ANALYSIS: Saving the Soul of the Naira

Nigerian Economy
Naira notes

Beyond the cry for the salvation of the soul of man from the ongoing pandemic disease outbreak (COVID-19) is the need to save the soul of the Nigerian economy through the worth of her currency (naira).

To this end, a proactive measure needs to be enacted with great caution and sense of urgency to effectively tame the dwindling force behind the soul of naira – which in our current situation – is like salt in the wound of the ailing economy.

But before the necessary issues are discussed, it is important to carefully examine the behavior of Nigeria’s currency relative to the world currency in the past years.

No nation in the world can be self-sufficient by being the producer and consumer of all goods and services needed in its country. Hence, trade is inevitable.

Nigeria, like every other country, has its fiat currency as a means of exchange in its local market but, can it be utilised to transact in the global market? No. So, there is a need for Nigeria whose currency is not accepted in the global market to buy the globally accepted vehicle currencies to transact in the market.

Of course, for every action is a price. The exchange rate of naira, which is the price of the foreign currency, is now the value of naira that is being exchanged for a unit of the foreign currency.

Preserving its credibility, Nigeria operated on a fixed exchange rate system from 1959 to June 1986 when the Structural Adjustment Programme (SAP) was introduced. Under this system, the naira was pegged at a particular price of foreign currencies irrespective of the demand and supply for naira via export and import.

Source: WDI, 2018; CBN,2018; SPM Professionals Analysis

During this regime, instead of leaving a mark on the exchange rate, Nigeria’s trade balance had a significant impact on the foreign reserve. Oil boom in the 70s not only increased foreign reserves significantly, but it also prompted the Central Bank of Nigeria to reduce the exchange rate.

In a fixed exchange rate system, a reduction in foreign reserves indicates an imbalance in the balance of trade which will not transcend on the exchange because the reserve is being used to augment for the trade disparity.

Source: WDI, 2018; CBN,2018; SPM Professionals Analysis

Based on the liberalisation policy under the Structural Adjustment Programme framework in 1986, the country switched to a flexible/floating exchange rate system where the exchange rate was left in the cold bare hands of forces of demand and supply.

Under this system of exchange, the demand and supply for naira through what is exported and imported determines the rate at which naira is exchanged for other currencies of the World.

If Nigeria exports more goods and services than it imports, more naira would be demanded, hence the value of naira appreciates, which means that less of naira would be required to get a unit of foreign currency.

On the other hand, if Nigeria imports more than it exports in terms of goods and services, naira depreciates. Hence, more naira would be required to buy a unit of foreign currency.

From the figure above, it can be seen that Nigeria experienced a high exchange rate when the floating exchange rate system was being used. With high demand for foreign currency for importation, depletion of foreign reserves was inevitable and also led to a high exchange rate.

The CBN had to fix the exchange rate in 1994 to check the persistent increase in the exchange rate.

Source: WDI, 2018; CBN,2018; SPM Professionals Analysis

In 1995, Nigeria adopted a regulated floating exchange rate system whereby the CBN would be monitoring the movement in the exchange rate to intervene whenever the need arises.

In this type of exchange rate system, CBN intervenes in the foreign exchange market to moderate the depreciation (or appreciation) of naira with the foreign reserve. When using managed system, the possible deficit or surplus in the balance of payment of Nigeria would have been covered by the loss of the foreign reserve.

Hence, the balance of payment is not a good economic measure for any country operating managed floating exchange rate.

Foreign Exchange windows

Since the inception of the CBN’s operation in 1959, it has added to its official window, other foreign exchange windows to increase platforms where foreign currencies could be assessed.

The official Forex market, which is controlled by the CBN, is the largest of the windows where forex is sold to authorised dealers. A spot transaction is done twice (Monday and Wednesday) by auction in this market.

Authorised banks have to credit their account with the CBN two hours before the auction day and the correspondent value in foreign currency would be paid 2 days after the auction day only after compliance with the regulations.

The Interbank forex market was established in 1989 to ease the pressure in the official foreign market. In this window, commercial banks, the NNPC, Private oil companies, and the treasuries of big firms are allowed to transact foreign currencies. The CBN intervene intermittently in the market to ensure that true value naira is being traded.

In a bid to expand the platform in which forex could be assessed by individuals for a variety of purposes mainly in small scale, Bureau de change windows were introduced in 1989. This market deals at the spot rate and one of the risks associated with it is currency run.

This mostly occurred when the buyers are far greater than the sellers of foreign currencies, a situation which occurs often because of speculation.

Importer and Exporter window is a recent window established where importers and exporters transact currencies. This window increased the liquidity of foreign currency for importers at a relatively low rate.

After careful consideration of the behaviour of the exchange rate in the past, it is expedient to have a glance at the incidence of COVID-19 on the world economy.

