Still on The Depreciation of The Naira

Alex Otti BY OUTSIDE THE BOX

alex.otti@thisdaylive.com

On the 5th of July we had opened a debate in this column on the depreciation of the Naira. For those who may have missed it, kindly go to the website and update yourself so you can follow today’s discuss. We received a response from Mr. Eustace Odunze, a renowned Economist and lawyer. We hereby publish Mr. Odunze’s piece and will conclude with our reaction to him.

WHY DOLLAR RATE MAY NOT GET TO N1,000

By Eustace Odunze

Dr. Alex Otti’s column, “Outside The Box”, is one of my favorite pages in the THISDAY Newspaper. I find it always very well written in simple prose with amazing details, well researched information and very easy to read. I have known Alex personally for decades and I have followed his excellent career from banking to politics and now to journalism. Nevertheless, the most compelling reason why I read him every fortnight is his near exact prognosis of the problems with the Nigerian economy, and his recommendations for mitigants are always spot on.

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 1970’s 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% import dependent. The major product of the Nigerian economy, oil is priced in US 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 its single product – oil.

The over aching question then is why is price of Nigeria’s oil denominated, negotiated, traded and settled in US dollars instead of in Naira. The simple answer is that the Naira is not a convertible currency as mentioned in the column. Currency convertibility is a very interesting concept in macro economics, it is confusing and difficult to understand even by trained Economists. Alex 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, ease of exchange of their currency, availability of huge business and employment opportunities etc why do others not actively pursue 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 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 Financial dictionary, the key definition of currency convertibility is the ability to exchange the currency without government restrictions and controls.

It means to freely float the currency or to fully deregulate the foreign exchange market. A fully deregulated foreign exchange market is the market that is governed purely by the interplay of the forces of demand and supply and the rate determined at the point of equilibrium between those two. Nigeria cannot afford this scenario and this 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 the real value.

Nigeria’s major supply of foreign exchange comes from the daily proceeds of crude oil sales, which accounts for about 85% of the dollar receipts. The next major source is home remittances from Nigerians abroad. In 2011 Nigeria’s total receipts from oil stood at $68.4b, it has been dropping since then to $58b in 2013, $55.5b in 2014 to $32.6b in 2018. There was a slight recovery to $34.2b in 2019, according to the Nigerian Extractive Industries Transparency Initiative NEITI . The near sustained drop in the total annual receipts is largely due to the drop in oil prices during the respective periods. The volume of crude exports held steady during the period due to the calm that was restored in the Niger Delta region. During this period, the volume of home remittances followed a near similar pattern from $24b received in 2014 and 2015, through a spike in 2016 to $35b, then dropping to $25b in 2018 and the worst figure in 5 years of $17.5b in 2019 and 2020.

The figures above clearly show that between oil exports and home remittances, Nigeria nets between $70b to $75b average annual dollar receipts. This is significant and in fact huge when compared to 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 US dollar when compared to some African countries like Botswana, Morocco and even our next door neighbor Ghana ? The trouble must then be with the demand.

The Nigerian economy being import dependent means that the greater supply of goods are imported. In fact a Nigerian Minister recently alleged that Nigerians import pizza from abroad. All imports are paid for with foreign currency, the implication is that despite the 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 circumstances. The first is to increase 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 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 center on diversification of the economy to agriculture. This is desirable since food import accounts for a significant portion of the demand for foreign exchange. It is, however, a slow and long drawn approach, its impact is in the long term and according to the renowned Economist John Maynard Keynes, “ in the long run we are all dead “. A quick win approach is the boosting of supply of foreign exchange from low hanging sources that are achievable with immediate policy changes by the government like 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 country. Nigeria can easily double its home remittances up to $50b 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 receipts in excess of $100b. With this scenario, ceteris paribus, the exchange rate of the dollar will have no business getting to N1000 as projected by Alex.

RESPONSE FROM

ALEX OTTI

Let me thank my friend and brother, Mr. Eustace Odunze, for exercising his right of reply and for his very kind words. It is our tradition to yield the column to readers who hold different points of view on any of the subjects we discuss here. Specifically, we had stated that we were opening a debate in the last but one column on the depreciating Naira exchange rate, titled “How Much Dollars Can Your Naira Buy?”. I am glad that a reader of Eustace’s stature has joined the discussion.

On a general note, I did not see that Mr. Odunze and I fundamentally disagreed on the subject matter. The kernel of his response was that it was possible for the exchange rate not to continue its slide. Of course, we had said that much in the essay in question, and it is our hope that it 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 for foreign remittances may not necessarily be within our control. Granted that improving security and building infrastructure could attract more remittances, one would need further tests 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 as it was last year when the Covid Pandemic forced many people out of job 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. A change in circumstances would also affect receipts, for instance remittances to build a house will cease when such a house is completed and remittances for 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 the 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. This will definitely have a very adverse impact on remittance flows. 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 to the Nigerian treasury. Beyond oil, there is gas which we have hitherto not paid serious attention to as we have been flaring same for decades and sitting on untapped trillions of standard cubic feet. Its use will not be limited to local needs but 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 in the column in question.

Finally, we must state that as 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 had 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 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 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 6 years, it can also move beyond N1000 if we continue with our current form of economic behaviour.