The expiration of Mallam Sanusi Lamido Sanusi’s tenure as Governor of the Central Bank of Nigeria is imminent, whether he is forced from office by the sheer brute exertion of higher authority or, more graciously, is allowed to see through his term which elapses in June. Commentators who have been paying attention should have a sense of the important elements of Mallam Sanusi’s legacy including his astute midwifing of the reforms that trailed the banking sector crisis of 2009-10 and his resolve in holding the line on the value of the persistently threatened Naira.
The latter half of Sanusi’s tenure has been marked by a tight monetary policy regime, targeted primarily at stability in domestic consumer prices (inflation) but also at maintaining the strength of the local currency whose value partially underpins inflation conditions. It is within the context of this demonstrated policy preference that we must consider the hint offered in the communiqué of the Monetary Policy Committee meeting of January 20 and 21 that the MPC is exhausting options available to it in the defence of the Naira.
That amounted to an expression of seeming capitulation by the MPC, an admission that we are nearing the inflection point when the CBN would be left with little option than to devalue the Naira. Is there rationale for such prompting at this time?
One way to answer that poser is to analyze currently prevailing conditions. On balance, those conditions do not look favourable enough to stave off the devaluation threat, hence the MPC’s aforementioned concerns. International capital flows are currently being driven by cheap money facilitated by leading global central banks, especially the United States Federal Reserve. The commencement of the paring of the Fed’s monthly asset purchases program bodes ill for Emerging and Frontier Market currencies, including the Naira. Admittedly, the local currency appears to have outperformed most EM and FM currencies in withstanding the effect of foreign capital shortages occasioned by the Fed’s decision and by market sentiment even in mere anticipation of the decision. A comparatively better outlook does not eliminate the threat.
Further, although international oil prices are firmly above the $100/bbl. mark, steady depletion of the country’s fiscal buffers – the Excess Crude Account, which balance reportedly stands at $2.5bn currently (down from $11.5bn at the end of 2012) and the Foreign Exchange reserves, which fell 2.3% in 2013 from its balance at the end of 2012, places significant strain on the ability of the CBN to defend the currency. Finally, under conditions as this and with domestic liquidity underpinning forex demand, the Naira often becomes the target of retail hedging by domestic speculators betting against the sustainability of its value. This is evidenced by increases in foreign currency deposits held by local users of forex in domiciliary accounts.
Recent history does not bode well either. The CBN has had to resort to extraordinary administrative measures in the defence of the currency, the latest major move being its segmentation of the mechanics of the forex market that effectively sidelined the Bureau de Change and Parallel windows in September 2013. In light of the currently very wide differential between the official exchange rate and the rates at the BDC windows, the apex bank has moved to mitigate the fallout of its policy thrust by removing the limit on the volume of weekly sales that deposit money banks could make to BDC operators. The devil is in the detail, but when viewed superficially, this comes across as a backtrack on an earlier policy move and it highlights the topsy-turvy nature of policy employed in the difficult task of holding the line on the Naira exchange rate.
It is pertinent to note that these dire conditions are occurring in a considerably tight monetary policy environment. In fact, policy has only got tighter. Currently, the Cash Reserve Ratio on public sector deposits in commercial banks stands at 75%. This effectively quarantines three-fourths of deposits made by government and any of its agencies in the DMBs. Under normal circumstances, such restrictive conditions should curtail domestic liquidity conditions enough to stymie speculative attacks on the currency. Yet, the portents for the Naira are not positive.
This naturally breeds the suspicion that the current value of the Naira is artificial. But is it, really? One metric for such valuation is the Effective Exchange Rate, which measures the weighted value of a country’s currency relative to the currencies of its principal trade partners. Using the Nominal Effective Exchange Rate barometer, the Naira is overvalued by about 5%, while with the Real Effective Exchange Rate (trade weighted exchange rate adjusted for trading partners’ inflation rates), it suggests about 22% overvaluation of the Naira.
Official devaluation of the Naira last occurred late in 2008, when the currency reeled under pressure from the effects of the global financial crisis. One must say that it was more tenable at the time, with the Naira official exchange rate under N120/USD just before devaluation. However, the free fall that followed should set the precedent for what to expect in the event that a forced devaluation, rather than a gradual depreciation of the Naira occurs.
By: Olugbenga A. Olufeagba
