To devalue, or not to devalue?

The debate about the appropriate value of the Naira featured prominently in the public domain last week. This prominence was driven by three developments: the refusal of the Monetary Policy Committee of the Central Bank of Nigeria (CBN) to further devalue the Naira, despite loud clamour and expectations from many financial analysts and business players; the statement made by President Muhammadu Buhari in Kenya that he remains unconvinced that devaluation will help Nigeria, his third public pronouncement on the issue within eight months of being in charge; and an editorial and a report in the Economist magazine urging Nigeria to devalue its currency, remove foreign exchange restrictions, and learn from (instead of repeating) the mistake the president reportedly made 30 years ago.

The devaluation debate, if can be called one, has calcified into two extremes: devaluation will kill the Naira, and by extension, the economy; not devaluing the Naira will kill the economy. Given that two extremes are now projected as capable of achieving the same result, it is clear that this debate needs some nuance. I think it is important to take the discussion on the Naira beyond this atomised version, for us to move beyond seeing devaluation as a cure-all or a kill-all, for the two sides and the rest of us to engage in a more deliberative way about the options available to us and the trade-offs necessary to survive the present slump, and for the government to not just encourage and harvest all of these but also to use the opportunity to fashion, implement and communicate a clear, holistic, and coordinated economic recovery agenda for the country.

Before going into the competing positions, it is important to state a few things. One, our problem is not the value of the Naira. Our problem is the economy, which is in a bad place partly on account of the plunge in oil prices and mostly because of our bad decisions/behaviours in the remote and immediate past. These bad decisions/behaviours have left us badly exposed at a time we need serious cover. The exchange rate problem is thus only a symptom, not our underlining condition. Attending to the symptom appropriately will help, but it won’t cure what ails us.

Two, the contending positions on devaluation have ideological/interest bases, which is not necessarily bad but the attendant fixations and distrusts could get in the way of reasoned deliberation. Three, while it is inconceivable that an elected president will be disinterested in the value of the national currency under his watch and while not making a fetish of the independence of the CBN, I think it is unhelpful for the president to continue to venture opinion publicly on monetary policy. And four, it is important to realise that there are no quick fixes, magic bullets or painless prescriptions: no matter what option we take, there will be real costs and important trade-offs; and the ride to recovery will be bumpy and long.

Now to the two positions. The pro-devaluation camp believes that the Naira is over-valued, that the value of the Naira should reflect the change in the purchasing power of the country and be determined by the forces of supply and demand, that the N100 or 50% difference between official exchange and black market rates has created opportunity for arbitrage and corruption, that the foreign exchange control is a barrier to trade and is hurting local production, leading to closures and job losses, that not devaluing amounts to robbing the three tiers of government of needed extra income while wastefully dashing away N100 subsidy on each dollar to those who can access Forex officially, that the wide disparity in the rates is further constraining supply of foreign exchange from other sources and putting more pressure on the Naira, and that the uncertainty created by the Forex regime is denying the country of much needed foreign investments, as current investors are pulling out and prospective ones are holding off, etc.

These are sound arguments and concerns. To be sure, the exchange rate, like the price of any other product, should be determined by the interaction of demand and supply. What has happened in Nigeria, due to the fall in oil prices and huge appetite for imports, is that the demand for dollar is significantly higher than its supply. With this, the dollar should cost more Naira than before, not same. Pegging the Naira at N199 to the dollar thus amounts to setting the exchange rate below the market price. And when the price of a product is fixed below the equilibrium price, what results is not just scarcity because demand will outstrip supply but inevitably a price higher than the actual market price, causing distortion and imposing a higher burden on the people and the economy.

Forex supply from autonomous sources will dry up as it will be plain stupidity for economic agents to sell dollars at 50% discount. And economic agents are not stupid. In addition, rationing Forex will create a perverse incentive for round-tripping (which is difficult to police) from those lucky to get it officially, will drive up demand both because dollar is sold cheaper than it should be and the natural inclination to game the system by inflating demand, and will not be a guarantee against the dreaded inflation as everyone, including those lucky to get Forex at official rate, is most likely to price their products at the black market rate, a tendency that is difficult to check except government wants to start fixing the prices of goods too, which in itself is a futile endeavour. Also, a combination of lower production (because companies cannot import intermediate goods), reduced investments, job losses, higher prices, reduced purchasing power etc., will slow down growth and put the economy at the risk of recession.

