Defiant Naira

Following the 2008 financial crisis, both the naira and the Nigerian Stock Echange All-Share Index (NSE ASI) took massive tumbles. Fast-forward to 2015 and similarly tough times are approaching. Once again, the ASI has declined roughly 30% since mid-2014 but this time, the naira has remained resilient.

The naira’s performance is even more intriguing given the performance of other currencies. Kazakhstan’s tenge which has closely tracked the naira since 2008 has been devalued by 22% (following a 20% devaluation in February 2014), Russia’s ruble fell roughly 30% in trade-weighted, inflation-adjusted terms against the dollar at one point last year and even the yuan has been devalued in recent weeks.

The Central Bank of Nigeria (CBN) continues to defy domestic and international commentators, using a spate of unusual policies to strengthen the naira. Effectively banning 41 goods from being legally imported, enabling commercial banks to refuse dollar deposits and reportedly cracking down the black market by cutting down trees in Abuja are some that have captured the imagination.

The Fear of Devaluation

Devaluation has already taken place – twice in the last 12 months – but the CBN seems intent on keeping the dollar just below the ₦200 mark while policies have become more frantic as the inter-bank rate hit ₦197/$1.

In many respects, the fear of devaluation is justified. The immediate costs of a devaluation to ₦230/$1 – the level analysts expect is the true price – will be very high. In such a scenario, firms with dollar-denominated liabilities will take a beating. For those in the energy and finance industries already suffering from the oil price drop, it could be the tipping point for a more severe financial crisis. This could induce a traumatic shockwave through the economy. GDP figures for the second quarter of 2015 show that growth slowed to 2.35% from 3.96% in the first quarter. Given the global economic headwinds, this slower growth indicates the economy is in a precarious position, one that the signal of devaluation could further aggravate.

For CBN Governor, Godwin Emefiele, his reputation may also be at stake. He has acquired international notoriety for squaring up to both the Financial Times and The Economist and in doing so, has put the naira at the centre of the international currency debate. So far, he is winning the battle over the naira.

The Case for Devaluation

Yet the reward for victory remains unclear. For all the negativity, devaluation will bring some respite especially if it closes the gap between the official rate and the parallel market rate. A single price would remove most of the market uncertainty which has stalled many investment decisions. It would also loosen the squeeze on the futures contracts market as market players regain confidence in the price of the naira. Understandably, investors are holding on to their funds until they are sure of which direction the naira will take in the medium-term. This is an unnecessary drag on growth in a time of austerity and economic turmoil.

Crucially, it would also curb the arbitrage and speculation that the CBN has been so intent on tackling. Ironically, reining in the “shallow” parallel market might require giving in to pressures to devalue. This would usher calm into the market and enable the CBN to release some of the tightening mechanisms that have been put in place. The continued absence of appointed ministers and the resultant delay in fiscal policy has put indirect pressure on the CBN to manage the economy. Devaluing now frees up monetary policy to temporarily serve this purpose. 

The Inevitability of Devaluation

Still, Nigeria’s import dependency makes devaluation a tricky proposition. Indeed, the real economy is likely to be hit hard and inflation – already outside the CBN 6-9% band, is likely to increase further. This would cause an inevitable squeeze on the budgets of ordinary people. However, in the medium-term, devaluation could prove a boom to the CBN’s push for more local content. The diversity of goods that Nigeria imports has come under heavy scrutiny recently and costlier imports might drive local production to more acceptable levels and increase demand for locally sourced raw materials.

Many see some form of devaluation as inevitable but the CBN has remained defiant so far. A more subtle question is the cost of the CBN campaign. Even if Mr Emefiele is right and the naira is fairly priced (despite indications otherwise from the market), it could be too costly to eventually win over the market. So far, the CBN has cornered the market with its policies and squeezed certain groups. Importing firms and multinationals that deal in foreign exchange have faced severe liquidity challenges while even those with “legitimate demand” for foreign exchange have reportedly been hampered by the constantly changing rules and inconsistent interpretations by the banks. The net effect has been a setback in economic and financial freedom for certain groups – a byproduct of the CBN’s war against speculators. Blocking off the channels that facilitate the flows of foreign exchange in an economy like Nigeria's is a risky manoeuvre. The fear is that the collateral damage from these will end up destabilising the financial system more than a strategic devaluation would.

The Bitter Pill of Floating

A more radical solution would be to free-float the currency. That would achieve the stated benefits of devalualtion but leave the naira at the mercy of speculators and the CBN will not be able to put a price floor on the naira. This has been suggested in a report by the Financial Derivatives Company Ltd (FDC). This seems a step too far for now. However, the report correctly points out the need to fix the structural causes of the naira's weakness such as fuel subsidy payments and leakages as well as an uncompetitive manufacturing sector. Devaluation or not, these are crucial issues as they also pertain to the real economy. In the long-run, moving to a floating exchange rate might be the most reasonable choice.

There is a sense that the CBN, and its Governor Godwin Emefiele, have wedged their heads in the sand and will remain unmoved, whatever the weather. Yet ceteris paribus, such a strategy is unsustainable. For Mr Emefiele, preempting the market by devaluing now would represent the concession of defeat and perhaps make his position untenable. But the likelihood is that at some point, his hand will be forced. In the event of that, the CBN is unlikely to have any more tricks up its sleeve to halt the resulting naira slide.


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