Nigeria is an interesting country! Over the past 40 years, the devaluation debate has been raging with our seasoned economists and public affairs analysts feasting on the topic. Willingly and unwillingly, we have consistently devalued Naira over the years from N2/$ to over N800/$ today with no end in sight. Despite these massive devaluations of our national currency, the IMF, World Bank and other western international financial institutions are still unrelenting that we have not devalued enough.
The question that remains unanswered is – at what value can we say we have a fair value of Naira that is acceptable to these international agencies? The second question is – are there other policy options in the rule books of IMF and World Bank for developing nations apart from the routine devaluation recommendations and its imposition on these poor nations despite the obvious ineffectiveness of the policy?
There is no doubt that exchange rate stability is a major macroeconomic goal of all nations. It is therefore not surprising that instability of exchange rates among the major currencies is a perennial concern and the political economy associated with it remains complicated.
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In principle, most economists will agree that there is a short-run trade-off between the real exchange rate and inflation; that managed float cannot be viable for long periods, particularly in economies that are very open to international capital flows; that over-valued currency makes holding the domestic currency unattractive thereby creating a dominant parallel currency market.
No single exchange rate regime would be right for all countries at all times, therefore, some observers have argued for a continued role for intermediate regimes. Many factors affect the choice of a monetary regime, including a country’s structural characteristics as well as short-run or operational considerations. Despite their proneness to crises, pegged regimes may remain the best option for a country in need of rapid disinflation or a country with close economic, political, and financial ties to the country it chooses as its peg. Similarly, the lack of well-developed, deep financial markets and limited implementation capacity may make a floating regime impractical for many developing countries.
The literature on exchange rate dynamics is vast. Unfortunately, monetary economists are yet to perfect the art of managing exchange rate especially in developing nations. Many models that are based on monetary policy fundamentals are failing to provide a convincing explanation of the behaviour of real exchange rates. Researchers need to do more in providing better understanding of the characteristics of exchange rate systems especially on a country specific basis.
In reality, these exchange rate management regimes are not implemented strictly on a stand-alone basis. There are often huge differences between what countries claimed to be doing and what they were doing in practice. Calvo and others in a paper titled “fear of floating” published by IMF in 2000, emphasised that many countries that claim to have floating exchange rates do not, in practice, allow the rate to float freely. They use interest rate and intervention policies to affect its behaviour and keep it along a predetermined path. Some countries declared pegged regimes yet engineered frequent devaluations to maintain competitiveness.
In the search for the magic wand for exchange rate stability, countries have experimented with fixed exchange rate, floating exchange rate, and intermediate exchange rate regimes with different variants of flexibility and fixity in different times of their history. With the benefit of hindsight, we now know that neither floating nor pegging exchange rate regimes neither are isolated from intermittent crises nor guarantee success in the long run.
On the parallel exchange rate and official rate dichotomy, economists have tried to unify these rates through exchange market interventions and monetary policies. Some ambitious policy makers even experimented with transforming the parallel market rate into the official rate or vice versa.
Nigeria’s attempt to unify official and parallel rates or at best reduce the gap between the two rates has continued to be a wild goose chase. Lately, the gap seems to be increasing despite the best efforts of successive administrations. The country is now trapped in the vicious cycle of exchange rate with no visible escape route in sight. Shortage of foreign exchange for payment of maturing obligations leads to growing external arrears, loss of creditworthiness, a worsening of the balance of payments, which in turn cumulatively leads to further worsening of the already bad exchange rate. This cycle erodes the wealth of the domestic citizens and ultimately leads to loss of confidence in the local currency thereby worsening the fate of the Naira and the cycle continues.
The truth is that no exchange rate regime will save a country that imports more than she exports from perennial exchange rate crises. Nigeria’s case is made worse by the citizens’ preference for imported goods even where effective local alternatives exist. The law of demand and supply will always reign in the foreign exchange market like in every other market.
As long as the demand for dollars is greater than its supply, the Naira will continue to be under pressure. As long as our aggregate dollar receivable is less than our aggregate dollar payable, our Forex crisis is not ending soon. As long as we import most of our consumables and continue to export less, it would be a fallacy to believe that the Naira would be stable. To put an empirical marker to this narrative, it is estimated that for countries that are overwhelmingly dependent on the Rexport of a dominant commodity for their Forex (in Nigeria’s case – crude oil), a 10% drop in the real price of the commodity export is typically associated with 3.8% depreciation of real exchange rate.
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The real solution for our foreign exchange problems lies outside the monetary policy space. A stable exchange rate is a by-product of other policy choices, rather than of a particular form of exchange rate regime. The best policy combo to achieve this is policies that fast-track local production of our major consumables. Stable and regular electricity, good transport infrastructure, and quality education are no-brainers in achieving this target. Without these fundamentals, our economic woes, exchange rate inclusive continue. Sad but true!
EJIKE NWOLISA (a Lagos-based economist)
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