Achieving exchange rate stability requires developed domestic production structures, a diversified economy and a conducive macroeconomic environment, writes Obinna Chima
The recent precipitous depreciation of the naira against the dollar on the parallel market has been a concern to stakeholders.
Despite certain measures undertaken by the Central Bank of Nigeria (CBN) to strengthen the naira, such as stopping the sale of foreign exchange (forex) to Bureau De Change (BDC) operators, the naira has remained volatile on the parallel market, trading at around N570 to a dollar.
While the development has shaken public confidence, some analysts believe the lacklustre performance displayed by the naira on the parallel market reflects the symptom of broader economic problems such as the country’s high appetite for imports, lack of a trade policy, among others.
Indeed, Nigeria’s heavy import dependence is majorly responsible for the high forex outflow and the perennial weakness suffered by the naira. This explains why the exchange rate is often the bellwether for Nigeria’s economic health, and why there is a swift pass-through of exchange rate movements to inflation.
A major chunk of Nigeria’s forex outflows are due to invisibles, which refers to services. These include inter- national payments for services as well as movement of money merely for transfer payments. Also, the country’s infrastructure deficit explains the huge level of importation of processed and final goods.
The main sources of forex exchange supply to a country include foreign currency receipts from exports of goods and services, monetary gifts and inflows of capital from abroad such as loans and investments. It is from these earnings that the demand for forex is met to spend on foreign imports of goods and services (including foreign travel, education medical treatment abroad), monetary gifts to foreigners, and loans and investments abroad. What is the implication of this?
It is that for Nigeria whose currency is not convertible or serve as international currency, she must necessarily earn foreign exchange through high productivity and export of goods and services, receipt of monetary gifts or receipt of foreign loans and investments in order to import needed goods and services aimed at the development of the economy and enhancing the welfare of the citizens.
Also, high levels of forex earnings and external reserves are the backbone of the naira exchange rate. They ensure stability of the rate while low levels weaken the naira. But then, it must be noted that the CBN does not produce forex; it is what is earned by the country that the Bank strives to manage and use to stabilise the exchange rate.
Understanding FX, External Reserves, Naira Exchange Rate
A member of the Central Bank of Nigeria (CBN) Monetary Policy Committee (MPC), Prof. Mike Obadan, in a recent article, explained that forex is relevant in the context of world trade, payments and capital flows into and out of a country.
This, he pointed out forms a major component of a country’s external reserves which according to the International Monetary Fund (IMF) consists of “official public sector foreign assets that are readily available to, and controlled by the monetary authorities, for direct financing of payments imbalances, and directly regulating the magnitude of such imbalances, through intervention in the FX markets to affect the currency exchange rate and/or for other purposes”.
In light of this, the Central Bank of Nigeria Act, 2007, Section 24, mandates the Bank to maintain external reserve assets in gold coin or bullion, balances in banks outside Nigeria, foreign short-term treasury bills and medium-term securities, Special Drawing Rights (SDR) of the IMF, etc.
The CBN Act 2007 enjoins the Bank to “use its best endeavour to maintain external reserves at levels considered by the Bank to be appropriate for the economy and the monetary system of Nigeria.”
“In light of this, the CBN has strived to carry out this mandate by using supply and demand management strategies, particularly, forex conservation and control measures as well as measures to ensure adequate supply of foreign exchange.
“This is particularly so because forex is a scarce resource that needs to be efficiently managed if the country is to achieve macroeconomic stability, and avoid chronic balance of payments and external reserve problems.
“It must be stressed that it is only forex, in the form of convertible currencies or internationally acceptable currencies, and not naira, which can be used for international transactions,” Obadan added.
The Professor of Economics and Chairman, Goldmark Education Academy, noted that for some time now, there have been issues about forex in the country, which predates the present administration, stating that over the years, genuine efforts of the federal government to achieve a headway on these have tended to be undermined by exogenous shocks in the past five years which pushed the economy into recession in 2016 and 2020.
According to Obadan, the first recession from the first quarter (Q1) of 2017, was triggered by the collapse of crude oil prices in the global market. The price of Nigeria’s Bonny Light crude oil then declined continuously from $62.22 in Q2 2015 to $34.39 per barrel in Q1 2016.
Owing to this, as at the second quarter, 2017, when the country exited recession, crude oil price per barrel stood at just $50.21 per barrel.
“Due to the heavy dependence of the Nigerian economy on the oil sector, the impact of the oil market crash was severe on export earnings, foreign exchange reserves, government revenue and other macroeconomic aggregates including economic growth.
“External reserves declined from $28.28.33 billion in Q2, 2015 to $23.8 in Q3, 2016. The other external sector indicators similarly deteriorated: balance of goods and services, balance of current account, financial account, overall balance of payments, and external debt stock and debt servicing.
“The net forex inflow became negative, implying that the country paid out more forex to the rest of the world for importation of goods and services than it received. This implied that the demand for forex was higher than receipt of forex and the pressure on forex and the naira exchange rate was very high. This accounted for the devaluation/depreciation of the naira in relation to the US dollar at that time.
“Secondly, the Covid-19 pandemic-induced economic crisis in 2020 resulted in recession in the third and fourth quarters of last year. The pandemic containment measures in the form of economic lockdowns and restrictions on international travels and business resulted in recessions for countries in various degrees.
“Again, the external sector aggregates of the Nigerian economy experienced serious deterioration due to the economy’s continued heavy dependence on the oil sector for export earnings and external reserves accumulation. Crude oil production reduced from 2.07 mbpd in Q1, 2020 to 1.61 mbpd in Q2, 2021. Reports even indicate further decline to 1.27 mbpd in August, lower than the 1.38 mbpd achieved in July 2021 caused by difficulties in some oil terminals.
