Devalued naira. Picture credit: The Guardian NG.
…managing exchange rates leads to some unintended consequences, one of which is the implied subsidy on foreign exchange from the Central Bank of Nigeria (CBN). There is no debate on the fact that whenever and wherever subsidies exist, distortions and irrational behaviour jump into the fray… If the exchange rate could move from N200 to N520 in six years, it can also move beyond N1,000 if we continue with our current form of economic behaviour.
On July 5, we had opened a debate on the depreciation of the naira, which has now received a response from Mr Eustace Odunze, a renowned economist and lawyer. This is hereby published and we will conclude with our reaction to him.
Why the Dollar Rate May Not Get To N1,000, By Eustace Odunze
The exchange rate of the naira to the dollar has always been a critical part of the management of the Nigerian economy from the early 1970s when Nigeria changed its currency from the pounds and pence to the naira and kobo. The currency exchange rate has always been a challenge to economic managers in their bid to determine the optimal value of the naira against the major currencies in the global economy. The currency of any country is the mirror of the economy of that country. The Nigerian economy is a mono product economy, which is 90 per cent import dependent. Oil as the major product of the Nigerian economy is priced in U.S. dollars and hence the principle of demand and supply, which governs the rate of a currency, does not impact the Nigerian currency with regard to this single product.
The overarching question then is: Why is the price of Nigeria’s oil denominated, negotiated, traded and settled in U.S. dollars, instead of the naira? The simple answer is that the naira is not a convertible currency. Currency convertibility is a very interesting concept in macro economics, it is confusing and difficult to understand, even by trained economists. Alex Otti dealt sufficiently with the issue of convertibility in his article, to which I am responding. One may then ask the question: With so much benefit to countries that have convertible currencies, like the ease of the exchange of their currencies, the availability of huge business and employment opportunities, etc., why then do others not actively pursue the convertibility for their currencies?
From recent memory, Nigeria has tried several currency management policies, ranging from the second-tier foreign exchange management policy of 1986, to the current one of a managed float. In all, there has not been any policy deliberately targeted at making the naira convertible, knowing that if the currency becomes convertible, oil will be negotiated and paid for in naira. According to the financial dictionary, the key definition of currency convertibility is the ability to exchange the currency without government restriction and control. It means to freely float the currency or to fully deregulate the foreign exchange market. A fully deregulated foreign exchange market is governed purely by the interplay of the forces of demand and supply, and the rate determined at the point of equilibrium between these two. Nigeria cannot afford this scenario, which explains why, though convertibility may appear attractive, it has not been the objective of the country’s currency managers. The situation is also compounded by Nigeria’s sustained balance of payments deficit and the state of our current and capital accounts.
It is interesting that whether a currency is convertible or not, the same factors of demand and supply apply to it, the difference being that the two critical factors of demand and supply are managed by the the government through regulation and controls. In most cases, the resultant rate of the currency is said not to be its real value.
In the light of all these, one believes that there are more sustainable and enduring steps to boosting foreign currency receipts by the Nigerian treasury. Beyond oil, there is gas, which we have hitherto not paid serious attention to, as we have been flaring it for decades, as we sit on untapped trillions of standard cubic feet of the commodity. Its use will not be limited to local needs, and it has a very large export potential.
Nigeria’s major supply of foreign exchange comes from the daily proceeds of crude oil sales, which accounts for about 85 per cent of the country’s dollar receipts. The next major source is home remittances from Nigerians abroad. In 2011, Nigeria’s total receipts from oil stood at $68.4 billon, which has been dropping since then, to $58 billion in 2013, $55.5 billion in 2014, and to $32.6 billion in 2018. There was a slight recovery to $34.2 billion in 2019, according to the Nigerian Extractive Industries Transparency Initiative (NEITI). The near sustained drop in the total annual receipts of the dollar is largely due to the drop in oil prices during the respective periods. The volume of crude oil exports held steady during the periods mentioned due to the calm that was restored to the Niger Delta region. During these periods also, the volume of home remittances followed a near-similar pattern, from the $24 billion received in 2014 and 2015, through a spike in 2016 to $35 billion, then dropping to $25 billion in 2018, and the worst figure in five years of $17.5 billion in 2019 and 2020.
The figures above clearly show that between oil exports and home remittances, Nigeria nets between $70 billion to $75 billion average annual dollar receipts. This is significant and in fact huge, when compared to the receipts of many African countries and indeed the rest of the world. The question to ask then is: Why is the exchange rate of the Nigerian naira doing so badly against the U.S. dollar when compared to some African countries like Botswana, Morocco and even our next door neighbour, Ghana? The trouble must then be with the demand. The Nigerian economy, being import dependent, has the greater supply of goods to it through external sources. In fact, a Nigerian Minister recently alleged that Nigerians import pizza from abroad. All imports are paid for with foreign currency, with the implication being that despite its significant foreign exchange receipts from crude oil and home remittances, the dollar demand far outweighs the supply, thereby putting severe pressure on the rate of the naira against the dollar. Outside the importation of goods, from the necessary to the extreme luxurious and even exotic, other invisibles like school fees, mortgage payments, and medical expenses are some of the key drivers of the huge demand for foreign exchange in Nigeria.
