Business Implication Of Devaluing,Floating The Naira Or Sticking With The Status Quo By Ugodre Obi-Chukwu

[abujagirl]

Founder of Nairametrics, Ugodre Obi-Chukwu in a series of tweets shed light on the predicament of the Naira.



He wrote:

• Nigeria is facing a major currency crisis caused by the drop in oil prices and our inability to diversify the revenue base of our economy
• From about $38b a year ago we have about $28b in foreign reserves which is probably below $20b if you net off currency swaps
• But it’s not really just reserves. At $28b its more than what Argentina, Portugal, Belgium Finland each has. South Africa has about $46b in reserves yet it still faces its fair share of currency crisis.
• The major problem we have is that this country is heavily reliant on import. It’s an addiction that has one solution NIGERIA NEEDS TO STOP IT’S OVER RELIANCE ON OIL FOR FUNDING ITS DOLLAR CRAVINGS
• However, it’s a long-term solution and will require decisions of constitutional proportions. The type that can tear a country apart
• For now we are left we three other alternatives that prolongs the pain rather than quench it.
• Think of it this way…all 3 options are painful but with different degree of hurt. How long it hurts depends on how quickly you get cured
• The alternatives are no solutions. They however provide a painful pathway to a cure. So let’s get to the alternatives
• The CBN (Govt actually) can either decide to a) Devalue b) Float the exchange rate or c) Demand side management (currently in operation).
• I will delve into all three options with a focus on the major pros and cons. Stay the course with me
• Devaluation is an option proposed by a lot of economists who believe the naira should trade relatively closer to d parallel market rate. They believe allowing a rate disparity encourages arbitrage which further encourages round tripping and erodes our reserves
• Unfortunately we have been devaluing since the days of SAP and yet the official rate always lags the parallel rate. Only once have in the last two decades have we had the official rate trading at as low as N2 discount to the parallel market rate and that was during Soludo’s era. Nevertheless it wasn’t to last as the world-wide economic crisis scuttled his Utopian plans. Devaluation is a subjective policy that is anti market and mostly occurs in countries that aren’t brave enough to diversify their income base
• The CBN has preferred this option because it gives them control over the price of the exchange rate. Our government loves to control everything. Electricity rates, fuel prices, water rates, etc.
• But devaluation will NOT WORK. It’s never been a reasonable solution to our currency woes. It only makes our leaders lazy. At what point do you stop devaluing? Devaluation is basically the government manipulating currency prices artificially just to push back demand artificially. In Nigeria, government revenue earned in dollars can double by fiat just by devaluing. Unfortunately, the government gains and the private sector mostly suffers.
• This takes us next to floating the currency. When you float the currency the market determines the price and not Buhari
• It’s like the stock market. If the CBN decides to sell stocks today, it will have to sell at the market price or hold. By floating the CBN allows market forces determine prices. Like everyone else It places a bid and hopes an offer matches that bid.
• If it floats today the official price will probably jump to N260 because that my friends is what u and I pay when we use our debit cards. When you get Western Union you will be paid at a rate of N260 and not the N200 rogue banks pay. You have a single price for all.
• The CBN will also sell dollars at that price and also buy at that price. Everyone is happy right? Not exactly
• Whilst floating solves the problem of a dual pricing and arbitrage it doesn’t take away demand and doesn’t bridge the supply gap. For e.g you may still not have dollars to pay for your children’s school fees.
• Demand may wane initially and supply might increase temporarily but it will be short-lived. Eventually demand will outstrip supply as those who had given up on dollars will come back to buy while those who have will hoard
• This will increase the exchange rate and some predict it could hit N350. The impact will be catastrophic. Make no mistakes about it
• Companies will go bust and people will lose jobs. Valuations will plummet and accounting profits will decline.
• Local businesses will be bought over on a cheap by foreign investors & our local competitiveness will take a hit. Confidence will drop
• Inflation will skyrocket and the price of fuel will likely cross N120. People will flee the Naira and dormant accounts will be the new Oil
• It’s the kind of catastrophe that can cause social unrest and hatred for the govt. Floating is a risk only a brave President can take. GEJ took a similar risk (subsidy) in 2012 and we all know how he recovered from it
• Floating is brutal and painful, nonetheless it’s my preferred option. I support it 100%
• Nigeria needs to move closer to a market determined economy. Our regulators need to regulate markets and not control markets.
• By the time iPhones cost N300k to buy our consumption loving students will think about designing their own phones.
• By floating the exchange rate the exchange rate will enter a period of price discovery where market forces determine its rate and not the CBN. The market need to wait for Buhari to decide whether to devalue or not in response to arbitrage opportunities.
• Speculators will also be reduced considerably and probably replaced by risk taker taking bets on either side of the price of the naira. With time the naira will find and equilibrium and businesses can start to hedge, plan and forecast their naira needs. Floating the naira in essence will create a new industry for the economy and could open the way for a robust financial derivatives market.
• Another advantage it brings is that the government can now focus on ensuring that Nigeria;s import dependent is capped not by fiat but by mixing smart policy decisions on the monetary side with targeted infrastructural spending on the fiscal side.
• The 3rd option is the demand side management which the CBN is currently implementing. It means using policies to stifle demand for FX
• Last Feb the CBN decided to move to a managed float system. A managed float system means the CBN allows the interbank market to source for its own dollars. However, the CBN controls the price and who it can sell to and who is eligible to buy. CBN can do this because it is the chief supplier of FX in the economy.
• By being the chief supplier of FX itself determines prices and decides who it wishes to sell its FX to. It’s everything a market is not
• Ironically they can still sell to whoever they wish to sell to in a full float. Difference is it is at the market price.
• In the law of demand and supply prices are more likely to go up if the supplier is a monopoly. Allowing it remain stable amidst rising demand means you encourage a black market
• The CBN is probably sticking to this ill-advised policy because they fixated on price control and lack the courage to convince PMB
• Imagine PMB waving the corruption card at GE and warning him not to do anything that will jeopardize d national security of this country
• To make matters worse the CBN has been poor at selling the policy of demand side management to the press. The CBN themselves appear divided on their policies. Read the last two MPC communiques to see the division inherent in their decisions
• This is the policy currently in place and going by the reaction of analysts and ordinary Nigerians, it appears to be doing everything but work. The CBN will not lift its restrictions and won’t allow flexible purchase of the greenback. Despite their ‘good intentions’, they are basically fighting a lost cause defending the naira especially in the present circumstances.
• Nigerians need to know that as a country we are at cross roads of a national renaissance. Things can only get worse if the CBN does not pivot from DSM. It is either they float the naira or continue to spend billions from our paltry reserves to defend the naira
• No matter the options that we have the implications will be wide and painful. It will however be a pain in vain if it does not end in a massive gain. Devaluation, DSM will not lead to gain, floating will.
• Take a moment and think….and then tell somebody to tell somebody to float the naira once and for all!