The Incidence of COVID-19

On December 31, the first report on a previously unknown virus came into the hearing of the WHO office in China. This virus was behind several pneumonia cases in an Eastern China city called Wuhan with a population of about 11 million.

Since then, the disease, formerly known as coronavirus, but now COVID-19, has affected 80,969 people in mainland China, killing 3,162.

Recently, the number of cases in China has suppressed as the outbreak is now gaining momentum around the world.

As of March 14, the total world cases were about 146,273 with active cases of 68,276 people (comprising mild condition of 91 per cent and serious condition of 9 per cent), recovery cases of 72,556 and death cases of 5,441 (that is 93 per cent and 7 per cent of 77,994 closed cases respectively).

The immediate actions taken by governments of the severely hit countries were massive closure of trade and industries. For instance, China placed the mainland under lockdown with Wuhan having roughly 50 million people. The Italian government locked down the entire country, same as in South Korea and Japan where all concentrations are now geared towards curtailing coronavirus.

The multiplier effect of these massive lockdowns of businesses is already injurious to the world economy in terms of demand for inputs and finished commodities, restriction to the mobility of labour, etc.

For China, the incidence of coronavirus slashed their oil demand by more than 20 per cent last month, leading to excess crude oil in the global market begging for prospective buyers, and then, a crash in the oil price.

Trade War on Oil Market

Following the fall in the world demand for crude oil and crude oil prices, the OPEC+ meeting and negotiations to cut oil production fell through and spurred a race for market share between Russia and Saudi Arabia.

The refusal of Russia to cut oil production spurred Saudi Arabia to boost production to about 12.3 million barrels per day starting from April 1. Russia, in retaliation, increased its output by 500,000 barrels per day. This disagreement pushed oil prices down by the most, since 1991.

The tit for tat jostle caused a fall in Brent crude by more than 20 per cent on March 9 and led to the biggest one-day calamity of the US stock market since the last financial crisis. More so, about $9 trillion was wiped off global equities in nine days into early March, as a result of coronavirus.

The ripple effect of this clash has little impact on the top three producers of crude oil (USA, Russia and Arabia). For instance, despite the challenges, Russia still has over $650 billion in reserve with no government debt and running a budget surplus.

But, for countries like Nigeria, whose source of foreign reserve according to (MTEF 2019) is 90 per cent generated from crude oil, it will be a disastrous occurrence if care is not taken. However, the assumption of producing 2.1mbpd of crude oil and benchmark price of $57 per barrel to finance the 2020 budget is now a mirage.

What needs to be done at the moment is reviving the foreign reserve from the suffering of the dwindling oil price. Nigeria’s foreign reserve decreased to $36,380 million in February, from $38,100 million in January 2020, about 4.5 per cent decrease in a month.

Uncertainties about how much the foreign reserve will fall in subsequent months is now a clarion call to safeguarding the foreign reserve from falling below $30million threshold set by the Central Bank of Nigeria.

To the best of our knowledge, proactive measures are needed to prevent the naira from the fate of devaluation, which in our current situation is salt in the wound of our ailing economy.

War of Currency

The outbreak of coronavirus has led to a trade dispute among the world’s largest economies which might trigger a currency war in the world. After the U.S. experienced a dramatic fall in the global stock prices and bond yield, the U.S. Federal Reserve was faced with the decision of cutting its rate to induce local businesses and prepare for another world economic crisis.

Several advanced economies in the world have resorted to a reduction in interest rate as a way to shield themselves from the wrath of recession. This has resulted in currency swing among countries in the world.

A cut in the interest rate of the U.S. economy will not only induce local production and cheaper export but also lead to capital flight to other economies whose interest rates are relatively high. Conversely, a rise in the interest rate will enhance more liquidity in terms of foreign direct investment in the economy.

In light of the dwindling crude oil prices caused by a coronavirus, all effort to increase production through the use of monetary and fiscal policy tools is on the toll. An export-based economy like Japan, in an effort to save the yen, will not hesitate to cut interest rates even below the zero rate, as the European Union.

The positive effect of the cut in interest rate by an advanced economy on Nigeria’s currency will be immense. This will be seen in the form of capital outflows from the advanced economy since investors are investors and solely after higher returns on their investment.

Loss of capital from these economies would mean greater capital inflows into the Nigerian economy, provided that the speculation of the MPR (monetary policy rate) increasing, becomes a reality.

The speculation of the current MPR increasing, will induce more foreign direct investment, which will affect the foreign reserve and, in a short time, restore the value of the naira.

Implication on Naira

Our Naira remains a classic Petro currency, whose fate is overtly tied to global oil prices. As the foreign reserve depletion is close to a $30 million Central Bank threshold for devaluation, the economy is yet to experience another blow of the 2016 economic downturn. A drop in reserves in Nigeria from $36 billion to $30 billion can happen dramatically given the future uncertainties.