There are two significant ways for Nigeria to tackle the worsening exchange rate of the naira under the present circumstances. The first is to increase the supply of the dollar to the economy and the second is to reduce demand. The best option, however, is the combination of policy initiatives to achieve both. Until now, Nigeria seems to be giving undue focus to the management of the demand side and this policy approach has achieved very limited results over time. A look at the supply side of things may perhaps achieve faster and better result. The policy trust in this direction seems to centre on diversification of the economy to agriculture. This is desirable, since food import accounts for a significant portion of the demand for foreign exchange in the economy. It is, however, a slow and long drawn approach, with its impact being in the long term. Acording to the renowned economist, John Maynard Keynes, “in the long run we are all dead “. A quick-win approach will be the boosting of supply of foreign exchange from low hanging sources that are achievable, with immediate policy changes by the government, like the improvement of tourism, home remittances and entertainment.
A closer look at the data of Nigeria’s home remittance clearly shows that the key driver is political stability and security in the country. Nigeria can easily double its home remittances up to $50 billion annually if the government can guarantee the safety and security of lives and properties of the citizenry. Nigerians typically feel more comfortable to remit money home when the country is stable and there is peace, equity and justice. If Nigeria doubles its diaspora home remittances in the next one year, with a stable outlook for oil prices and the current peace in the Niger Delta, Nigeria can achieve an annual foreign exchange receipt in excess of $100 billion. With this scenario, ceteris paribus, the exchange rate of the dollar will have no business getting to N1,000 as projected by Alex.
The Response To Eustace Odunze
On a general note, I did not see Mr Odunze and I fundamentally disagreeing on the subject matter. The kernel of his response is that it is possible for the exchange rate not to continue its slide. Of course, we had said that much earlier, and it is our hope that the rate does not continue to depreciate. We also recognised the impact of remittances as a major foreign exchange source, alongside Foreign Private Investment and Foreign Portfolio Investment. Perhaps, what we did not state was that we could double our current levels of remittances in order to further tame the crises. While we may not be able to argue this, it is important to note that the drivers of foreign remittances may not necessarily be within our control.
…some of our recommended courses of action, like gradually floating the naira may lead to a spike in exchange rates. The good news is that after that spike, the interplay of demand and supply would force the rates to settle at an equilibrium. Wherever it settles is the equilibrium price, also known as the true value of the currency.
Granted that improving security and building infrastructure could attract more remittances, one would need further evidence to categorically state that remittances are sensitive to those factors. This is because other factors like the availability of funds to remit, the economic situation of the countries where the remitters reside, amongst others, may be other important considerations. If things are as they were last year when the COVID pandemic forced many people out of jobs worldwide, there will definitely be a drop in remittances to Nigeria. Again, remitters living in countries that are facing systemic economic downturns would have their ability to send money abroad impaired.
Changes in circumstances would also affect receipts, for instance remittances to build a house will cease when such a house is completed and remittances for the upkeep of parents and siblings would stop when the parents are no more or when siblings become independent. Another important point is that the longer immigrants stay away from Nigeria, the more their links with the motherland attenuate and eventually, we may get to a generation that has little or no link with Nigeria. These will definitely have very adverse impacts on the flow of remittances. The point being made here is that it is difficult to plan on handouts, especially from those outside your influence. This source of foreign exchange, though significant, can only command certainty when received. Building a model around it can be a little bit tricky.
In the light of all these, one believes that there are more sustainable and enduring steps to boosting foreign currency receipts by the Nigerian treasury. Beyond oil, there is gas, which we have hitherto not paid serious attention to, as we have been flaring it for decades, as we sit on untapped trillions of standard cubic feet of the commodity. Its use will not be limited to local needs, and it has a very large export potential. So, here, we would not only save on foreign exchange but boost our foreign currency inflows. We had mentioned a few other potential export products and potential alternative products to save on imports earlier.
Finally, we must state that as the exchange rate is a function of demand and supply, the fixation on absolute numbers may not be as useful as the policy framework. To the extent that we run short on supply and demand does not go down, prices would continue to go up and the local currency will continue to weaken. Therefore, some of our recommended courses of action, like gradually floating the naira may lead to a spike in exchange rates. The good news is that after that spike, the interplay of demand and supply would force the rates to settle at an equilibrium. Wherever it settles is the equilibrium price, also known as the true value of the currency.
The next good news is that faced with the true value, consumers would be forced to make rational decisions about their choices. We argued in the piece under discourse that managing exchange rates leads to some unintended consequences, one of which is the implied subsidy on foreign exchange from the Central Bank of Nigeria (CBN). There is no debate on the fact that whenever and wherever subsidies exist, distortions and irrational behaviour jump into the fray. This argument is also true of the subsidy on petroleum products, which has not only led to inefficiency in that industry but an unexplained consistent increase in the consumption of petroleum products. The point here is that the absolute rate of exchange is not relevant. If exchange rate could move from N200 to N520 in six years, it can also move beyond N1,000 if we continue with our current form of economic behaviour.
Alex Otti is a Nigeria economist, banker and politician.