Devaluation  (1)

After four years absence at the back page of this prestigious publication, I am very delighted to be back as an Op-ed Columnist. Since my last piece here on the 9^th of January 2012, I have doubly realised that writing provides me with a great opportunity to share my pennyworth thought on issues related to economy, business, politics and life.

Now, it will not be a surprise that my piece today joins the debate that is as old as the movement of exchange rate in Nigeria. It was first in 1986 that the entire country debated whether the Naira should continue to be sold at a dollar to the Naira, following the collapse in the price of oil (ironically, the same cause of the fall in oil price in 1986 is the same cause since 2014 – oversupply and glut inventory of crude oil). The Naira was eventually devalued by about four to the dollar.

That was the start of Naira devaluation. Between that September 1986 episode and February last year, the Naira has been devalued nine times. Five of these episodes were significant – by at least 10 percent. Indeed, the first four episodes of devaluation between 1986 and 1999 ranged between 24 and 74 percent. Since the turn of the century, there have been five episodes of devaluation, reducing the value of the Naira to the dollar by a cumulative 42 percent during the period.

So, what happened to the economy following these episodes? So much, but not much of the intended consequences, and that is essentially what my piece is about. Before then, let us examine the merits and arguments against further devaluation of the Naira.

Proponents of devaluation make the following arguments. First, further devaluation will make the Naira reflect and align more to its real value against major currencies of the world. This argument often presupposes that the true value of the Naira is the rate at which the Naira exchanges for the dollar at the parallel market (the rate at the parallel market cannot be regarded as the real value of the Naira because of the measures driving the rate). Second, devaluation will narrow the gap between the official exchange rate at N200 to the dollar and the about N350 at the parallel market (yes, but could be short-lived if the price at parallel market continues to rise). Third, devaluation will diminish the incentive for arbitrage (the most important point in my opinion). Fourth, devaluation will lead to increases in exports and reduction in imports (in the Nigerian case, it is not supported by empirical evidence).

Those that argue in favour of no further devaluation, at least for now, provide the following arguments. First, given the structure of the Nigerian economy, any further devaluation will drive up prices and inflation (yes, this is supported by empirical evidence). Second, while the main assumption of every devaluation effort is that it will improve and increase exports, as it makes prices of domestically produced goods relatively cheaper, this assumption has not been supported by any shred of evidence in Nigeria. Third, further devaluation will lead to macroeconomic instability, underpinned by volatility of inflation and exchange rates. Fourth, in relation to past devaluation episodes, it had not worked, and there is no shred of evidence that it will work now.

Permit me to now make two very important considerations that demonstrate that devaluation argument is too simplistic and needs to be broadened. Before I do that, let me confess that I naturally lean towards a weak Naira (please read carefully, weak Naira).

First, the price elasticity assumption that makes devaluation a very potent tool for the correction of balance of payments problems in many countries in the past does not apply here. A fundamental assumption of devaluation is that it will lead to fall in imports; rise in exports, as domestically produced goods becomes cheaper to foreign made goods. So, in our case, as the prices of imports go up, Nigerians will look for alternatives, demand less forex, and reduce imports. However, two critical features of the Nigerian economy make this scenario very disturbing. There are virtually no alternatives to some of the products we import, especially machineries and industrial goods. What is more worrying is that where there is alternative, there are no “good enough” substitutes for Nigerians. In the past, therefore, rather than diminish our appetite, devaluation has always succeeded in raising domestic prices and generating price instability. In such circumstances, it will be folly to rely entirely on market forces and not any form of priortisation of our reserves.

The second point I want to make is on the true value of the Naira. The most appropriate economic test to arrive at the true value of a currency is to compare international prices of goods and services. Economists term this purchasing power parity (PPP). The movement in exchange rate, at least for a convertible currency, which Naira is not, also reflect changes in the parameters of the economy such as growth rate, interest rate, inflation rate, reserves etc. A look at changes in domestic prices and these parameters in the last eight weeks does not sufficiently explain the changes in the exchange rate of the Naira during the period. It merely points to speculation. And I understand the arbitrage argument and the incentives it provides to trade in currency, rather than engage in production. However, our appetite for forex and our ingenuity have no boundaries to the extent that I believe if the CBN should release the about $28 billion reserves it currently holds to the market for N500 to the dollar, Nigerians and foreigners will swallow it in just a week.

In conclusion, have I argued in favour of no further devaluation, in whatever circumstances? No. However, it is obvious that devaluation does not provide and can never be a substitute for the serious economic policies and choices required for the progress we seek to make. Where we are today is largely a cumulative effect of poor and weak fiscal choices over the years. If we are not ready for appropriate fiscal choices, it will be folly to rely solely on monetary policy instrument such as the adjustments of exchange rate, which are short term in nature, as the silver bullet that will solve all our economic problems.

Ogho Okiti

Dr. Ogho Okiti is an economist and CEO of Time Economics, an economics consulting firm, based in Abuja. You can follow him on Twitter @Dr_Okiti. 081.7153.0058 (Text Only, Please)