The Central Bank’s foreign reserve helps preserve the naira’s value where CBN can sell foreign exchange to buy naira in an attempt to uphold the naira value. The decision of making a strong naira value is a subject of supply of foreign exchange and action taken by the CBN which provides an indicator to foreign speculators on impending devaluation.

If this occurs, the current economic mess would be aggravated when foreign investors begin to exit Nigerian equities and bonds en masse. Furthermore, if the Central Bank’s strategy falls through and Nigeria runs extremely low on foreign reserves, the naira could depreciate and allow speculators to arbitrage.

Failure to arrest all forces that will bring further pressure on the naira will be more disastrous than the 2008 global financial crises which incurred a heavy economic toll on Nigeria despite its higher foreign reserve of $53 billion.

Appropriate coordination of the monetary policy tools with fiscal adjustments will be a safety helmet to restoring the soul of the naira than considering naira devaluation. Devaluation would impose more hardship on manufacturing importers in terms of inputs (leading into cost-push inflation) and also an unsourced increment in the national external debt profile just as the case in 2016 when additional N8 trillion was added to the debt profile as a result of careless devaluation.

It is readily known that the best time to prepare for a battle is not in the midst of battle, but before the battle. COVID-19 has come like a flood, not just to battle and suck off human life, but to suck the economic vitality.

The soul of a man is ultimate; as it was known to be the apex of creation, but it is logical to know that the strength of the soul of humans mostly depends on the soul of its economy. In other words, the human soul can be made well to prosper only when the soul of the economy is saved and prosperous.

Thus, the human soul and the economic soul are two interjected that should not be separated.

In Nigeria, it is not enough to stay glad relatively because of the low or no case of COVID-19, as it has a huge and deadly impact on the economy. COVID-19 is a global crisis and one of the key variable factors that link Nigeria to the rest of the world is her currency.

In other words, one of the key components of which the soul of the economy thrives is the soul of naira (i.e. the worth of the currency relative to the world currency, especially the U.S dollar).

It is then essential to note that timely actions amid COVID-19 battle should be jealously guarded with uttermost precision and accuracy, in order to make better the soul of naira which will further make better, the soul of Nigerians.

What then is the optimal response in the midst of this?

The best way to know what to do first is to know what is not safe to do.

Devaluation? – A No Go Area

Devaluation in itself is not deprived, provided that the economic stance of the economy support and can withstand the policy implication. For example, during the great depression in the late 1930s, countries that followed devaluation policies were found to recover more rapidly from the global crisis.

Before we proceed, it is important to make clear what devaluation is. Devaluation in Nigeria context is when you deliberately allow the worth or value of Naira to be reduced in exchange for another currency (for example, Dollar).

In other words, you have more naira to pay when exchanging with dollars. Mathematically, you formerly exchange N200 for $1, but the policy of devaluation now mandated that you exchange N350 for $1.

Countries that practiced this policy always have things to establish within their economy before adopting the policy – things like; ensuring that things consumed by households and firms are largely produced in the economy – and also ensure processed and well-refined production that attracts foreign buyers in the competitive global market.

Simply put, the country is self-sufficient in terms of consumption and production. Example of such a country that carefully and intelligently practiced this is China. Given these characteristics and conditions, is Nigeria capable of devaluation?

According to the latest report released by NBS, 2019 Q4, the total trade value for Nigeria stood at N10.1 trillion (25.9 per cent higher than 2018 Q4 and 14.05 higher than 2018 YoY).

In 2019, import grew by 28.8 per cent, relative to 2018 as against total exports, which grew by 3.56 per cent relative to 2018. It is made clear from the report that importation in Nigeria is increasing while export is decreasing (see figure 1).

Given this stance of the import-export trend, is it still logical to agitate for Devaluation? Of course not! The implication is, if devaluation is adopted (i.e. soul of naira is reduced), it then means that the cost of living will be increased and the standard of living will be lowered.

For example, if Mr A purchases 5 bags of cassava flakes for $5, using an exchange rate of N200/$, thus an equivalent price will be N1000 for 5 bags relative to a 35 percent devaluation of N270/$, thus, the new equivalent price will be N1350. This simply means that Mr. A will spend more money (N350 additional cost) buying the same bags of cassava flakes.

Source: NBS, 2020; SPM Professionals Analysis

Also, according to the 2019 Q4 report, the percentage share of crude oil export is 76.1 while non-crude oil percentage share is 12.7; this infers that our export base is largely driven by the oil sector.

What does this speak of amid COVID-19, in the economy? Following the on-going outbreak, it should be noted that Nigeria’s export base will further decline as global demand for oil consistently fall due to COVID-19 trade restrictions. In other words, we should expect the 2020Q1 report will be marked by another fall in export alongside the net export.

