Thursday, 10 September 2020

FLOATING IS AN OPTION.

The naira should be floated to find its exchange rate value on the market if Nigeria's economy is to function well be productive. The writer discusses what economists call "purchasing power parity"  - what your currency can purchase for you in your national market as a way to measure GDP per capita.

Because we are an import economy, we want to maintain an artificially strong naira/dollar exchange rate, to subsidize the import habit of our elite.  We produce and export nothing that is value-added. Over 90% of our forex comes from oil. When an economy lacks "complexity" (value-added manufacturing as a ratio of GDP) but depends on exports of natural commodities or minerals, the exchange rate value of its currency is determined by the level of its foreign reserves, which accrues mainly from income from such commodity or resource exports. These reserves determine how many months of imports such a  country can pay for. So when oil prices are high for a long period, the reserves swell, and the naira value relative to foreign currencies rises. When the oil price crashes, our reserves are depleted. When reserve levels indicate a country's ability to pay for up to six  imports is threatened, market forces weaken the strength of the currency (naira in this instance). The value of the currency crashes, because that value is not underpinned by diversified exports as is the case with mature economies. If oil were $100 per barrel, for example, and our reserves rose to $60 or $70 billion, the naira value relative to the dollar will go up. For this reason commodity dependence exposes a country to currency instability except the country builds up huge reserves (eg Saudi and the Gulf countries which have invested heavily in oil refining AND have huge sovereign wealth funds in addition to exporting crude. It is OBVIOUS that there is backing for that legal tender in terms that are relevant internationally. The naira is not so fortunate because our economy is "naked" and globally uncompetitive.

What all this means is that CBN efforts to "defend" the naira is pure folly, economically speaking. It weakens the very  value of the naira it is defending because the dollar supplies come from the external reserves,  but is politically "expedient" because it creates an impression of patriotic nationalism. But it's just populism. Foreign investors have  exited, and forex is not coming in as investments aren't at a level that can create confidence.

So the only way to reposition our economy is to shift it from import-oriented to one that is export-oriented. For as long as CBN continues to subsidize the value of the naira this will not happen, because they are creating incentives for an import orientation. Forex "ban" makes the matter worse because local productivity is not enough to meet the gap in demand for the previously imported products. Smuggling booms. Meanwhile, in a frontier economy, Aso Rock cabals have access to the naira at CBN rates, so they obtain huge amounts of subsidized dollars from the apex  bank, and turn around to sell the dollars at the street market rates with huge profits. Arbitrage reigns. The black market booms.

But if CBN devalues the naira or allows it find its value in the market, this will create an incentive to manufacture locally and EXPORT in order to earn forex.  Ecause imports become more expensive. But other policies must accompany this approach. The absence of those policies is why series of devaluations have not solved the problems, but only import inflation. 

The necessary accompanying policy thrust is trade policy. Instead of forex bans, anyone can import, but slap high tariffs (revenues for the government!) on imports deemed luxury items. Provide policy support to enable local production of such goods to be cheaper than foreign imports. That way, rich people can buy expensive imported goods, poorer people can buy cheaper "local-made". More exports, more forex, and eventually the value of the naira stabilizes. The "cheap" exchange rate of the naira (from the perspective of foreign trade partners) will lead to greater orders of Nigerian manufactures, which = more forex earnings.  Foreign investors seeking profit will also flood the country with dollars because the market is "open" and trade transparent. This will also help stabilize the naira. 

But this is difficult when Nigeria is being mortgaged to a country like China. If our government treats China as its financial lifeline, can we slap the appropriate tariffs on imports from China which are so cheaply produced that it makes production in Nigeria uncompetitive? This is part of a broader problem  of the absence of a worldview that includes a strategy to rise in the world, including economically.

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