, on the other hand, can also engender instability, especially for developing countries. This is why many countries have a “managed float” of some sort or the other. That is therefore not abnormal. We have done this for many years, but the circumstances today differ fundamentally from yesterday’s. First, therefore, let us find the naira’s true value and narrow the gap between the interbank and parallel market. Then, the CBN can intervene in the markets as may be necessary, but from an evidence-based standpoint.
The economy will be the loser otherwise, as dollar liquidity shortages continue, driving the naira ever downward and foreclosing the prospects of its recovery in the absence of better news for oil. The economic precept that no central bank can have at the same time a fixed exchange rate, free movement of capital, and an independent monetary policy (a choice of two of these must be made, while markets determine the third) still holds sway. Floating exchange rates, despite their risks (which can be managed) serve the very useful function of letting monetary policy serve purposes beyond certitude. In the case of Nigeria, it can play the key roles of attracting much needed forex liquidity in the markets, and nudge the economy towards a more productive state when combined with effective trade and industrial policy.
• Prof. Moghalu is the President of Sogato Strategies LLC, and was a Deputy Governor of the Central Bank of Nigeria from 2009-2014.