It is important to recall here that devaluation in itself is not a bad policy, but given the stance of the Nigerian economy, it is not safe. “You do not win after the battle; rather you win a battle before the battle with adequate planning and structure.” Aside from devaluation of the naira, what else is not safe?’

Reducing the Monetary Policy Rate? – No!

How does this work? Monetary Policy Rate (MPR) is the benchmark for every other market‘s interest rate in the economy (especially short-term interest rate and inter-bank rate) which can also be used to sway money supply. MPR also gives foreign investors an idea of the standard rate of the economy.

The economic principle here is that; low-interest rate makes is quick for lenders to withdraw their money out of the economy, because, the lower the rate, the lower the return to the lender (including foreign lenders). Low interest in an economy deters foreign lenders (investors) from coming to invest in the economy. ‘

The implication to this will be capital outflow (i.e. capital flight) from the economy, which further weakens the foreign reserve account because foreign investors will have to transact from naira to dollar. Also, the reduced demand for naira as against dollar will further reduce the worth and mere the soul of naira.

It can be observed from figure 2 below the movement between MPR and foreign reserve. It can be observed that a sharp decline in MPR in 2008 led to a consistent fall in foreign reserve from 2008 till 2011, similar to this experience is 2014 and the contradicting experience in 2016.

Also, it can be observed that there exists a time lag response of foreign reserve to MPR; this could be associated with the wait and see principle enacted by foreign investor (i.e. a careful decision taken by the investors to observe the stability of MPR).

Source: CBN Bulletin, 2018; SPM Professionals Analysis

Given the stance of Nigeria’s foreign trade, should we then rely on domestic advantage(s) to imitate force against the global crises or engage foreign advantage(s)?

The way out!

It is called the way out, not the way forward; remember, you do not prepare for battle amid battle but before the battle. Thus, the optimal response discussed here is temporal.

Contrary to what was discussed earlier, is the solution.

Firstly, in a bid to take advantage of the global interest rate is for monetary authorities in Nigeria to revise the MPR back to 14 percent (or 14.5 per cent). The report shows that given the COVID-19 crises the United States of America lowered its target range for its Fed rate of funds by 50bps to 1 – 1.25 per cent on March 3, due to incidence coronavirus threats alongside the United Kingdom and Canada. To this end, foreign investors will be on the lookout to invest in countries with higher interest rates, where higher returns could be earned.

An increase in MPR will stimulate capital inflow into the Nigerian economy and will increase the demand for naira to stabilize the mitigating effect of declining oil prices on the exchange rate. This is not to agitate for appreciation of naira, but to help to strengthen the pressure on the foreign reserve which the Central Bank of Nigeria uses to stabilize the soul of naira.

Also, the monetary authorities can revise back to the initial Cash Reserve Requirement (CRR) for the commercials banks such that money funds can be made available for private sector investment advancement. But the caution is, the monetary authorities must be on a firm look-out for the possible inflationary pressure that can emanate.

When then is the responsibility of the federal government?

The federal government should further strengthen their base to curb every form of leakage in the economy, especially at this sensitive period. It should further allow for fiscal optimisation of the fiscal budget and not a reduction in the fiscal budget, especially on the capital project, because a fall in fiscal activities will further strengthens a fall in the economic activities.

The Way Forward!

The way forward is not to take us out of this present battle, but to prepare us ahead of the upcoming one.

China, being the manufacturing hub of the world, alongside India, who has just been ranked 5th in terms of nominal GDP by the International Monetary Fund, has been strongly marked by building its economy not fundamentally from agriculture, but the manufacturing sector. It is time to begin to take diversification beyond agriculture, but the manufacturing sector.

A recent report by NBS showed that about 80 per cent of importation in 2019 Q4 for Nigeria is the manufactured goods. Also, countries that thrive most as earlier cited are countries with a robust manufacturing base which allows for inclusiveness of growth (i.e. growth that engages human participation). The question is how then can the manufacturing sector thrive in the Nigerian economy?

To answer this, the federal government needs to pay a close look at creating an enabling environment and facilities for investment and manufacturing industries in the

economy. An important factor in this is power supply and well-paved roads. Having this in place makes production efficient and cost-effective for the private manufacturing sectors to thrive through cost minimization which will in-turn make manufacturing exporting relatively cheaper in the world market.

Paul Alaje
Paul Alaje

Paul Alaje, Senior Economist, SPM Professionals.
p.alaje@spmprofessionals.com

(Editor’s Note: This article was written before the finance minister announced this week that crude oil benchmark in the 2020 budget will be reduced to $30 a barrel and before the CBN announced Friday that it was returning to a uniform exchange rate).



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