There is an emerging debate that since the Nigerian government buckled
to float the naira, with the parallel and official rates of exchange
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 materialised as largely theorised 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 observes
rightly that the best period of capital (especially portfolio) flows to
Nigeria and an attendant strong naira were during periods 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 that while there is a problem of general
attractiveness of emerging market currencies at this time, the
particularities of the Nigerian naira within this general context have
been worse than those of 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 based economies’ currencies since the oil
price crash in June 2014. The naira has lost almost half of its value
against the US dollar, making it worse than the Russian rouble,
Kazakhstan’s tenge or Angolan kwanza. The Bloomberg analysis described
the naira as the 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 currencies and
asset holdings. A lot of previous analysis have put the fair value of
the 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 account for the wide gap between the official and
parallel market rates. This additional risk premium effect is also
corroborated by the fact that the naira has depreciated the most of all
the major oil currencies. This indicates that there are additional risk
factors beyond oil prices that have 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 Nigeria’s long-term economic fundamentals
much better?
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.
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 misalignment 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. Nigerian oil production has fallen from its peak
capacity of 2.2 million barrels per day to 1.5 million barrels, 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 pertains to policy flip-flops and
un-coordination between the monetary and fiscal authorities such that
they neutralise 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 crowd out the private sector from accessing
loans from banking system. Why 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 liberalising
the currency market because they were watching the body language of the
fiscal authorities.
The naira has been one of the most unattractive of the unattractive emerging market currencies because of the anti-market economic policy we have pursued in the last seventeen months.
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 most unattractive of the unattractive 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 neutralising monetary and fiscal policies and security issues, which have put additional risk premium on what should have been a fair value of the naira.
The 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.
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