Naira: A Currency Under Pressure

Source: THISDAY LIVE

With the value of the Naira, particularly, measured against the Dollar, currently falling  at a geometric rate, there is no doubt that the national currency, more than ever before, needs more urgent attention of the monetary authorities, write Kunle Aderinokun and Olaseni Durojaiye

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rguably the trending topic in the Nigeria’s economic space today is naira devaluation and it has put those for and against in a fierce debate with either side marshaling strong points why their opinion should carry the day. The issue has arose largely due to the wide gap between the demand for foreign exchange forex) particularly the United States Dollar and what the economy is able to supply.  Many trace the decrease in the supply side of the greenback to fall in oil price in the global market arguing that this is expected as oil and gas exports account for not less than 80 per cent of the country’s export.

Though the root cause have been traced to the fall in oil price, the challenge appears to manifest in the form of inability of the economy to fund the demand side which is put at $3.6 billion monthly against a supply side put at $1 billion. Sounding a warning note, analysts predict that if the price of oil fails to pick up and head north, the supply side might dry off precipitating an economic crisis in that eventuality.

However, operators in the economy argue that the current scenario is not encouraging as it has continued to impact the economy negatively, thus the call on the Central Bank of Nigeria (CBN) to take another look at its forex and monetary policies which they contend is anti-business as it is not able to fund the forex needs of businesses who depend on imports for machineries and some other raw materials that are not available locally.

Interestingly, the $3.6 billion monthly demand appears to include forex demands from outside of the shores of the country. According to the Director of Monetary Policy Department at the CBN, Moses Tule, other neighbouring African countries source their forex demands from Nigeria. What this means is that Africa’s largest economy has to shoulder some of the foreign exchange needs of some West African countries alongside the large appetite of its very sophisticated population for the foreign exchange.

According to Tule, “As of June 2015, the total external reserves of the 15 African countries in West Africa were just about $32.6 billion. Of that amount, Nigeria had $29.6 billion. And none of currencies of these countries has come under that kind of speculative attack as the naira.”

A measure of the pressure on the naira was the sudden fall to N352/$ last Tuesday from N325 at which it sold previous Friday. This followed speculations that the CBN may soon exclude payments of school fees from its lists of items eligible for foreign exchange at the official market, which spurred panic buying of dollars at the parallel market  and saw the naira falling to a new historic low.

This, among other reasons, explains why proponents of devaluation continue to insist that the CBN must shift ground and reduce the tight grip on forex policy arguing that even without doing so, many operators have resorted to running their business at the  parallel foreign exchange market, ignoring that of the CBN in the process.

The debate has assumed the dimension of a conundrum, similar to between a rock and a hard place scenario. While the feedback from the CBN and by extension the Federal Government remains that devaluation is off the card, the issue of devaluation or not remains a burning issue among stakeholders, particularly economists and operators in the economy.

Renaissance Capital Analysis

According to foremost Financial Advisory firm, Renaissance Capital, there is a dichotomy between what the  corporate Nigeria and investors expect and what policy makers told its research team during a visit to the country. According to RenCap note, “What we observed was a dichotomy between what corporate Nigeria and investors expect and what policy makers told us. The arguments for either case were strong, but we noted some level of convergence from a few banks that devaluation could become inevitable by March –April 2016. This timeline was attributed by the banks to: products becoming unavailable due to companies’ inability to replace inventory due to forex scarcity; weak earnings from banks’ 2015 financial year results – some talking about auditors taking a tough stance on issues; and if the fourth quarter gross domestic product (GDP) data suggests a recession.”

Divergent Opinion on Devaluation

Speaking at TheCable Colloquium, organised by the online newspaper, Edo State Governor, Comrade Adams Oshiomhole, noted that the crux of the issue borders on speculation and not that of demand and supply pointing out that devaluation as being canvassed would lead to further economic crisis for workers. He also argued that devaluation, from statistics, would not guarantee increase in export activities as being canvassed.

“The evidence we have is that 98 per cent of our exports are in oil and gas, which are priced in dollars. So, no matter what your exchange rate is, the per cent will not change. On the other hand, when you devalue, will fewer people travel, again? The evidence is: No.

“What we are dealing with is not a supply issue; we are dealing with pure speculation issues. If you devalue, the main people that will be trapped are the workers. Will devaluation curb our appetite for imported goods as the IMF argued in the 1980s? The evidence from the CBN shows that policies in the Nigerian environment cannot curb our appetite for foreign goods.

“The last time the CBN devalued in 2014 our exports actually declined and our imports increased by 2.9 per cent after devaluation. When human beings don’t labour to earn they do not spend rationally,” he posited.

FBNQuest’s Macroeconomic & Fixed Income  Analyst, Chinwe Egwim, and Equity Analyst, Bunmi Asaolu, who responded to THISDAY enquiry, align with Oshiomohole’s argument, asking: “What if they (CBN) devalue to N280/$? Will that really reduce demand? Not really.”

