Stabilising Naira through fiscal/monetary policies – Part 1

nairaOur economy did well in the last decade with the average GDP growth rate between 2005 and 2015 reaching an impressive 5.9%. Notwithstanding, the economy is still in the doldrums as it struggles to cope with a myriad of economic challenges. Lately, global oil revenues have declined due to a fall in prices, which plunged below US$30 per barrel in early 2016 for the first time in 12 years. As the petroleum sector contributes approximately 11% to our economy and oil exports currently constitutes about 90% of our export revenues, the effect on our nation’s income has been devastating. Revenue available to governments at all levels has plummeted with most state and local governments unable to pay the salaries of public servants at the moment.

As a result of the decline in international oil prices and the attendant effect on our foreign exchange earnings, the pressure to devalue our currency is mounting daily. However, we are not alone in this quagmire. On March 14, 2016, the Central Bank of Egypt further devalued the Egyptian Pound by 13 per cent against the US Dollar. This announcement followed similar devaluations of national currencies by Russia, Venezuela, Kazakhstan and Azerbaijan in response to the severe economic pressures that these countries were facing. Several other Gulf States are also experiencing intense pressure on their currencies. However, unlike Nigeria, countries such as Saudi Arabia, Oman and Bahrain have significant foreign reserves which may help them stabilise their currencies without undue strain in the short term.

According to CBN, our external reserves have fallen to about $27.88 billion as at March 2016. This represents approximately a 65% decline in reserves from about $42.8 billion in 2014. At the moment our foreign reserves is equivalent to just five months import cover.

A key reason for the depletion of our external reserves over time is the high rate of domestic demand for foreign exchange which has steadily risen over the years, severely straining the capacity of the Central Bank to meet it. Domestic demand is fueled by importation of petroleum products; auction sales to BDCs, banks and other government agencies to fund foreign exchange requests for imports, foreign school fees, personal travel allowance (PTA), business travel allowance (BTA), medical tourism and international card transactions; Joint venture cash call payments; Public sector uses and infrastructural development.

As demand exceeds the supply of foreign exchange and the CBN continues to maintain a narrow fixed exchange rate band for the Naira to U.S. dollar of between N197-N199, it has had to use its external reserves to meet the excess demand and defend the value of the naira. Suffice to note here that several countries have either experimented with fixed rate regimes or have tried at one time or the other to exert artificial influence over the exchange rates of their national currencies and failed. Japan and Switzerland are classic examples.
These failures are also a clear indication that adjusting monetary policy only without corresponding action on fiscal policy is unlikely to produce the desired effect of exchange rate stabilisation. Indeed, fiscal policy must be adjusted to shift the fundamentals of the economy in the intended direction.

The Central Bank announced a number of measures in June 2015 in a bid to introduce stability in the nation’s currency in response to the effects of dwindling foreign exchange earnings. Several administrative controls were put in place. One of these was the removal of 41 imported items from the list of commodities for which foreign exchange could be obtained from the CBN for the purpose of importation. February 2015 saw the stoppage of foreign exchange sales to BDCs by the apex bank and the closure of the Wholesale and Retail Dutch Auction System (WDAS and RDAS) windows in a bid to curtail arbitraging or the so-called round tripping and speculative activity. These measures have failed spectacularly as the excess demand has poured into the parallel market, widening the exchange rate differential by as much as 100% at some point and thus expanding the incentive for arbitraging.

Many experts believe that the Naira should be devalued while others argue that the time has come for the CBN to abandon the fixed rate currency regime and allow the Naira to find its equilibrium levels which is believed will be somewhere between N250 to N260 as policy coherence replaces current uncertainties and enables the return of private sector foreign exchange, foreign direct investment and portfolio inflows to the official market. However, President Muhammadu Buhari has clearly stated that this is not an option for his APC government with its “change” mantra.

I sympathise with the CBN Governor and the President because they are caught between the devil and the deep blue sea. While the current official exchange rate is largely artificial; does not reflect economic realities and the true value of the Naira, a sudden devaluation in the short term is likely to lead to even higher inflation, greater unemployment, more hardship for Nigerians and a significant risk of political unrest. The opposition would argue that this is not the sort of ‘change’ Nigerians voted for. In any case, devaluation is only a temporary measure which does not fix the fundamentals. There are several fundamental factors that have contributed to the downward pressure on the Naira, and are still exerting a massive influence on the currency. Nigeria is undeniably an import-dependent economy. According to the National Bureau of Statistics, Nigeria’s import bill in 1984 was N167.88 million, but in just the 2nd quarter of 2015, Nigeria spent N1.493 trillion on imports. CNBC Africa also reported in an opinion write-up on its website on January 20, 2016, that Nigeria spends N1.3 trillion importing food annually! Nigeria’s food import bill is said to be rising at a rate of 11% annually, according to data on the website of Doreo Partners. The National Bureau of Statistics reported that the Federal Government spent about N1.82 trillion on importation of petroleum products between January and September 2015. Petroleum product imports accounts for 45% of the consumption of foreign exchange earned by the CBN, according to a recent interview granted to Silverbird TV by Comrade Peter Esele, former President of the Petroleum and Natural Gas Senior Staff Association of Nigeria (PENGASSAN). Some experts believe that the true figure is much higher. The Chairman of the Senate Committee on Tertiary Institution and Tertiary Education Trust Fund (TETFund), Senator Binta Masi, stated in January during the commissioning of a project at the Federal University Lafia that Nigeria spends over $2 billion annually on foreign education.

It is obvious that as long as Nigeria continues to spend colossal amounts of its foreign exchange earnings on consumption of foreign goods and services, there will always be a massive excess demand for foreign exchange to settle these transactions. Therefore, while devaluation of the Naira may eventually reduce the pressures on the external reserves held by the CBN and reduce round tripping by narrowing the exchange rate arbitrage gap, it will not solve the demand issue in the long term.

The CBN should work hard to encourage harmonisation of its monetary policy with the Federal Government’s fiscal policies to encourage a shift in the nation’s status as an importing nation to that of an export-oriented country. No economy can operate on independent monetary or fiscal policies alone. There has to be a synergy of both monetary and fiscal policies for the Nigerian economic fundamentals to shift towards true, inclusive growth. For effective harmonisation, there should be a more cordial relationship between the CBN and Ministry of Finance. The relationship should emphasise information sharing, cooperation and coordination of policies and more crucially, eliminate uncertainties that adversely affect investments.

With regard to monetary policy, economists are aware, there is an intricate link between interest rate, exchange rate and the general price level and the challenge is to establish optimum levels of these consistent with internal and external balances. Policy choices must be made as the three variables cannot be controlled simultaneously as it appears that CBN is attempting to do at the moment.

• To be continued tomorrow
• Olorogun David Edevbie is Commissioner of Finance, Delta State.

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