“One hundred thousand naira is now behaving like ten thousand naira; and no one is saying anything about it!” -Anonymous Social Media Blogger
Exchange rate is very important particularly for a country like Nigeria, whose currency is not convertible. According to Investopedia, a convertible currency, is any nation’s legal tender that can be easily bought or sold on the foreign exchange market with little to no restrictions.
A convertible currency is a highly liquid instrument as compared with currencies that are tightly controlled by a government’s monetary authority. Sometimes, convertible currencies are referred to as hard currencies. A convertible currency commands the confidence of investors as a reliable store of value and therefore gives them the assurance to save, spend and trade in such a currency. Countries whose currencies are convertible tend to have a few things in common. The first is economic growth and stability. The next is political stability. The others would include price stability, moderate inflation rate and reasonable unemployment rate. In simple terms, such economies provide solid bases of predictability and security that will enable investors and users of such currencies to have a reasonable level of certainty about their net worth and the value of their holdings in such currencies. Examples of currencies that are convertible are the US Dollar, the Euro, the Japanese Yen, and the British Pound Sterling, in that order.
There are a lot of other currencies that are either fully convertible, like the ones listed above or partially convertible like the Chinese Yuan. The vast majority of Third World countries have currencies that are generally not convertible. Our almighty Naira belongs to those currencies that are not convertible, even though it once had the strength to acquire such a status. Holding such currencies become very risky as they may lose value easily and converting them to other currencies may pose a challenge.
So, despite opportunities in those economies, investors would have to be careful as what they may earn from the opportunities may be wiped away overnight, on account of the depreciation of the local currency. It is also a very big risk for foreign investors because they count their profits in hard currency and not in the local currency of the economy they invested. For instance, a project in Nigeria may look very profitable to a local investor who invested, say, N1m in it. If the net profit is, say, 30% of what he invested in Naira terms, it would be a loss to the foreign investor if the exchange rate of the local currency depreciates by more than 30% since the principal and profit will have to be accounted for in hard currency.
Snapshot of exchange rates at the official window and parallel markets for 2015-2021
YEAR OFFICIAL PARALLEL
2015 N196.5 N268
2016 N304.5 N374
2017 N305.5 N364
2018 N306.5 N365
2019 N307.5 N362
2020 N379.5 N470
2021 N411.25 N500 As at June 30, 2021
Recently, the official exchange rate hit an all time high of N411 to the dollar and just last week, the unofficial market crossed the N500.00 per dollar mark. With inflation at about 18%, prices are on the rise. People have continued to express fears and ask where the dollar was going to settle. There are predictions that N1000.00 to the dollar may become a reality in no distant future. This prospect has engendered even more demand for the dollar as speculators and savers alike feel safer holding foreign currency than the Naira. Nevertheless, all these are about the quantum of dollar available to the market and the use of same by the people and government. Therefore, this whole thing is about that inexorable law of demand and supply.
The troubling question is this; why was the dollar exchanging for less than N200 in 2015 only to now be exchanging at N500 barely six years later? What has changed so drastically in the economy to warrant this kind of depreciation? Is there anything that can be done to reverse this trend? Have there been circumstances in the past where the depreciation of the naira or any other currency, has been reversed? We shall open discussions of this all-important issue today and hope that it would not only generate intelligent and profound debate but hopefully identify some suggestions about the solutions to the problem of the persistent loss in the value of the Naira.
It is settled that the fundamental law of demand and supply holds here and may explain the rise in the rate (price) of the dollar over time. When demand for the dollar outstrips supply, the rate would inevitably go up. Conversely, when the supply of dollar outstrips demand, it would be expected that rates would go down, all things being equal, like students of economics would say. It is also true that when rates go up, demand would reduce and vice versa. Over the years, we have experienced a consistent drop in dollar inflows owing to decline in oil prices, along with drop in quantities sold and in the export of non-oil products. Within the same period, the country has consistently experienced an increase in imports and more reliance on foreign goods and services, even for items that are available locally. Expenditure on invisible items, like school fees and services, continues to put pressure on the available stock of foreign currency.
For proper context, we shall rely on the numbers posted by The World Bank, even though we have seen numbers from other sources that are markedly different. Within the years, 2010 to 2013, the country’s current account surplus was between $13b and $19b. In 2015, it reversed to a deficit of $15.4b. Recovery was not witnessed until 2017 with a surplus of $10.4b. The year 2019 saw another trade deficit of $17b, which slightly reduced to about $16b in 2020.
The deficit witnessed in 2020 could be understood in the context of the Pandemic and the recession that followed. Recovery from recession in the early part of this year did not stop the country from running up a trade deficit of over $11b in the first quarter of this year. If this trend is maintained for the rest of the year, we should expect that 2021 will end up with a trade deficit of about $44b, the highest in four decades. So, what do all these mean? Simply put, in the years where the country ended up with trade deficits, it was importing more than it was exporting.
