Khan: Nigeria Needs a Workable Foreign Exchange System

The Managing Director/Chief Economist for Africa, Standard Chartered Bank, Razia Khan, in this interview stresses the need to resolve the foreign exchange bottlenecks in the country. She spoke with Obinna Chima. Excerpts:

What is your take on the new fuel price regime that was announced by Nigeria’s government?

It is very good to see because there has been increasing doubts about the willingness to allow for pricing that would not stall economic growth. What became clear with the shortage of fuel was partly a function of the difficulty in obtaining foreign exchange. The attempt to regulate at much lower pricing did not work. What we saw was that the actual price of fuel in Nigeria was probably a lot higher than the new ceiling or the “deregulated” price. So, this is the right time for reform in the industry, by putting in place reforms that would hopefully increase the supply of fuel and deal with the bottleneck.

The hope is that at this new price, there would be a lot of supply of fuel. But I think the relevance of this goes beyond the announcement. In term of showing the resolve of the authorities to deal with what had become a pressing economic issue, it obviously raises the hope that we would see a similar approach being adopted when it comes to other constraints that the economy is facing as well as other bottlenecks that have held back growth. So, it is very interesting because a part of this new fuel price regime is the idea that oil marketers would get foreign exchange that they need from whatever secondary sources might be available and they are allowed a leeway to show whatever pricing they need to show subject to a new ceiling. That at least is better that the situation we had before.

In terms of public finance, there was a weak system in place previously. You never knew what he extent of budgetary commitments to subsidy was and that was an exceptional flawed system in place previously. Now, we should all breathe a more easier that Nigeria’s public finance looks to be on a sound footing simply because the uncertainty over the re-emergence of fuel subsidy appear to have gone away.

But the more important thing for all is the need to adopt a pragmatic approach when it comes to policy. Clearly there was a desire to keep prices low, that wasn’t working given the forex constraints. The next question inevitably is what this means with the desire to do something about forex. So, I think the real significance of the fuel price move isn’t just the fact that we have seen some level of deregulation of fuel price, but it is an evidence of a much more pragmatic approach on the part of government. And this is going to be the key.

There is a broad-based recognition that in the absence of a workable foreign exchange market in Nigeria that causes great problem to the economy. There is a forex shortage; it is the second best outcome. Many of our Nigerian clients were saying that up to a year earlier, they didn’t really mind the risk of further naira weakness on the official market if only it would come with improved availability of forex. What has been really damaging to Nigeria’s business prospects is not being able to obtain forex at at. So, any policy measure that looks like it is going to address that will be positively received.

What does the hike in fuel price mean for the strength or weakness of the naira and in an expanded budget environment what would be the impact?

The budget has been passed, the spending has started and so there should be more liquidity. The central bank can obviously deal with this by engaging in regular mop up. The CBN governor has said that it is not a good situation that inflation should be higher that policy rates. So, are we going to see a further tightening of policy? Well the suggestions are that, that may be the case. I don’t one should look at the impact of the fuel price hike on the parallel market to judge.

But what is needed presently is spending. The other very important factor is that so much more of budgetary resources are going to be devoted to capital expenditure. I understand that the finance minister has said that it would release on a quarterly basis, N350 billion, which is a little over five per cent of the budget. If that comes on a quarterly basis, we are looking at about 20 per cent spending being capital expenditure. But that is still an improvement in what we traditionally saw in Nigeria.

So, should we anticipate pressure on the parallel market with the passage of the budget? I don’t think that would come from the budget. Firstly is because the budget was passed in the context of a significant gap in public finances that had already built up. So, it is not that Nigeria is going to be hugely liquid. And also, the nature of spending. If it is capital expenditure p, it shouldn’t result into big liquidity injection into the economy.

What is the outlook for inflation?

This is going to be very interesting to observe. If you look closely at the National Bureau of Statistics published data, they have been putting in regular monthly schedule which they have been sending along with the Consumer Price Index (CPI), what the price of petrol is in different states and in different months. And we know that prior to the announcement of the new fuel price regime, the price being paid for fuel was more than N145 per litre. Now, there would be some elements of opportunistic pricing because as fuel prices officially goes up, some people would use that as excuse to raise transport prices. So, it is inevitable that we would see a little of that filtering into inflation. But we should not make a mistake of thinking that this ‘deregulation’ actually a sustained price hike.

This is because relative to the evidence that we have before us, in a lot of instances, higher prices were being paid for fuel prior to the new fuel price. So, inflation needs to be monitored closely. This is another argument in favor of further monetary policy tightening. The risk towards further tightening is building. It creates a dilemma for policy makers of the much weaker economic growth and a lot of the issues that they have to deal with are bottlenecks that had arisen partly as a result of policy itself.

So, they do need to think about everything they need to bring inflation down. So, from our price indicator research, the suggestion was that the controls put in place that restricted some items from forex is still having an impact on month-on-month inflation. That suggests that if you really want to do something about inflation, you will have to think about whether that is the best way to go about encouraging domestic production.

When are we likely to start seeing capital inflows into the economy?
No one is necessarily going to be investing still if they think that there is a foreign exchange regime that is not workable because it doesn’t allow for the queue for foreign exchange that builds up to be resolved. So, the more important thing, even more important than the level of interest rate in Nigeria is what can be done to resolve the foreign exchange bottlenecks. And any investor who talks about it solely from the view of a devaluation is probably coming up with the wrong argument.

We all know know that you can’t absolutely pick a number as a fixed exchange rate regime for Nigeria that is going to work. A devaluation is not the answer. A move to a workable foreign exchange system that better equilibrates demand and supply is what Nigeria needs. That could take the form of a currency band and around a certain mid-rate. It could be a band that moves gradually over time. There are ways for the authorities to control the full extent of this. But I think it has become clear to a lot of stakeholders that this is needed. No one in Nigeria should think that a simple devaluation, with no change in the fixed income rate regime put in place in February last year is going to bring in a great deal of forex.