The debate on the adjustment of the exchange rate of the naira is beginning to gather momentum. The nation is understandably divided over it. If it can be avoided no one wants a devaluation of the naira. But the naira is now under increasing demand pressures. The unofficial exchange rate now stands at nearly N400 to the US dollar, while the official rate hovers around N200. The following article by me on the issue was first published in this paper in October, 2015. At the time the naira exchange rate in the parallel market was N238 to the US dollar. It is being published again, without any editing by me, because I believe that a downward adjustment of the naira exchange rate is now inevitable. The CBN cannot save the naira from devaluation now unless there is a substantial build up of our foreign reserves through increased oil exports and revenue. This is unlikely in the short to medium term. Further delays in allowing a more flexible exchange rate will worsen the situation and constrain economic growth.
As in 1984-5, Nigeria is again at loggerheads with the international financial institutions. It is under strong and persistent pressure from the World Bank (WB) and the International Monetary Fund (IMF) to devalue its national currency, the naira. At a recent meeting of the WB/IMF group in Lima, Peru, a senior official of the IMF was reported as urging Nigeria to devalue its currency ‘as a way of adjusting to the reality of the current (global) economic conditions’. These conditions include the sharp decline in the global price of oil, as well as a fall in the price of non-oil/commodities exports. Specifically, the IMF official argued that exchange rate pressures in Nigeria and other oil producers had been considerable since last year. Nigeria’s oil exports and revenues have fallen considerably, while the high demand for foreign exchange in Nigeria has continued to exert considerable pressure on the exchange rate of the naira. In other words, while earnings from oil and non-oil exports have in the past year declined by over 70 per cent, the demand for foreign exchange to finance Nigeria’s huge import bills has not fallen. Because of Nigeria’s high import dependency, there is a supply/demand gap in foreign currencies that is putting pressure on the naira exchange rate. There was also some reference by the WB/IMF to ‘uncertainties in Nigeria’ about the May elections and the policy direction of the new federal government regarding urgent policy reforms. These were claimed by the WB/IMF as additional factors that have led to pressures on the naira. Very few informed analysts will dispute this.
But the CBN Governor has rejected the calls for the devaluation of the naira. As an alternative to a more flexible exchange rate, the CBN has introduced administrative measures that are intended to limit access to foreign exchange, as well as a ban on some 41 listed import items as a way of reducing the demand for foreign exchange. The CBN Governor has vowed to defend the naira at all costs against any devaluation, adding that it was a question of nationalism. Economic nationalism is good and popular, but it has to be based on the prevailing economic realities. If it has any potential of hurting the economy, then it should be reviewed. The WB/IMF has dismissed the CBN administrative measures aimed at import restriction as detrimental to the Nigerian economy, as both local and private investors see these measures as very detrimental to their economic activities. There is already considerable concern in the Nigerian business circles over these restrictions, as their impact on business in Nigeria will be negative, with loss of productivity and jobs. Instead of these administrative measures, the WB/IMF are urging the federal government and the CBN to permit the naira exchange rate to adjust so as to reduce the demand for more foreign exchange, and to help contain the level of imports that is no longer sustainable in the light of the external shock (the decline in oil revenues) to the Nigerian economy. So far, the CBN has ignored these local and foreign pressures to devalue the naira.
In all these, it appears that, right now, the federal government is in support of the position of the CBN that the current exchange rate of the naira should be maintained at all costs. In effect, for now, President Buhari has ruled out any further devaluation in the exchange rate of the naira, despite its volatility. This is not surprising. When he was in power from 1984-85 as a military ruler, Buhari rejected similar calls by the WB/IMF on Nigeria to devalue its currency. Then, Nigeria faced a severe external shock, worse than the current one, with severe balance of payments disequilibria, a huge foreign debt, and lack of foreign credit. Nigeria had drifted into economic chaos during the Shagari government, which lacked the capacity to effectively tackle the underlying structural problems of the Nigerian economy. Tougher economic measures had become urgent and imperative. The nation was on the verge of total economic and financial collapse. Productivity in the manufacturing companies fell, leading to a rise in unemployment and long food queues. Nigeria resorted to rationing ‘essential commodities’ as a result of severe import restrictions.
In response to the severe economic and financial crises, the Buhari military regime also resorted to import licensing, trade by barter and counter trade. But all these administrative measures failed to address the underlying structural imbalance in the domestic economy. Buhari rejected the advice of the WB/IMF to introduce a structural adjustment programme (SAP), the highlight of which was the devaluation of the naira, to curb imports and promote non-oil exports. Buhari considered the measures being urged on him as impractical and politically inexpedient, as it would certainly lead to an inflationary spiral in food prices and other vital imports. In Egypt, similar currency devaluations had led to ‘bread riots’ and instability in the Arab world, a situation that could threaten the survival of his new military regime. He considered the WB/IMF prescription for devaluation as an invitation to suicide and so rejected it.