“So, devaluation will not cut demand enough and it also won’t bring in as much as you need from portfolio inflows. When the JPMorgan index addition happened, we got inflows of $5-6billion per quarter. The shortfall for government revenue due to oil prices falling could be as high as 60bn dollars  per year. Devaluation won’t fill that gap,” he adds.

In the same vein, analyst with a Lagos-based economic advisory group, Rotimi Oyelere, in an interview with THISDAY, speaks along the same line with the proponents of no devaluation. Oyelere explains the naira had already devalued itself adding that official devaluation would lead to more economic burden on the citizenry.

“The currency has devalued itself; official devaluation will lead to more burden on the citizenry. Official devaluation will lead to increase in price of almost everything, name it, petroleum products and those products that are produced locally with locally sourced raw materials due to the transportation element.

“Many of those clamouring for devaluation already have the greenbacks stored up in the private vaults, they want official devaluation so that they can make a kill; they simply want round-tripping to continue.”

Director General of the Lagos Chamber of Commerce and Industry (LCCI), Muda Yusuf, however disagreed. In his argument, he maintained that the CBN needs to reverse some of its policies arguing that the current “foreign exchange policy is not sustainable” and asked rhetorically that “is the naira not already devalued.”

Yusuf’s argument that the forex policy is not sustainable corroborates the views of analysts at Renaissance Capital who maintained that “the arguments for either case were strong, but we noted some level of convergence from a few banks that devaluation could become inevitable by March-April 2016.”

“It is a bad situation that we have found ourselves in. The CBN needs to reverse some of its policy. The model of foreign exchange policy in place is not sustainable; CBN needs to be flexible; they should stop fixing exchange rate.

“The CBN policy is hurting the economy. As we speak, nobody is running its business on CBN’s model of exchange rate. Even those who were not included in the banned list can’t even get forex from the banks and it is the CBN policy that is causing the problems. Factories are closing down, people are losing jobs and investor confidence in the economy is waning. Foreign businesses can’t repatriate their profits and dividends,” Yusuf insisted.

“What can be supported by empirical evidence and market economies is to allow autonomous forex to come in.  This include Diaspora remittance, forex from multinationals, donor agencies and export proceeds; if they do that supply will improve. This is what can be supported by empirical evidence and market economics,” he argued.

On his part, Chief Executive of Financial Derivatives, Bismarck Rewane, appears to support a policy that encourages in flow of autonomous forex. He hinted at this in his contributions at the Cable Colloquium when he stated that, “In this country, 10 to 15 years ago, we had Western Union and MoneyGram, and these people were bringing money into Nigeria. Nigerians in the Diaspora have $21 billion every year, which can come in, why are they not bringing it here?”

A former chief economist of African Finance Corporation and Chief Executive Officer, Nextnomics Advisory, Temitope Oshikoya,  holds the same view as Rewane. He says: “As oil exports remains the main official government source of foreign exchange earnings, there has been pressure on foreign reserves and the exchange rates. However, there are other autonomous sources of foreign exchange including diaspora remittances. Both sources appear to be drying up partly because of uncertainty regarding government policies, including policy summersaults relating to capital accounts.”

But Oyelere disagrees still that failure to officially devalue the naira may lead to a recession. According to him “the economy is still looking good, Nigerian Bureau of Statistics  ((NBS) forecast showed a four per cent GDP growth rate so I don’t foresee recession with government’s continued funding of sectors that will stimulate the economy. We are not suffering from efficiency demand; it is efficiency demand that leads to recession, historically,” he states.

Seeming Convergence

However, Tule who was one of the discussants at the colloquium may have introduced an interesting twist to the debate when he hinted that devaluation of the naira might happen eventually on the back of a strong industrial policy adding that there was the need to put in place a strong framework that encourage foreign direct investments.

Whether the framework will be in place by March or April remains a question of time as is the prediction of the few banks, according to RenCap note, which see devaluation becoming a reality by March or April.

Cause of Recent Sharp Naira Fall

Market watchers have identified the reason for the sharp decline in the value of the naira.

One of the them is the Chief Executive Officer of Eczellon Capital, Diekola Onaolapo, who points that, “the recent development in the parallel market indicates that the BDCs (Bureau De Change) are increasingly finding it difficult to source for dollars from autonomous sources in the country since the CBN stopped supplying dollars to that segment of the FX market. “

“The dwindling supply position coupled with the unabating demand is the primary reason for the sharp decline in the value of the naira within the last one week. Small businesses that are heavily exposed to the FX market with elastic demand for their product(s)/service(s) will continue to bear the full brunt of the sharp fall in the value of the naira. Should this continue in the coming months, some of such businesses may be forced to shut operations or aggressively seek for substitute items within the country to remain in business as the cost associated with imports may become unbearable,“ he adds.