“This decline in output partly explains why the observed increase in oil prices to about $70+ per barrel has not impacted much on government revenue or foreign reserves accretion.
The former Director-General, National Centre for Economic Management & Administration, Ibadan, however, pointed out that the parallel market rate is determined mostly by speculators and rent seekers in a shallow and illegal market, which he argued constitutes a very tiny proportion of the forex market in Nigeria.
“Because the quantity of forex available in that market is very small in relation to the demand of the desperate economic agents that want to buy forex at any cost, the exchange rate is necessarily high. It cannot serve as reference for the naira exchange rate.
“If it is so, then it is the case of the tail wagging the dog! The parallel forex market needs to be avoided by decent economic agents. It will continue to exist as long as the naira is not convertible, the productivity of the economy remains low and the country does not earn enough forex from export of goods and services and capital inflows,” Obadan stressed.
Therefore, in order to stabilise the forex market and reduce the pressure on the naira exchange rate, Obadan said there was the strong need to move away from the country’s flawed pattern of economic management of the past.
He therefore called for a revival and rebuilding of the productive sectors of the economy to achieve higher capacity utilisation and productivity, and competitive manufactured exports; strong government encouragement of local refining of petroleum products for both domestic consumption and exports; as well as strong and effective surveillance of the forex market by the monetary authority to check round-tripping of forex from the deposit money banks to the parallel market.
In addition, Obadan advised the government to ensure that during oil booms, it saves forex and build fiscal buffers; increases sourcing of local raw materials and revival of the capital goods industry; promote fiscal and monetary discipline and harmony; create an enabling environment for productive capital inflows, especially foreign direct investment; and actively promote restoration of confidence in the economy to check capital flight.
“A good handle on the current insecurity challenges along with macroeconomic stability will be very helpful in this regard; rationalise imports structure to manage demand for forex; as may be permitted by supply considerations, use external reserves stock to support the exchange rate through increased funding of the foreign exchange market; and use moral suasion to encourage Nigerians to patronise home-made goods and reduce their high propensity for disruptive trade and commerce.
“Import only when it is absolutely necessary. They should also eschew unhealthy speculation in foreign exchange as well as rent-seeking behaviour and adopt positive attitudes towards ensuring a stable exchange rate for the naira,” he added.
Need for Effective Trade Policy
Nevertheless, the federal government has been advised to take urgent steps to overhaul the country’s trade policy in order to enhance forex inflow and achieve exchange rate stability.
Some experts who spoke with THISDAY, attributed the current scarcity of FX in the economy, partly, to delayed release of an updated trade policy for the country.
Minister of Trade, Industry and Investments, Mr. Niyi Adebayo, had said his ministry was working towards producing an updated trade policy.
However, a former Director General, West African Institute of Financial and Economic Management, Professor Akpan Ekpo, stressed that trade policy was very crucial for any economy. Ekpo said trade policy helped in creating opportunities for entrepreneurs to manufacture and export non-oil products.
He stated, “The country needs an updated trade policy as soon as possible. But one thing is having a trade policy, another thing is implementation. So, we need a trade policy that will take into account the present situation in the economy.”
Also, Senior Lecturer at the Department of Economics, Pan-Atlantic University, Lagos, Dr. Olalekan Aworinde, emphasised the need for the federal government to have a practical trade policy in place.
Aworinde said, “When you have a trade policy, the implication is that the direction as well as the volume of your trade will go to a particular country or a particular part of the world. This has a lot of implications on the forex market.
“Lack of trade policy could be one of the reasons why we have been seeing the continuous devaluation of the naira. If you have a trade policy in place, you will be looking at a situation of export expansion because it is the expansion of exports that would bring in the forex earnings.
“The implication is that you are likely going to see a situation where the naira is stable, if you have more goods from your country being exported to other countries, because you will be receiving dollars in exchange. This improves the dollar supply. But in Nigeria today, the reverse is the case. We now have a situation whereby we now have more imports than exports, which is one of the reasons we have the constant pressure on the naira exchange rate.”
Former Deputy Governor of the CBN, Prof. Kingsley Moghalu, in a recent interview on Arise News Channel, stressed the importance of export diversification. Moghalu pointed out that there was need for the country to have education, industrial and trade policies that are in alignment to support the growth of the economy.
He also said there was need to focus on productive knowledge in Nigeria, saying many people go through schools, but only a few have the kind of skills that can drive an industrially powered economy.
Moghalu stated, “We find that the oil sector still continues to be the main source of revenue for the country, whereas export diversification should focus on value added manufactured goods that are competitively produced in the country, traded in the international market, and bringing us forex back into the country. That means you need to deal with trade policy. Why should goods that are imported from China be cheaper than goods manufactured in Nigeria?
“That is a practical problem for industrial production in Nigeria. So, these are things we need to look at with trade policy, to export finished products. The way you benefit from devaluing the naira is that your foreign trade becomes more beneficial to you.
“But we still continue to be an import-dependent economy and the gap between our export and import is so huge. So, trade policy is very important. We conduct monetary policy, fiscal policy, forex policy, without an alignment with trade, so there is broken connection.”
Therefore, achieving adequate amount of forex earnings and stabilising the exchange rate require developed domestic production structures, a diversified economy and export orientation that is supported by an effective trade policy as well as a conducive macroeconomic environment.
