Today 07/05/2015, the naira gyrates both in the official markets and parallel markets at between 180-220, at varying times to the United States Dollar, falling from it previously traded prices of 160 to the dollar for much of last 5 years.
This represents devaluation. What essentially is devaluation? It is a deliberate or sometimes consequential effect of lowering the value of each unit of a particular currency.
Devaluation at it primal mode, makes local products cheaper, more price competitive in the export markets because less of a foreign currency can now buy more of the local product, creating an incentive for the foreign buyer to drive a hard bargain and buy more units of produce without a corresponding increase in spending.
The incentive to the seller or export country is that more of it goods are in demand and sold, thus creating a avenue for further production, employment and all associated activities.
Thus on a grander scale, devaluation is worth the effort. It is intrinsically producer friendly. It enhances a more competitive , productive use of factors of production.
It could provide a means for hedging out or undercutting competition/competitors in the market place. Most national government use economic tool as hidden incentive to protect their industries and drive external demand.
On the flip side, devaluation has the direct effect of making imports uncompetitive in price, meaning more expensive, leading to lowering in their consumption and importation. People seek alternative, locally made substitutes which are much lower in price, provided quality is not a limiting factor.
In recent times, competitive devaluation of the Yen, the Japanese Currency and the Euro has produced trade surpluses in this countries and produced in the same wake, record profits for it corporations as their produce become more price competitive on the global stage.
Applying this learned fact to the Nigeria economy is a whole kettle of fish. Devaluation has no place here.
With the wholesale embrace of the Washington Consensus, which has been proved to accounts for much of the deindustrialization of Africa, and Structural Adjustment program and subsequent devaluation of the Naira in 1986, we have continued in this path. All forms, of government since then, tyrannical to democratic alike has abide by this not- well-thought- out policy to no definite tangible benefits. The evidence of the epic failure of this policy is with us. Not that we don’t realize this is a failure; it appears our ruling, pilfering overlords see no other way to national redemption.
Now, devaluation works in economies that have no local supply problems. It is mercantilist and export loving.
Nigeria on the contrary historically has a supply problem. Local Industries lack the technical knows how to produce goods in mass quantity. Mass production ethics and principles is not a part of our economic history and culture. The factories here are largely small, a self serving complexes of a foreign subsidiary which produces just to satisfy and make enough rent-seeking profits.
The rest of demand, including the basic raw materials used in this sub-optimal industrial production is met by massive importation of all shades and forms, from the wholesale and new to the dilapidated and scandalous.
Nigeria is an import dependent nation and that is set to remain so for a long time to come. In view of that, we cannot fully appreciate the benefit of devaluation.
It is not a workable economic prescription needed in this economy.
Yes, the chorus line goes that it may lead to the emergence of an industrial policy that is import-substitution based. From evidence of about 30 years of active practice, this utopian aspiration remains an illusion, understandable only by the gods.
It makes sense that by deduction, an import dependent economy must not embark on devaluation of it primary currency. It simply has no stake to protect in the export markets. And in the contrary, except the devaluation policy is promoted by a desperately evil regime hell Benton destroying it citizenry, devaluation of an import dependent nation currency lowers considerably immediately, the standard of living and purchasing power leading to shortages of both primary raw material and finished outputs.
Now, there appears a paradox. How can a non-exporting nation or rather a nation whose sole exports are subject to extreme volatility in value maintain the value of its currency in the long run without developing multiple streams of foreign income to preserve and maintain the equilibrium in balance of payments?
That answer will best be explained and provide at another forum, not this.
Now, back to Nigeria’s current currency crises, the subsequent devaluation and the direct import of such devaluation in diminishing purchasing power and standard of living, collapse of real wages, we as economists are called to action to proffer solutions first to:
1. Stabilize the currency gyration
2. To arrest the decline in value
3. Proffer solution to it revival back to former levels.
In reality, arresting the gyration cannot be done. It simply cannot happen to defend the currency by a foreign reserve against speculators and currency vultures, both local and global, at in a globalized world. The Thai and Malaysian examples during the 1997 Asian Crises and their first attempts at defending currency values with stockpile of foreign reserve against international speculators ended up in a bank run , with the speculators walking away with the spoils of war.
Yes, this is even true under a managed float system that is the Naira Exchange System today.
Point 2: Which is to proffer ways to arrest the decline in the currency value.