The Way Forward

Most of the analysts,  who are economic and financial experts, believe the CBN should adopt the floating exchange rate policy.  While some of them favour managed floatation of the exchange rate, the others support complete floatation.  A floating exchange rate or fluctuating exchange rate is a type of exchange-rate regime in which a currency’s value is allowed to fluctuate in response to foreign-exchange market mechanisms.

Proffering a way out of the naira challenge, Oshikoya suggests as follows” N350 to $1 does not represents the true value of the Naira and neither is N200 to $1 given the magnitude of the shock. The current parallel value is a mix of the true value and uncertainty relating to policy. One policy guide would be to ask: what are the objectives of government? One principal objective is to finance the expansionary budget deficits at a lower borrowing cost. Within the context of the monetary policy trilemma, interest rate has been reduced from 13 per cent to 11 per cent. This can be reduced further to 9 per cent or 10 per cent and also assist in pushing bond yields down. Once this objective is achieved and real borrowing cost will be around 1 per cent, the CBN can then move towards managed floating exchange rate and partial capital controls.

“The managed floating rate system can use differential inflation rate between Nigerian and its major trading partners as a guide; this would result in a depreciation of around 10 per cent maximum, taking the central rate to N220, while the margin around it is widened. It can combine this with limited demand management but giving preferences to importers of raw materials and capital goods for manufacturing and industrial production. The ban on sourcing of foreign exchange from the CBN by the BDCs is a good one. BDCs should source foreign exchange from autonomous sources, which are larger than the inflows to CBN. Given anecdotal evidence on misuse and diversion of foreign exchange, the idea that banks should publish their foreign exchange utilisation is a good one.”

In his own prescription, Executive Director, Corporate Finance, BGL Capital Limited,  Femi Ademola posits that, “the CBN should consider a complete floating of the currency while using the supply of foreign currency to manage the price exchange rate; not directly setting the price. Although this may lead to a significant decline in the Naira immediately, it would moderate and stabilise at the appropriate market-determined rate in the short to medium term while the Naira could appreciate quite significantly over a long time as we moderate demand for foreign products by looking for local substitutes and thus encourage local production. Because the country’s assets are mostly kept in foreign currency while most of the liabilities are in local currency, the usual financial fragility of an emerging market is not applicable to Nigeria and the financial system may also not suffer much as banks’ foreign currency liabilities are not so significant to threaten banks and corporate balance sheets; hence there should be no fear to floating the currency.”

“The adoption of this method will be in line with the economic theory that you can’t simultaneously have an independent monetary policy, a fixed/semi-fixed exchange rate regime and a liberal capital mobility regime. One of these three has to give way for the remaining two. Since Nigeria is not thinking of jettisoning the independence of the monetary authority, and restricting capital mobility appears not sustainable, Nigeria should benefit more from a complete floating of the Naira, especially in the long term. However, a complete floating of the Naira needs to be supported by strong, transparent and implementable fiscal policies that can encourage more exports than import, to maximise the benefit of the “devalued currency”. The absence of the right fiscal policies has been making the approach seemingly inappropriate.”

“While the CBN will try to supply foreign exchange to the interbank market to meet with genuine import needs, the parallel market would be meeting the ostentatious need from autonomous sources. This may be a step towards the complete floating of the currency while supply by the CBN would moderate the effect as the case may be depending on the trigger targets, either inflation or monetary aggregates. This method has been adopted in many African countries including South Africa,” points out Ademola.

Giving the same prescription, Managing Director, Dunn Loren Merrifield Asset Management & Research, Tola Odukoya, notes that “the floating rate option appears to be the most suitable one for us at this point in time.”

According to him, “My view is based on the fact that the current fixed rate system has created a massive arbitrage for players in the currency market given the wide berth between the subsisting rates in the official and parallel markets. In addition, at some point in time we may have to devalue the currency given the sustained erosion of foreign reserves, the outlook for oil prices and the expected expenditures as contained in the 2016 budget.

“While the two-tier system has its merits, especially in the short term, its consequences can be dire given the challenges we have as a country with respect to transparency. For example, the two-tier or multi-tier system can easily create ample room for economic rent for factor of production benefitting from implicit protection, amongst other issues.”

Still from the same school of thought, Onaolapo states that, ”the CBN would have to relax its restrictions on the naira as its current strategy of holding on to the naira can only last for a while.”  This, he points out,  could be achieved via “a managed floatation of the currency which would go a long way to eradicate the current wide gap between the official and parallel market, as well as boost supplies from autonomous sources within the country.” “This is beyond devaluing the naira and holding on to it at a new rate and band. We believe that devaluation as a standalone measure will not adequately address the challenges in the FX market.”

Onaolapo adds: “On the fiscal side, a short to medium term measure is to curtail the nation’s importation for refined crude products. For instance, CBN data indicates that out of the US$2.9billion the apex bank allocated to importers in the month of December 2015, 47.2 per cent (US$1.4billion) of this amount was for the importation of petroleum products into the country. Thus, fixing the nation’s domestic refinery would go a long way to cushion the pressure on the nation’s scarce FX resources and by extension the naira.”