Money, Credit, and Nigerian Finance: To float or not to float the currency?
Nigeria's currency management system has been in the limelight for years. Many 'experts' and market players claim that Nigeria's managed-float system has been a significant drawback to the country’s ability to attract foreign investment. Some even go further to say that leaving the market to determine the value of the currency is best and will facilitate Nigeria's economic growth. This statement, to say the least, worries me, as I imagine these 'experts' are viewing Nigeria through the lens of textbook economics. By now, we should all be aware that the traditional economic theory of market efficiency is not fully reflected in real life, and even if it is...efficiency is not always socially optimal.
When it comes to the case of emerging or developing economies, this is even more true. In a global environment where your currency is not frequently traded, and your economy depends heavily on imported materials, you simply cannot afford the market-system playing around with your currency for gains.
Currency in itself is not a commodity, and although it is technically an 'asset class,' it does not provide value in itself. Instead, it's importance is in its role as a medium of exchange to purchase value-enhancing products (depending on the consumer's perception of value). In plain English; You can not eat, wear or live in currency, so it's role as an asset class should be limited.
To understand the possible influence of currency on societal welfare and the economy at large, let us look at an example of a fictitious citizen living in Nigeria;
Imagine a young lady named Lara earns 400,000 Naira per month, the equivalent of ~ $1,100 (with an exchange rate of N360/USD). Let’s assume a universal minimum wage of $1,000 per month; in which case, Lara is considered to earn a reasonable salary. A week after receiving her salary, imagine the 'market' determines that the Naira is worth N500/USD; she now earns $800, just below the global minimum wage.
All she had to do was sleep, and wake up in another (global) socio-economic class.
To counter this argument, free-market proponents claim that the standard of living varies across countries, so 400k Naira could still be considered a high salary in Nigeria. However, I find that the argument does not carry much weight since the world is becoming a global village.
Nigerians are participating in global trade now more than ever. Parents send their kids to international schools (paying in foreign currency), entrepreneurs are importing materials for their businesses, and ordinary citizens order goods from global online stores.
You might even be shocked to know that when a Nigerian resident wants to purchase something from Amazon, Amazon will not say, 'oh, the market just reduced your socio-economic class, so here's a discount.'
Again, currency management is a social issue...not to be entirely left to the market.
What will happen if Nigeria allows the currency to float (especially during this pandemic)?
Capital will look for safer assets, usually dollar-denominated.
Due to the outflow of capital, the Naira will depreciate.
Then, the cost of imported goods will increase.
And since most finished products in Nigeria rely on imports, inflation will accelerate, putting extra pressure on the value of Naira ….. the list goes on.
Ultimately, the above will result in a loss in consumer welfare.
We will explore the drivers of Nigeria's exchange rate in another article, but let us consider what determines a socially optimal currency for Nigeria.
In my opinion, a socially optimal currency needs to be two things;
Weak enough to boost exports.
Strong enough to maintain the standard of living of its citizens.
Essentially, the central bank needs to strike a balance between the currency being strong enough, so the citizens feel like they have their life together, but weak enough so that exports appear competitively priced in the global market.
Weak enough: A weak currency, as weird as it may sound, is useful in many ways. To fully grasp this phenomenon, let's take a look at China. China has achieved competitiveness in international trade due to its cheap labor and relatively weak currency (translating to more affordable goods). Assuming a fully-floating, un-manipulated currency, then by simple demand and supply analysis, the Yuan’s value should be high enough that Chinese goods seem overly expensive and exports should decline.
However, due to strategic planning, the Chinese government has restricted excessive appreciation of its currency. Likewise, Nigeria should maintain an exchange rate level that will enhance the competitiveness of her exports in the international market. As exports rise and government revenue increases, there will more buffer to withstand exchange rate volatility.
On the one hand, Nigeria can achieve a weak currency without maintaining a managed-float system. But since the country is part of the OPEC and does not determine the price nor quantity of its crude oil exports (being its primary source of fx), it would be risky to allow the currency float.
The crude oil market is unforgiving. If Saudi Arabia decides to flood the market with oil supply (like they did earlier this year), oil price declines rapidly (like it did this year), and foreign portfolio investors withdraw their funds from Nigeria (like they did this year), the exchange rate would have probably experienced uncontrollable volatility.
The weak currency might have ramped up exports(although highly unlikely during a pandemic). Still, there is a problem; consumer welfare is damaged.
Strong enough: As I explained earlier, the strength of the currency is necessary for everyday life. In 2016, the Central Bank of Nigeria abandoned its currency peg, causing the Naira to lose about 40% of its value. The Naira dropped from about N190/USD in June 2016 to about N321/USD in August 2016. One of the effects was on the fees of those who schooled internationally; Fees became expensive while wages remained the same. Another issue was the pass-through effect of the depreciation. The price of imports went up, leading to the cost of goods consumed in the country rising and inflation soaring. Hence, the ability to manage the currency is essential to maintain consumer spending power.
In conclusion, the government's goal should be to maximize societal welfare, and to achieve this, the country's currency should be safeguarded. Therefore, I am a strong proponent for a continued managed float. I suggest the debate be directed toward determining the central bank's currency management principles, through that, we will achieve a market environment beneficial for all.