Consider the case of an economy that has been enjoying a prolonged boom, backed by massive capital inflows from abroad. A sudden external shock precipitates massive shortfalls in foreign earnings, capital flight and the fall of the national currency, recession and inflation. To redress the situation will necessitate finding ways of stimulating an expansion in exports while keeping a lid on imports. To achieve this will require enhancing competitiveness against trading partners while allowing lower wages to make the country’s products cheaper in world markets.
Clearly, the quickest way to effect such adjustment is through a devaluation of the national currency – defined as the reduction of the value of a national currency against a reference anchor under a fixed exchange rate system. Since we in Nigeria operate a managed float, we should be speaking, stricto sensu, about depreciation rather than devaluation as such. Recovery in such a situation may take the form of a V-shaped trajectory, as devaluation triggers negative to zero growth, before the graph begins to head north. However, the authorities could equally decide that fiscal and other macroeconomic measures are preferable to devaluation. A long-term adjustment may still be achieved, but the process might take longer and the pains perhaps more prolonged. The decision to devalue is not just an economic one; it is also a matter of political choice.
The collapse of global oil prices has forced some of the major oil exporters to devalue their currencies. Russia has undertaken a major devaluation of the Ruble. Angola, Azerbaijan and Venezuela have similarly devalued their currencies. Saudi Arabia, on the other hand, has taken a political decision not to devalue the Riyal, aided by its war chest of US$700 billion reserves.
In economic theory, when a country devalues or depreciates its currency, it serves to make their exports cheaper while making imports more expensive. When dollars become increasingly scarce and panic begins to set in and the parallel market for FX begins to boom, often the best thing to do is to devalue the currency. When that happens, dollars will become more expensive, as economic actors would need more of the local currency to purchase every additional dollar. This would force a new price level for FX and also ensure that only those who seriously need dollars at the new price are able and willing to pay for them.
Devaluation can also plug the premia between the official and parallel market rates, thereby reducing the tendency for round-tripping and other rent-seeking activities by commercial banks and bureaux des changes (BDCs). In theory, devaluation should eliminate foreign exchange misalignments while restoring equilibrium in the external balance. It is also expected to promote long-term growth by stimulating more exports while reducing imports. More earnings from trade will lead to expansion of new investments while generating more employment.
For devaluation to achieve the desired outcomes, however, it has to satisfy the Marshall-Lerner Condition. This is a condition established by two giants in the field, Alfred Marshall and Abba Lerner, who argued that, for devaluation to bring about favourable outcomes in the balance of trade, the demand elasticities must be greater than unity.
If goods are elastic to price, the quantity demanded will increase. Similarly, if goods imported are elastic, total import expenditure will decrease in response to devaluation.
Of course, there will be a time-lag for these effects to emerge. Information may trickle down slowly; some contracts may still be subsisting, and some actors may be slow in responding to signals due to structural, informational and institutional bottlenecks. In other words, things may get worse before they get better. This, in a nutshell, is the theory.
Looking at Nigeria, I must confess that our public finances are not in good shape. President Buhari has lamented that the country is broke. The States have had problems paying civil servants’ salaries. In July 2015, the States were bailed with a sum of US$2.1 billion, in addition to the restructuring of a debt of some N660 billion that they owe to the commercial banks. But most are still not out of the woods.
Global oil prices plummeted from a high of US$115 per barrel to the lowest levels of US$28 per barrel. Within the space of a year, we lost more than 70 percent of our revenues; aided by thieving politicians who sacked our national treasury like barbarians. The 2016 budget, which is yet to be passed by the National Assembly, is a rather ambitious project of N6. 08 trillion. The unfortunate padding shenanigans notwithstanding, there is a yawning deficit of about N1.6 trillion which nobody has a clue how it would be financed.
Meanwhile, the Naira has been on a free-fall. While the official price has been pegged at N198/200 to the dollar, in the parallel market it has gone down to a low of N400 before settling to its current N315. In desperation, the CBN was forced to place an import ban on 41 items, ranging from toothpicks to tomato puree, angering some of our trading partners. Manufacturers continue to raise alarm against the lack of FX to import much-needed raw materials. Our foreign reserves have plummeted from a high of almost US$60 billion to a low of US$27.8 billion. Inflation, which had been tamed to 8 percent in recent years, is spiraling beyond the 11 percent mark. Dollarisation, which had been aided and abetted by the ruling elites, has led to a staggering US$20 billion of ‘dead capital’ hoarded in our commercial banks. Water everywhere, but not enough to drink!
The stock exchange has not fared any better. When it opened for trading at the beginning of the year in January, the NSE’s capitalisation dropped from N9.75 trillion to N8.939 trillion, a staggering loss of N811 billion. Capital flight, which began prior to last year’s elections, has continued unabated. Foreign investors are holding back on future investments until they have a full picture of how things will evolve.