All these valid points notwithstanding, I see four problems with the pro-devaluation argument. One is that devaluation will impose a certain pain on the poor and the middle class because it will certainly lead to higher prices, reduction in the standard of living of those with fixed incomes, fall in purchasing power which combined with higher production costs could also lead to job losses. Two is that the arbitrage claim while real is overstated: if those getting dollars at official rates are diverting to black market in huge numbers that would have increased supply and lowered price in the black market. Three is the validity of the assumption that those pulling out or holding on to their investments will return or now invest because of devaluation. This is not necessarily so, as portfolio investors are very fickle and they and foreign direct investors are more motivated by the best returns they can get and not who has devalued. So why take a certain pain for an uncertain gain? And four is that while devaluation might increase Forex supply, it will not resolve what is essentially a major mismatch between Forex supply and demand because CBN is still responsible for the bulk of Forex in the country.

According to information from CBN, the fall in the price of oil has reduced monthly earnings of the Bank from $3.2 billion to about $1 billion. At the same time, request for Forex jumped from N148 billion in 2005 to N917 billion (or $4.6 billion monthly) in 2015, a whopping increase of 519%. A projection has it that our foreign reserves, which have plummeted by 25% in 18 months, will not only be wiped out in the next nine months but will also be in the negative if CBN decides to meet all requests for Forex. This is because the monthly possible rate of depletion ($4.6 billion) is higher than the actual rate of addition ($1billion) by almost a ratio of five to one. Given that most of our Forex is from oil and the outlook for oil price looks grim for the rest of the year, what is the guarantee that the black market rate will not adjust upward with official devaluation and how will devaluation of the Naira solve Forex inadequacy? The fact is that whether we devalue or not, we still have a supply and demand problem and some form of rationing might be unavoidable until oil price and our reserves go up.

The anti-devaluation vanguard is led by the president himself. According to this camp, devaluation will hurt the poor, compound our economic woes, and it holds little value for us as an import-dependent country. As stated above, the pain of devaluation is real, a pain that will be compounded by increase in energy cost. If we devalue, the official price of petrol is likely to go up by 50% or so. The benefit that should accrue due to fall in price of crude oil will transform to higher prices for refined products because we import them and because of the fall in value of the Naira. And because we have not fully deregulated, government will either subsidise the increase or pass on the hike to consumers.

When the president says that devaluation only benefits countries that export goods and services, there is a tendency among some to sneer or to put it down to a suspected statist or dirigisme impulse. But there is an economic theory behind this position. It is called the Marshall-Lerner Condition. Named after two renowned economists, Sir Alfred Marshall and Abba  Lerner, this theory states that for currency devaluation to have positive impact on a country’s balance of trade, the demand for import and export must be elastic, meaning a slight change in price will significantly affect demand, leading to significant fall in expenditure on imports and significant rise in income from exports. But Nigeria will not benefit from devaluation because the Marshall-Lerner Condition does not exist here: we are import-dependent (or our demand for import is inelastic and that won’t change overnight) and because devaluation will not make our major export (oil), which is priced in dollar, cheaper or more competitive.

However, the anti-devaluation argument is also not faultless. There is a difference between devaluation as a deliberate policy for improving balance of trade terms and devaluation forced on you by a decline in your economic fortunes or the mismanagement of your fortunes. With changes in our oil-fuelled fortunes and resultant mismatch between supply and demand for dollar, the price of dollar against the Naira cannot remain unaffected. The only way we can successfully and sustainably keep the rate the same is if we had built up massive foreign reserves in the time of plenty. We did not. So something has to give. Though we don’t have any excuse for not providing enough cover for the rainy day, it is important to also note that this is not  peculiar to us. Most of the so-called petrol-currencies have taken a hit: the Canadian dollar fell to an 11-year low last year; the Norwegian Krone has fallen by 26% since 2014; the Colombian Peso, by 38%; the Brazilian Real, by 42%; and the Russian Rouble, by 49%. Fall in the value of the Naira is almost inevitable. If it bothers us so much, we have the option of re-denomination.

Holding on to your Forex rate in the face of almost 80% fall in the price of 95% of your export is akin to insisting on protecting yourself from a massive rainstorm with a torn umbrella: it is a lost battle. While noting that the inflationary impact of devaluation is real, its real effect may be a bit exaggerated. In November 2014, CBN devalued the Naira from N155 to N168 to a dollar; then again to N199 to a dollar in February 2015. Combined, that’s 28% devaluation. It impacted inflation but not in the same proportion. Inflation was 7.9% in November 2014 and is just 9.6% now. Besides, there will always be trade-offs. With such a plunge in revenue, it will be difficult to keep external reserves, exchange rate and inflation rate same. Something must give.

In sum, the two sides have their points but they lack the religious certainty they are invested with. It is good for us to recast the debate from the narrow mould of one option is painful and the other is pain-free. Nothing can be farther from the truth. No matter what option we take, there will be serious costs. Rather than the ideological righteousness and haughtiness displayed by both sides, what we need is a very practical approach, one that acknowledges the costs, puts an empirical value on them, chooses the less costly option to our people and the economy, and acts before the costs are further compounded.