Devaluation: A hasty move with far-reaching consequences

The recent devaluation of the naira by the CBN, which was initially denied but later confirmed by reports from Daily Trust, is no longer a secret. The devaluation reflects the ongoing issues caused by the multiple exchange rate system over the years. This system led to various distortions, including the growth of a parallel market, capital flight, and a decline in foreign direct investment. As a result, it has become clear that this system is no longer beneficial for the economy and needs to be discontinued.

Reform is undoubtedly necessary, but the government should have approached the situation cautiously and avoided the hasty implementation of untested policies. Monetary policy requires careful monitoring and timely interventions, which can pose challenges for central banks and policymakers. The exchange rate plays a crucial role in monetary policy transmission, impacting various aspects such as domestic currency value, inflation, the external sector, credibility, capital flows, and financial stability.

Looking at successful examples from other countries and considering the stories of the IMF’s structural adjustment programme in the 1980s, the recent launch of the eNaira and naira redesign could provide valuable guidance. Besides, Tinubu claimed the latter was designed to deter him.

The current situation indicates a substantial devaluation of the naira, with its value dropping from around N470 per dollar to an average of N765 per dollar in a span of two weeks. This dark art of managing the exchange rate falls under their responsibility, but they are expected to actively monitor and control it in line with economic factors and policy objectives, adhering to established guidelines.

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As the acting CBN Governor clarified, the recent monetary policy decision—the exchange rate unification—is a managed float, not a free one. The naira’s exchange rate fluctuates within a range due to the CBN intervention and limited market transparency, resulting in weaker market forces.

The CBN’s discretionary intervention and devaluation of the naira have led to volatility, uncertainty, and adverse effects on businesses, investors, and the whole economy. The extreme intra-day volatility at the I&E window has raised concerns about market manipulation. In one day, last Friday, the dollar was traded between N461.5 and N841, an unusual occurrence globally.

In the short term, which is the main concern, the intervention has reduced the market influence of the naira, potentially hindering export competitiveness and foreign investment. This shows implementing a managed-float currency system should not have been rushed without careful planning and research. 

As an institution, the CBN has a crucial responsibility to adhere to guidelines and uphold its objectives, which encompass maintaining monetary and price stability, preserving the international value of the naira, and fostering a resilient financial system in Nigeria. Safeguarding these objectives is vital for establishing and maintaining a stable and effective currency system.

Similarly, the successful implementation of the naira devaluation must align with the objectives above. However, additional considerations come into play. The policy’s responsiveness to economic shocks should have been evaluated, and numerous economic factors, such as productivity levels, unemployment rates, sectoral production, demand for goods and services, export competitiveness, and external debt, must be considered. These interconnected factors collectively shape the feasibility and potential outcomes of a naira devaluation, highlighting the complexity and challenges associated with implementing such a policy.

Objectively, the devaluation policy is unfavourable for an import-dependent economy like Nigeria, albeit in the short run. It is assumed that all will be good in the long run, but many will not live to see it. 

The devalued naira has increased the cost of imported goods. Importers and general consumers find buying raw materials and consumer products more expensive. The payment of these imports creates higher import bills for Nigeria. The impact will be on all transactions conducted after the devaluation, so it will take time for the prices of some goods and raw materials to increase as delivery takes time. 

Consequently, without measures to increase exports, the increase in import spending outweighs the gains, widening the trade deficit and posing challenges to maintaining a favourable balance of payments. The import-dependent Nigerian economy is particularly vulnerable to devaluation’s negative impact on trade imbalances and external accounts, requiring careful consideration of associated risks and strategies for managing these challenges.

Additionally, higher costs of imported goods and essential commodities lead to increased consumer prices, impacting purchasing power and potentially destabilising the economy. The persistently high inflation rate of 22.4% will continue unless alternative actions are taken. 

Another issue is the sudden reduction of the external reserve. In the first half of 2023, Nigeria’s external reserve decreased by $2.9 billion, reaching $34.1 billion in June, the largest decline in six years. The external reserve serves as a crucial indicator for evaluating the country’s currency value. Additionally, Nigeria carries a substantial foreign currency-denominated debt of $42 billion, and devaluing the naira adds to the country’s fiscal challenges by increasing the burden of loan repayment and making interest payments in stronger currencies more expensive. This strains Nigeria’s financial position.

To fully benefit from devaluation, favourable investment conditions and robust infrastructure are essential for efficient export operations. With a weaker currency, stimulating domestic production and job creation can enhance export competitiveness and attract foreign investment. 

Overall, this situation highlights that in the battle for monetary policy reforms, the CBN appears to be disarmed. Despite suspending the CBN governor, it shows they are unprepared. It will be hard-hitting for the economy if they continue on the path they started.