Now, long held beliefs is that by moving the interest rates up or down, the monetary policy and by extension, the government of a nation can determine and regulate the value of currency solely by regulating demand for the currency.
This is perhaps the more important policy lever in an import driven society as evidenced by the CBN in November 2014 when it announced the first round of devaluation.
It moved the MPR (Monetary Policy Rates), the lending benchmark a point upward.
This same line of action was toed by the Russian Central Back in its 2014 Rubble crisis currency. It sent interest rate spiraling. This policy of interest rate fixes policy is as old as central banking itself. It is deep in the central banking play book.
However we live in uncertain times, necessitating the unconventional as the convectional is no longer effective.
The success of the recent rate increase is mixed.
In Russia, it worked fairly well as in a few months later, the Ruble had appreciated considerably, ultimately leading to a lowering of rates, howbeit cautiously.
In Nigeria, we are yet to experience that happened. The primary reason I adduce to that is that Russian economy had natural enormous spare industrial capacity to hold the slack necessitated by devaluation and rate increase. Something Nigeria is not privileged with.
Now, moving interest rates up to shore up currency values by themselves is a dubious policy because, currency valuation is just a symptom of a economic outputs.
Interest rates is fundamentally linked to asset pricing and asset prices within a economy, the value of real wages and all kind of valuation that ensures continuity in production within a country. Interest rate has to be view as a whole package before it weaponization in currency wars.
Extremely peculiar to Nigeria, nominal interest rates have remained between 20% -30% within the economy for as long as I can remember. No one has ever explained to us why interest rates, a staple in production, asset selection and asset use should be that high.
No one, not even the Central Bank of Nigeria. This phenomenon is taken as a given in this rent –seeking economy.
Evidence suggests that capital accumulation and industrial production cannot be supported under such duress inducing abnormally high interest rate regime within a country. At least not for a long time. Only speculative activities will be able to access such capital at such cost, leading to asset prices bubble, severe disequilibrium in resource allocation within the economy, sub-optimal employment, an unusual high strain of inflation and other anomaly.
To the third point of reviving the currency value. Old central banking rules suggest an interest rate increase. That is the standard tool. However, for reasons already stated it is just a tool, but not the right tool and more often a devious tool.
A new thinking is required for a new world.
Most Central Banks, from developed world to emerging market have their work out into two defining cardinal points:
1. To create an environment for full-employment within the country.
2. Manage inflation, within an often defined band usually 2% for developed economies.
Addressing these two cardinal factors is crucial to a nation well- being. Success in these is attached to the primary reason for governance and governments, especially democratically elected ones in popular democracies- the well being of the citizens of a nation.
In fulfilling this modern dual mandates, movement of interest rates depending on the economic realities is the textbook solution. And it works more because these countries ratio of informal sector to formal sector is negligible so often the transmission link between official policy and actual effect within the polity is coordinated and strong. The famed Central Banker Alan Greenspan is feted for his use of interest rates in steering the United States economy for over two decades.
NIGERIA as nation has an informal sector that is almost bigger than the formal sector so economic coordination and transmission is generally and historically weak.
The effects of the disconnect and inability to coordinate savings and capital formation will be discussed in another edition.
Now, aside the utopian goals of central banking which is previously defined, the Nigeria Central Bank has the unthankful task of managing a foreign reserve and regulating the exchange rate, as it is a politically charged topic.
Now, I beg to differ on this. The CBN we know is not even competent enough to creditably deliver the full employment mandate on a normal season, in the face of a large informal, unbanked sector (which it has not found a solution for). The core value of inflation which is a product of under-supply economies, a colonial legacy and a direct effect of historically high lending rates and low capital formation.
Now, it has to shoulder the burden of currency manipulation to achieve goals which are best left to the market to decide on.
As we have seen with the second round of devaluation of the Naira in December 2014, the CBN cannot manage the pressure. It cannot maintain the strategic foreign reserve and at the same time defend the value of the currency. It will lead to a bank run. Only currency investors and speculators can win this game.
Now, can we move over to a better, brighter, more informed future?