The roots of our problems lie in our reliance on a commodity that has seen its best days; in our failure to diversify, following the example of countries such as Chile, Malaysia, UAE and Indonesia. We must wake to the realities that low oil prices will become the ‘new normal’ for the foreseeable future. This is due to several factors.
First, the emergence of new suppliers ranging from Brazil to Ecuador, Equatorial Guinea, South Sudan, Ghana and the United States. The slow recovery in Europe and the slowdown in China and the BRICs also mean that there is more oil chasing fewer dollars. Secondly, the crisis of the Ozone Layer, Climate Change and its attendant ecological hazards have forced the global community of nations to agree on the reduction of CO2 emissions over the coming decades. In the OECD countries, there is a desperate search for more sustainable and cleaner forms of energy. Hybrid and electric cars are becoming more fashionable. Thirdly, manipulation by international high finance. Today, over 60 percent of world oil is traded on the financial markets. Goldman Sachs and Morgan Stanley are the two biggest traders in world oil. Powerful hedge funds and pension funds have the clout to manipulate prices in ways that would yield them enormous profits at the expense of suppliers. Fourth, there is the question of global geopolitics. World oil has never operated on purely market principles. At one stage it was dominated by multinational oligopolies such as Total, Elf, Shell and Exxon-Mobil who had the capacity to overthrow governments that did not agree to play ball. Then the Arabs found it expedient to use it as a political weapon under the aegis of OPEC in their war with Israel. Today, Obama’s America may have a vested interest in bringing down oil prices so as to effect regime change in Russia, Venezuela and Iran.
I am not in favour of devaluation for several reasons.
First, our main export product is petroleum, a commodity for which we are price-takers. Depreciating the Naira will have no effect on its price.
Secondly, devaluation will further fuel inflation while worsening the collective welfare of the majority of Nigerians who are struggling to make a better life for themselves.
Thirdly, devaluation can take on a momentum of its own, creating a downward path-dependence of never-ending devaluation.
Fourthly, it will open the floodgates for portfolio investment inflows — fair weather friends who will make for the border at the first sign of trouble.
Fifthly, it will impact negatively on dollar-denominated debts of the deposit money banks (DMBs). Our commercial banks owe foreign lenders lines of credited estimated to be over US$4 billion. Devaluation will increase the magnitude of debt to be paid by the DMBs in dollar terms. Clearly, we cannot afford another banking crisis so soon.
Sixthly, there is evidence in economics literature that devaluation in small open economies may be contractionary in the long-term. Nobel laureate Paul Krugman has provided empirical evidence from developing and transition economies showing that devaluation could become contractionary in the long-term. Aggregate demand will dampen and the economy contract as devaluation redistributes income from wage-earning workers with a low marginal propensity to save to those with a high marginal propensity to save, such as entrepreneurs and exporters. Penny wise and pound foolish!
But avoiding devaluation comes with a price. It is likely to deepen uncertainty while heightening risk premia in the calculations of potential investors. We still have the challenge of dealing with two exchange rates, one official, and the other unofficial. As long as a premium exists between the two, round-tripping and corruption will persist in the foreign exchange market. Pressures will continue to mount on the monetary authority to favour some as against others in allocation of scarce foreign exchange. Monetary authorities are not saints. Thou shall not tempt thy God.
We can continue to hold forth against devaluation if we have a plan to massively restructure the country’s economy to restore confidence in our currency without depleting our foreign reserves. Propping up Naira must never be for the sake of vanity or misguided nationalism. Populism should never be the litmus test of sound economic policy.
Ultimately, we face what some would term a ‘perfect storm’. The issues facing our economy go way beyond mere issues of the exchange rate. They centre on repositioning of Nigeria away from the rentier state paradigm to that of a technological-industrial economy with an increasingly diversified base. We must take the first steps to bring about a massive agriculture-based industrial revolution in our country. We must reform our public institutions and effect a change in the collective mindset. We must also support the administration in the war against corruption to its logical conclusions while plugging the leakages that have haemorrhaged our public finances for decades.
I often ask myself how things would be if we could use a combination of carrots and stick to persuade some of our countrymen and women who have squirreled away more than US$200 billion in offshore accounts to bring it back and invest it in this beloved land of our forefathers.
More than any other institution, the CBN will have to play a central role in that transformation. It will have to reinvent itself as a developmental central bank; a forward-looking knowledge institution that ensures a stable and prosperous economy, with a stable currency that is increasingly convertible under conditions of low inflation and full employment.
In the words of one of America’s most illustrious statesmen, the late Robert Kennedy, “Some people see things as they are and say why? I dream things that never were and say, why not?”
Obadiah Mailafiya
