The question of depreciation of a nation’s currency can heighten sensitivities of people in terms that are often regarded as political. Some would regard it as erosion of national pride. Very few leaders show courage to face the challenge posed by such sensitivities.
The fact is that naira as of now is overvalued. Will naira depreciation really affect the economy adversely? Will depreciation be a better alternative to losing fiscal and external balances?
The issue now is very real, requiring pragmatic approach to it. One rarely sees the issue being openly debated in the media. Why does this situation exist? This issue is being faced in fact by all the oil exporting countries as of now. Economies cannot sustain themselves if international crude oil prices keep falling to $40 or below $40 per barrel. Even Saudi Arabia, a proponent of high oil production to beat the challenge of shale oil, is finding it difficult to face the music of the international oil price declines and is likely to have budget deficits of the order of almost 20 percent of GDP. A relatively more open society with a decent intellectual base like Nigeria cannot ignore this reality.
Let us here begin with the proposition that despite the serious constraint of not having a diversified export base, it is necessary to consider depreciating the naira for one reason: it provides incentives that one cannot afford to ignore. Depreciation, so goes the traditional theoretical construct, would help improve exports, heighten import costs and push up inflation. Once prices rise, the inclination of the authorities, so goes the neo-classical thinking, would be to raise short-term interest rates which in turn would dissuade borrowers to invest. Some stretch the logic to also include the reluctance of lenders to lend when rates of interest go up because of the possibility of ‘adverse selection’ emerge. Lenders also would be concerned that their lending would be subject to the rules and regulations in place, an aspect that is being closely watched by the Central Bank of Nigeria (CBN). When credit does not pick up, new capacities to produce would be put on hold and growth as a result would suffer.
This theoretical construct is no longer valid as the recent global economic and financial crisis has proved. This is because markets have been found to be incomplete and suffer from enormous number of infirmities. Asymmetric information, high transaction costs, wage and price rigidities and lack of expeditious enforcement of contracts all exist in all economies, more so in emerging and developing economies. Nigeria is no exception. The country also suffers from lack of sound transparency practices and of accountability. There is no other way than to have some intervention by both the Federal Government (FGN) and CBN to be on the same page on the issue of the external value of the naira.
Let us take each of the aspects of the theoretical construct mentioned above. High import costs would provide incentive to domestic entrepreneurial dynamism to produce consumer goods locally if the impulses of such private agents are triggered and pushed strongly by FGN policy actions. In any case, in the total quantum of Nigerian imports, consumer goods form a critical part. Raw materials that go into domestic manufacturing are limited. As regards exports, they cannot improve if crude oil prices continue to fall. Non-oil exports have never been a major factor. This should provide incentives for quick policy action to promote diversification of the economy as well as skill formation with a view to improving non-oil exports. And if prices rise as a result of lower external value of the naira, they would force the economic agents to work towards improving competitiveness. Inflation also acts as an incentive for people charged with economic governance for ensuring that price flexibility is not misunderstood as limitless and unregulated ‘mark-up’ of commodity prices in the local markets.
A more critical aspect of the theoretical notion that interest rates would go up when commodity prices increase is not proved decisively. At least this has not happened in recent years in many advanced economies and Asian economies. The transmission mechanisms of monetary policy do not provide such a clear formulation. At best one could think of a Taylor rule-type formulation wherein the growth aspect also enters the equation but this is not validated in the case of many developing economies where financial markets are not so developed as in advanced economies and where estimates of growth potential differ widely.
What should the CBN do in the circumstance? The coordination between the FGN and CBN should help the CBN buy up the US dollars even if it means pumping in more naira money into the economy. But the FGN could help absorb whatever excess liquidity is created as a result of the CBN dollar-buying by issuing government securities. The CBN should make both spot and forward purchases of the US dollar so that the foreign assets get accumulated giving confidence that the economy could have a cushion against any unforeseen shocks. Yes, fiscal deficit would increase but they can be sustained if the expenditure policies are fashioned to strengthen infrastructure and social welfare programmes.
The REER data made available by the CBN need to be recast with the US’ weight reduced because the US is no longer a country importing Nigerian oil. Should this be done, it would be clear that depreciation is needed for improving external competitiveness over the medium term. In the short run, the positive impact of depreciation would not be felt but by deferring depreciation, Nigeria’s external competitiveness and fiscal imbalances cannot be set right. This is the main issue that should be openly discussed and corrective actions taken expeditiously.
A. Vasudevan