In 2001, Japan had a problem with deflation. Asset prices canned and by extension, the cost of products in the economy assumed a downward deadly spiral. There was need to bring back inflation and re-inflate the economy. Mind you, this is the direct opposite of what we face in Nigeria today. In January 2001, the Japanese currency was well valued against the US Dollar so there was not a question of export competitiveness. However there was a nasty stint of lingering local demand sag. The Japanese invented the economic policy of 量的緩和, Ryōteki kanwa, also called Quantitative Easing as an effective antidote to the problem. Remember the problem was Deflation.Task: To re-inflate the economy.How: We are going to print boat loads of money, the Yen in this case and the Bank of Japan is going to use that money to buy bonds and securities from the markets and banks are going to push all that money into the economy in form of borrowing to lenders. We are going to keep interest rates so low so that people can access capital cheaplyExpectations: More money chasing goods will re-inflate the economy and increase asset prices. Now, historically the Japanese have taken a low currency exchange as a given to their export lead growth model. It simply made their good competitive in the international market place. Also the fact that the currency was largely in a free float. The effect is graphical. Every policy has an unintended consequence.With hindsight, the result is very clear; Quantitative Easing did not end deflation in Japan. The unintended consequence is that The Yen appreciated. From a low of 119.4 in January 2001, it strengthens continuously over time, in a span of 9 years to an exchange rate high of 76.11 against the dollar. We may suggest that that was too long a time in economic history that other factors could have contributed to the Yen strengthening over time. Yes, true. There was noise in the economics space such as the shutting down of credit markets and onset of financial crises in autumn 2008 that lead to a flight- to- safety in Japanese Yen and Bonds by market participant. The 2011 Fukushima Nuclear Accident are notable noise. However, in the graphical example presented below, the currency has already set in its path of strengthening and would have strengthened respective of these notable event.
Now, except of brief period in 2006 when the yen returned to the 119 range, it was largely subdued.
Now, in more recent times, QE has become fashionable and another notable participant in the venture is the US Federal Reserve, the US Central Bank. It began Quantitative Easing, at some point buying back $60billion a month worth of treasury bills and bonds expanding it balance sheets to a record $4 trillion, keeping interest rates subdued at near zero percent for an extended period of over 6 years.
Right now, the US Federal Reserve has tapered easing and set to rate rates. What we have seen with the US Dollar index, a measure of the US Currency by market participants is the strengthening of the US Dollar over time from the beginning of QE programs till now.
The strengthening currency has become a side distraction to the US Feds rates aspirations.
Check US Dollar Index graphs.
The USDOLLAR index shows graphically the effect of Quantitative Easing QE which began in August 2011 on the value of the US Dollar.
The inference and similarities of the unintended consequences of QE are well documented. It to produce a strengthened of the host nations currency.
Back to Nigeria: A POLICY PRESCRIPTION OF A NEW ECONOMIC MODEL.
Can the Central Bank begin to be more inventive and as a first step begin to lower interest rates unilaterally from the present MPR rate of 12% to a benchmark 4% within 6 quarters?
Can the CBN begin to take the necessary legal groundwork to begin a limited at first, but steadily rising Quantitative Easing program in Naira for the nation of Nigeria?This QE should be about 30% of nominal GDP .
The aim is simple and especially important to Nigeria. The lowering of interest rate has the potential to solve once and for all, the problem of lending that has plagued resource entities in this nation.
It will redistribute resources and reorganize asset pricing to more realistic terms across the landscape. It also will make banking services competitive and lending competitive so that the huge informal sector will be incentized to becoming identifiable, as a precursor to formal lending relationships.
A competitive lending rate has the potential to solve the industrial supply deficit historic in Nigeria’s economy.
Effect: Before we talk about the effect, what we have to state categorically is that the success of this program recommendation will be based on the institution of a market driven, free- float exchange rate system.
The CBN will cease to actively manage, either by Dutch auction or other measures, the exchange rate. The Naira will be free float.
Also, the need for balanced budget and fiscal discipline by the central government to ensuring the success of this program cannot be over emphasized.
Effect: We will have in one fell swoop, cured all our economic malaise. We will benefit from the unintended consequence of Quantitative Easing. We will have the artificially low exchange rate begin to strengthen again the US Dollar naturally, especially give the background of the possibility of the emergence of a nascent export base and increased production and supply by market participants.
There will be no need for exchange controls as is being proposed, all signs of a floundering, fundamentally stalled economic policy.
As seen above, the graphs speak volumes for themselves. I don’t want to present the Chinese Yuan graphs at this period to buttress the points because of space constraints.
Can we begin a new bold step today?
In approximate terms, if we begin today, the Naira is most like to move from its current N200 to the dollar to N90 within a span of 3 years.
Thank you.
Dipo Ehindero is Economist at Purple Economics L.P and First Capital Trust Plc