23

Mar

SHOULD THE NAIRA BE DEVALUED? 06022017

2017-02-06

SHOULD THE NAIRA BE DEVALUED?
BY: HENRY BOYO

The above is the title of the first leg of a trilogy published on the naira exchange rate between May and June 2014, in both the Punch and Vanguard Newspapers. The other titles are “Advantages of a stronger naira” (26/5/2014) and “Who is afraid of a stronger naira” (02/06/2014).  
Evidently, the controversy surrounding appropriate naira exchange rates has been sustained over the years; nonetheless, the fundamental questions remain the same. This article provides answers to some of the most frequently asked questions regarding the naira rate. Please read on:
 
Why are some experts recommending that the naira exchange rate should be devalued?
Indeed, the suggestion that the naira is overvalued is not new, and even the managers of the much celebrated, yet comatose economic empowerment and development strategy, NEEDS, had, over a decade ago, indicated N180=$1 as the appropriate equilibrium and desirable rate for the economy.  Much more recently, however, the huge untamed speculative market demand for dollars may have influenced the suggestion, by some experts, that the naira should be quickly devalued to avoid a catastrophic free fall.  
 
Would the naira rate become stable with devaluation?  
Historically, the naira exchange rate has suffered multiple devaluations, which evidently, did not prevent further depreciation in the last two decades.  Consequently, another official devaluation would not necessarily induce long-term rate stability.
 
Experts have claimed that naira depreciation would increase our exports
Curiously, this argument has often been made to confuse and deceive Nigerians; interestingly, the Nigerian industrial subsector was more diversified and productive, with increasing employment opportunities when the naira exchange rate remained less than N5:$1.  Amazingly, the industrial landscape has become famished, and the values of non-oil Nigerian exports, have actually plummeted, as naira sunk to the present N160:$1.  Sadly, much cheaper imports have quickly replaced the output of our erstwhile thriving industrial subsector, and there is, no reason to believe that an exchange rate below N160:$1 would reverse this trend. 
 
Will a weaker naira reduce inflation?
Capital no!  Historically, once again, inflation rate remained below 5percent between 1975-85, when the naira was much stronger.  In fact, a weaker exchange rate will invariably instigate higher production cost across the board, and also fuel inflation; for example, if a manufacturer required just N100,000 to import a container load of raw materials when naira was N1:$1, same factory would currently require to borrow over N5m at over 20 per cent interest rate, to purchase the same stock.  All manufacturers, who import vital inputs, have sadly suffered this fate, with disastrous consequences for growth and employment.  Thus, further naira devaluation will seriously deepen poverty nationwide.  
 
Will a weaker naira reduce cost of funds to the real sector?
No!  If anything, a weaker naira will actually instigate higher cost of funds, ironically, even when we are blessed with increasing dollar revenue from crude oil.
 
How does a weaker naira instigate cost of funds?
A simple example may suffice; if Nigeria earns $1bn from crude oil, with naira exchanging at N1:$1, the three tiers of government would share N1bn; if on the other hand, the exchange rate falls to N160:$1, the $1bn forex revenue would be substituted with freshly created N160bn before distribution to the three tiers of government; worse still, if naira rate falls to N200:$1, the payment of N200bn for $1bn would in turn, further instigate the burden of excess naira supply, in bank coffers.  However, the fear of inflation will compel the monetary authorities to restrain liberal access to the surplus funds unleashed on the system by CBN's increase of money supply with its unilateral substitution of naira for distributable dollar revenue.
 
Consequently, the CBN would thereafter, seemingly, ‘altruistically’ proceed to restrain liberal lending to customers, by offering to pay mouth-watering interest rates, presently above 12percent, to borrow the perceived surplus cash from banks, in order to control inflation by reducing consumer demand and access to loans.  Such high returns on government’s interest-free deposits, obviously, increase cost of funds to businesses and inadvertently also reduce the attraction of banks lending to the real sector.
 
Thus, with CBN's ‘unconstitutional’ monthly substitution of fresh naira supply for dollar revenue, the more dollars we earn, the greater will be the threat of surplus naira and the attendant regime of high interest and low exchange rates and irrepressible inflationary uptick, with disastrous social and economic consequences.  

Will a weaker naira reduce fuel prices and subsidy?  
Once again, the answer is no; in actual fact, if petrol price remains  at the current level of N97/litre, a weaker naira rate will increase the domestic price of fuel, and will also increase the value of fuel subsidy beyond N2tn annually.  For example, we know that international crude oil price is the benchmark for the feed stock of all refineries worldwide; thus, if 1litre of petrol ultimately sells, for example, for $1 ex-refinery, this would be equivalent to N160/litre in Nigeria.  If however, the naira rate falls from N160:$1 to, say, N200/litre, the same petrol ex-refinery in Nigeria would now also sell for N200/litre. Instructively, however, lower naira rate will neither spur the price nor demand for Nigeria’s crude oil export.
 
Furthermore, if however, petrol continues to be sold domestically at N97/litre instead of the devaluation induced price of about N200/litre, the value of subsidy will increase to N103/litre, instead of the current N53/litre with the present naira rate of N160:$1. 
 
Will a weaker naira reduce the dollarization of the economy and stop capital flight?
The truth, of course, is that a weak and unstable naira exchange rate will actually promote dollarization of the economy and capital flight.   A continuously depreciating naira will elicit less consumer confidence in holding the local currency as a store of value.  Conversely, however, a stronger and stable naira would induce confidence, and make the local currency desirable as a means of exchange and a solid store of value, at the expense of other foreign currencies. Consequently, the greater the intensity to forsake the naira because of continuous depreciation over time, the greater will also be the propensity for capital flight and the adoption of dollars, for local transactions.
 
In reality, a weak naira exchange rate is actually not the result of reduced earnings of dollar revenue; in fact, evidence on ground suggests that the naira exchange rate has ironically steadily fallen simultaneously with vastly improved foreign reserves.  For example, in spite of our relatively paltry reserves of $4bn with four months' imports cover from 1995, the naira exchange rate remained at N80:$1 for over four years.   Curiously, however, the naira exchange rate fell to below N150:$1, when reserves rose above $50bn about three years ago, with over 15 months' imports cover.
 
Evidently, a weak naira is primarily the product of the surplus naira instigated by CBN's monthly substitution of naira allocations for dollar revenue, and CBN’s regular auctions of dollar rations.
 
PostScript: Sadly, by January 2017, three years later, the naira rate has since nosedived beyond N300=$1, purportedly as a result of crude oil price and output dropping below $30/barrel and 2m barrel/day respectively. Nigerians may however silently wonder, why naira rate still remain under intense speculative pressure even when crude price is steadily approaching $60/barrel with output also nearer 2m barrels/day.

Sadly, despite the positive tide, historical evidence unfortunately does not suggest that the naira exchange rate will appreciate, even if crude oil prices unexpectedly exceed $100/barrel with output well beyond 3millions barrel/day; indeed the resultant naira liquidity from such bountiful outcome will further spur inflation and crush the naira rate well beyond N1000=$1. Don’t believe me, just check the historical relationship between bountiful dollar reserves, inflation and naira exchange rate.

SAVE THE NAIRA,SAVE NIGERIANS!!