By Olu Akanmu
There is an emerging debate whether since the Nigerian
government buckled to float the naira, with the parallel and official still
widely far apart, whether the flexible exchange rate policy was the right thing
after-all. This view argues that the much-expected
private capital flows to the Nigeria with a market -driven exchange rate, which
will complement government supply of the dollar to the currency market has not
materialized as largely theorized and expected. The parallel market rate
continues to fall even as the naira does same in the official market.
Reinforcing this argument of whether a flexible exchange rate policy is right, is
the view that all emerging market currencies are falling relative to the dollar
anyway, due to capital flows out of emerging markets to dollar denominated US
Government treasury bonds that provide safety and value preservation in a
period of crashing commodity prices and uncertainty. The argument observed rightly that the best
period of capital (especially portfolio) flows to Nigeria and an attendant
strong naira were during period of high oil (commodity) prices and low interest
rates in advanced economies. The extrapolation of the argument therefore is
that the problem was not with the naira or the fixed exchange rate policy but a
challenge of the global economy at this time.
In this essay, we argue while there is a general attractiveness
problem of emerging market currencies at this time, the particularities of the
Nigerian naira within this general context have been worse than its peers. This
makes the naira even more unattractive than other unattractive emerging market
currencies. A Bloomberg analysis on
August 23 this year, showed that the Naira has lost most value of all oil
currencies since oil price crash in June 2014. The naira has lost almost half
of its value against the US dollar, worse than the Russian rouble, Kazakhstan’s
tenge or Angolan kwanza. The Bloomberg analysis described the naira as worst performing
currency among 150 globally depreciated currencies since June 20. The question
really should be why the Nigerian naira is the worst performing of all the oil
currencies and among its emerging market peers? Why has the Nigerian naira not
responded positively to the flexible exchange rate policy? It should be noted that
the poorest performance of the naira among world oil currencies is based on the
official depreciation of the exchange rate. If we use the parallel market rate,
which is the price most non-connected, non-privileged people and business
source the naira, the Nigerian currency will be in a particular class of its
own.
The argument remains valid that investors will not move
assets to the naira when it is overvalued relative to their current currency
and asset holdings. A lot of previous analysis have put the fair value of naira
to the dollar at about N290. Yet there remains significant premium on this rate
or anything close to it in the parallel market rate, which is now above N400. The market in its collective wisdom is clearly
putting an additional risk premium on what would have been the fair value of
the naira at least in the short term. This additional risk premium continues to
hold the wide gap between official and parallel market rates. This additional risk premium effect is also corroborated
by the fact that the naira has depreciated most all the major oil currencies.
This indicates that there are additional risk factors beyond oil prices that
has made the naira depreciate beyond the normal average of world leading oil
currencies. What are the additional risk factors that need to be addressed
urgently to get naira closer to its fair value, which reflects much better Nigeria’s
long-term economic fundamentals?
The first risk factor putting additional premium on what
should have been a fair value of the naira is the uncertainty of the market
that Nigeria is fully committed to market reforms and that state actors will
have the courage to pursue market reforms through to the desired end. The
market took notice when President Buhari said in one his national independence
anniversary interviews that he does not believe in a flexible exchange rate
policy. This was just barely three weeks after the monetary authorities floated
the naira. Given market perceptions that the Nigerian Central Bank is not truly
independent, such open communication of policy mis-alignment within government
can only create market uncertainty and amplify investor risk perception.
The second risk factor is national security and the capacity
of the Nigerian state to sustain oil production and revenue by ensuring peace
in the Niger Delta. Nigeria oil production has fallen from its peak capacity of
2.2 million barrels to 1.5 million parallels, with the potential for such negative
trajectory to continue if we cannot secure enduring peace in the Niger Delta.
The security issue in the Niger Delta is complex and can only be solved with
toughness, wisdom and political sagacity. There are clear limitations of the
capacity of the armed forces to secure peace and fight internal terrorism on two
fronts simultaneously in the North East and the Nigerian creeks. The third risk
factor is policy flip-flops and un-coordination between the monetary and fiscal
authorities such that they neutralize each other’s actions or elongate the lag
time for positive policy effect to come through. A good example is that while
the fiscal authorities are pursuing a policy of reflating the economy, pushing
liquidity into the system with the much delayed budget implementation; the same
liquidity is being sucked out of the economy by high yields on government bonds
and treasury instruments. The high yields on government bonds, crowds out the
private sector from accessing loans from banking system. While would the banks
lend to the real sector when they can get risk free returns on government bonds
at rates close to twenty percent? The monetary authorities are however pushed
to this extreme to defend the naira because of the long delay in liberalizing
the currency market because they were watching the body language of the fiscal
authorities.
In conclusion, the low attractiveness of the naira to
international investors is not just typical of an emerging market currency
problem at this time of investor preference for the dollar denominated US
government bonds. The naira has been one
of the least un-attractive of the un-attractive emerging market currencies
because of the anti-market economic policy we have pursued in the last
seventeen months. The improved attractiveness of the naira that should have
been occasioned by the new flexible exchange rate policy has been mitigated by
mixed policy signals by state actors, mutually neutralizing monetary and fiscal
policies and security issues, which have put additional risk premium on what,
should have been a fair value of the naira. Recent action of the reserve bank to
withdraw the remaining national oil corporation foreign currency deposits from
the banking system in one fell swoop, clearly an action directed by the fiscal
side of government, has created new spikes in dollar illiquidity in the market
and a new trajectory of downward pressure on the naira. Such developments
clearly suggest that that the fiscal and monetary sides of government need to
be coordinated much better to get us out of recession and get the naira to
appreciate closer to its fair value. The flexible exchange rate policy is
therefore still right even when its salutary effects are yet to come through
strongly in the short term. Staying with the abandoned fixed exchange rate
policy could have been worse. Strong actions to address the three additional risk
factors described above that put additional risk premium on the naira will
ensure that the expected salutary effects of the flexible exchange rate policy
come through quickly and more strongly.
Published in newspapers in Augsut , 2016.
Olu Akanmu publishes a blog on Strategy and
Public Policy on http://olusfile.blogspot.com
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