This is significant as it means that the country was borrowing to finance the excess of expenditure over revenue. Of course, this is not to discountenance other sources of foreign currency inflows like, remittances and foreign private and portfolio investments. It should be understood that in addition to remittances for school fees, other invisibles should also be factored in. The point remains that where the demand for hard currency far outstrips the available foreign currency, pressure is brought to bear on exchange rate and the net result is a high foreign exchange rate regime.
The next question is, why is the country exporting so little in spite of the potential for rapid growth in the export sector? This is even more disconcerting in view of the fact that before the advent of oil, Nigeria was among the world’s largest exporters of such products like palm oil, groundnuts, cotton, cocoa, timber and rubber. The simple answer is that one cannot give what one does not have. Oil, now generally accounts for 80% of our exports. When oil prices go down like we had witnessed in the recent times, our revenues inevitably go south, even if the quantity of exports remain the same.
When demand for oil drops, as has been the case lately, thanks to alternative energy sources, prices go down and the country’s earnings also go down. In the same vein, when our supply goes down for any reason, including crises in the Niger Delta and insecurity in other parts of the country, we earn less from exports. Attempts at diversification of the economy have yielded limited results. The manufacturing sector of the economy has remained miniscule.
Agriculture, though accounting for a large part of the economy does not feature significantly in our export market, accounting for between 2% and 3% of exports. So, are there other things to export? Of course, the answer is yes. Nigeria is rich in solid minerals and what we hear is that illegal mining, particularly in parts of the North, has been the order of the day. Of course, these transactions are not documented and are not in the purview of National Accounting. Proceeds from such activities only go to boost the current account position of other countries where they are lodged.
There is also so little that the government is doing to encourage investments in solid minerals, otherwise, results would have been showing by now. We had warned on this column that the solid minerals sector runs the same risk as crude oil, where crude is exported in its crude form and reimported as refined products, adding little or no value to the naturally occurring substance. The other areas gaining currency lately are the entertainment and ICT industries. A deliberate approach towards these sectors will add to the foreign currency receipts of the government.
Turning to consumption, it is imperative that the country is a consumerist society. Ordinarily, there should be nothing wrong with it, after all, Income is calculated as Consumption plus Savings plus Taxes. The only challenge is that when consumption does not lead to local production, it becomes a loss to the economy. This loss is due to the fact that, rather than the stimulation of local economy, the effect is felt in the country where the goods are produced. The pressure on foreign exchange is felt in the local economy while the benefits are enjoyed by the producing foreign economy.
Most importantly, the job creation benefit accrues, not to the local economy, but the foreign producers. This is the reality of the situation with Nigeria. Nigerians are already used to foreign goods, even in the face of local alternatives. We import virtually everything consumed in Nigeria, including toothpicks and tissue paper. The incentive to import all these is latently in the presumed subsidies we enjoy by keeping the exchange rate at levels below the market rates. While it is understood why the Central Bank keeps managing the exchange rate under a “managed float system”, it bears repeating that this system produces some unintended adverse consequences, including subsidising conspicuous foreign consumption and creating an arbitrage window through which roundtripping occurs.
We are of the view that CBN should begin to consider floating the Naira outrightly and intervening from time to time to achieve desired results. Granted that rates would go up in the short run, but they would begin to settle at equilibrium levels over time. It will have the added advantage of removing restrictions and ensuring that the real prices of imports are paid by consumers.
The CBN would get maximum value from its hard currency holding, which the government would deploy to pay its local currency bills. Exports would become appropriately priced and promoted, while imports would become more expensive forcing local alternatives to become more attractive. The truth is that there is a limit to what CBN can do with the dollar. To the extent that it cannot print dollars, as it becomes scarce, the CBN must act one way or the other.
As a deliberate policy, government should design programmes to boost local production and assembly of goods in the economy. What we see looks like an unspoken program of de-industrialisation. In the last one week, we have been greeted with news reports that Toyota, which has a very large market in Nigeria, opened an assembly plant in Ghana. We do not need a rocket scientist to tell that their target consumer market is Nigeria. Drilling down, one would be left in no doubt that such action is a fallout of deliberate policies by Ghana on improving its ease of doing business regime.
It therefore becomes necessary that the Nigerian government continues its drive on infrastructure renewal which is a major consideration for setting up businesses. Other issues of concern will include security, tariffs and skills. Most of the multinational corporations that operated in this country in the 1980s, seem to have voted with their feet. Those who are old enough will understand what we are saying. The nation must understand and address the reasons why they left. Government should also be deliberate in encouraging local investments in production by creating incentives and ensuring that the country moves up the ladder in ease of doing business.
This is a country of over 200m people. The local market is large enough to absorb whatever can be produced locally so, the existence of a big market is incentive enough for local production. At the minimum, the pressure on foreign exchange to fund imports would be drastically reduced. When this is done, we should begin to think of boosting our capacity for generating hard currency by exporting more locally manufactured goods. These are the easiest ways to tame the tide of the depreciating Naira. If we continue the way we are going, we should then brace up for N1000 to the dollar sooner than later.