But in December, 1985, Babangida replaced Buhari as military ruler. Shortly after, he introduced what he called a ‘home grown’ SAP after a long and heated debate in the country, with the overwhelming majority of the Nigerian public rejecting any devaluation of the naira. But courageously, he pushed through the tough economic and financial reforms that the situation called for, including the massive devaluation of the naira. The reforms soon paid off. Imports fell and non-oil exports expanded considerably. Nigeria returned to fiscal balance and balance of payments equilibrium. New foreign credits were extended to Nigeria, the food queues ended and the economy recorded a modest growth. Of course, the global rise in oil prices assisted the process of economic recovery, but the exchange rate adjustment introduced at the time by the Babangida regime and the CBN made this modest economic recovery possible. Had he not taken those urgent and necessary monetary and fiscal measures, particularly the devaluation of the naira, Nigeria’s economic crisis would have worsened. Of course, Babangida later abandoned some of these effective economic and financial measures for reasons of political expediency. This soon undermined the modest economic recovery achieved during his regime.
Right now, we are at a similar crossroads as in 1985-86 when the issue of the exchange rate of the naira evoked very strong negative response from the government and the Nigerian public. Again, the CBN has rejected all calls for a downward adjustment of the naira. But can it really save the naira from further devaluation? Right now, the official exchange rate of the naira to the US$ is N200 to 1, while at the parallel market, the exchange rate is N238 to the dollar. This is a clear indication that the naira is overvalued. One indicator of overvaluation of a currency is the difference between the official nominal exchange rate and the parallel market exchange rate. The parallel exchange rate is probably nearer the net effective exchange rate than the official rate. One possible cause of the probable overvaluation of the naira is the rising inflation rate that now stands at nearly 10 per cent. This was caused by the excessive expansionist policy of the federal government in recent years. So, the issue of devaluation is not simply a question of nationalism or patriotism. It has more to do with the global recession, the fall in the value of our exports and the failure caused by our inconsistent economic reforms over the years to diversify the economic base. Nigeria’s domestic economy is not yet mature. Growth is still fragile as it depends mainly on oil exports. This situation makes it difficult for the Nigerian economy to successfully withstand the external shocks we have now had for a year. Market conditions are not always perfect. They can be easily manipulated by financial speculators. And devaluation is not always the answer to external shocks of the kind now facing Nigeria. But any alternative offered by the financial authorities must be effective, sustainable and credible. Administrative restrictions lack these qualities.
To save the naira from further devaluation, oil exports and revenues need to rise significantly. The short term prospects for this are not encouraging. Commodities’ prices are also falling and do not offer Nigeria any real alternatives. Nigeria’s foreign reserves now stand at less than US$30b, enough only for four to six months’ imports. The SWF of US$1b has been depleted by US$700m to meet domestic deficits, leaving a paltry balance of US$300m. Our foreign debt is growing, exports are falling, and there is a rising demand for foreign exchange from the manufacturing sector. The volatility of the naira exchange rate is leading to capital flight and a disincentive to both local and foreign investment in the economy. Planning is made more difficult by the volatility in the exchange rate of the naira. Foreign investors will be looking to other countries with financial stability, particularly in respect of exchange rates. In the circumstances, it will be tough for the CBN to maintain the current official exchange rate of the naira.
Of course, the World Bank and the IMF are sometimes wrong when they urge devaluation on developing countries facing external shocks, irrespective of their respective situation. Some countries need it, while others do not. And the refusal to undertake the necessary exchange rate adjustment is not simply a question of patriotism or nationalism as the Governor of the CBN was reported as claiming. Even China, the second largest and fastest growing economy in the world, has had to devalue its national currency by nearly 30 per cent to boost its exports. The result has been positive. This year, China’s economy will grow by nearly 7 per cent, while Nigeria’s growth rate will fall from nearly 7 per cent to only 2.5 per cent. Actually, the US wanted China to revalue its currency. Instead, it devalued it to promote its exports. Many of the advanced industrial countries have also had to devalue their currencies at one time or the other. In 1966, the British Labour government devalued the pound sterling when it needed to borrow from the World Bank and the IMF. Brazil, Chile, Argentina and Mexico are some of the BRIC countries that have had to devalue their currencies in recent years to cope with external shocks to their economies. Most African countries, including Ghana, Zimbabwe and Tanzania have had to devalue their currencies in the past year. If it devalues, Nigeria will not be the only African country to do so. And it is always better to devalue early than later under stronger international pressure.
So, if it decides to devalue the naira, Nigeria will not be an exception, as it is simply a matter of adjusting to external shocks. If we do not devalue now, then we will have to take additional economic and financial reform measures, as tough as those of the Babangida years. These will still have to include the devaluation of the naira. Such reforms will have to include a review of the existing oil subsidy, which cannot be sustained financially for much longer. Major reforms will also have to be undertaken in our oil sector to eliminate the vast corruption and oil theft there. The cost of government will have to be cut considerably. As long as the reform measures are fair and transparent, they will be accepted by the Nigerian public. Smuggling of imports into Nigeria through our porous land and sea borders will make nonsense of the present strategy of import controls. Unless there is a significant recovery soon in our oil exports and revenues, I believe that Nigeria will be forced to devalue its currency, the naira, before too long. In fact, by the second half of next year the dollar exchange rate could be as high as N300. An early and modest devaluation of the naira will be in the overall economic interest of our country.
