Zuhumnan Dapel
One of Nigeria’s most alarming economic indicators in the past half century is the latest freefall of its currency, the naira. In the past eight years, its dollar worth has dropped more than 200 per cent.
To redeem the currency’s value, the Central Bank of Nigeria earlier this month introduced a foreign exchange rate policy known as the “Naira 4 Dollar Scheme.” According to the apex bank, a rebate of 5 naira is paid to the remittance recipient for every $1 (or $13 for $1,000) remitted to Nigeria. The policy is scheduled to run for 60 days, with the sole goal to increase and ease the inflow of remittances, and ultimately, to improve the value of the naira. Like other sceptics, I’m dubious of the two-month deadline—it is likely that the central bank will wish to maintain the policy for as long as possible after first testing its performance.
One would assume that the original intention of the scheme, although not clearly spelt out by the central bank, is to raise and stabilize the value of the naira. However, this policy move may not be effective or pay off, let alone deliver the desperately needed relief, because of the strong positive relationship between the exchange rate and volume of remittances. Before I explain my pessimism, let me provide some historical background on the naira.
First introduced in 1973 as a replacement of the Nigerian British Pound, the naira fluctuated in value between 1973 and 1985, but was, on average, stronger than the US dollar, with 1 naira worth roughly one and a half dollars. One of the reasons for this was that the Nigerian government at the time, through the central bank, oversaw fixing its value. Unlike today, where there are streams of exchange rates, there was only one exchange rate at that time. There was no parallel market for the currency, and the rate was pegged by the government.
In 1985, powered by the drive for reforms and to end restrictive control of the value of the naira, the government introduced a market for trading the currency with the demand for the currency determining its value—the exchange rate. This means if the demand for a dollar using naira is higher than the demand for the naira using the dollar, then the value of the dollar will go up and that of naira will go down.
In the immediate aftermath of liberalising the Forex market, the value of the naira dropped over 230 per cent and by January 2000, coinciding with the return to democratic rule, the value of the US dollar rose from less than one naira to more than 100 naira. For roughly 14 years, it maintained an average of approximately 143 in value. Then came the 2014 bust in world oil price which slashed Nigeria’s oil revenues and external reserves and set the value of the naira on the steepest downturn. After reaching a level not seen in half a century – peaking at close to 500 as of February 2017 – the currency’s average between the month of the oil price crash and September 2019 was 362.
Worthy of note: the standard deviation of the exchange rate – a crude measure of the currency’s steadiness – for the years following the shock in world oil price is more than five times larger than that of the period preceding the oil price crash, indicating that naira had become unstable. This was not only linked to oil prices but also to the foreign exchange policy regime’s pursuit from mid-2015. Bending in the wind of popular opinion, the central bank allowed the local currency to float, letting the forces of demand and supply set the rate, opening the currency to speculative attacks that left it further weakened. See evidence in the chart below:
Why the “Naira 4 Dollar Scheme” may be a blunt monetary policy tool
Coming back to the “Naira 4 Dollar Scheme,” I show, using remittance data and the naira-dollar exchange rate data from the World Bank, the response of remittances to the results from the analysis of exchange rate data.
The chart above – scaled in a log for convenience – shows the relationship between the exchange rate and dollars sent to Nigeria in remittances. The curve slants upward from left to right, depicting a strong positive connection between the two variables; in other words, the higher the exchange rate (that is, the weaker the naira) the higher the total remittances. For instance, based on my estimate using the data, as shown in the second chart, if the dollar appreciates by one naira, Nigerians abroad are willing to send home an additional $73 million per year in remittances. This finding has a striking policy implication: if the central bank wants to attract more remittances into the country, it will have to raise the value of the dollar by devaluing the naira, which is counterproductive to the bank’s original goal of saving the naira.
Moreover, the launch of policy coincided with the global coronavirus pandemic, which triggered a fall in remittances to Nigeria. A full accounting of this year’s crash in remittances is not yet available, but the experience during the 2007-2008 financial crisis is instructive. Between 2008 and 2011, outflows fell by roughly 10 per cent.
This time around, the World Bank has predicted a global fall in remittances of over 20 per cent. The International Monetary Fund likewise forecasts that money sent to sub-Saharan Africa will drop by 20 per cent.
What can be done
One option would be to reform or disband the Bureau de Change but not the service it is expected to render. Currently, most traders in the foreign exchange market operate under a cloak of darkness. They don’t work from offices, but on the busy streets of Zone 4 in Abuja, the nation’s capital, with pockets loaded with the foreign currencies they peddle. Their operations are not subject to the searchlight of financial regulators and other law enforcement officials. As a result, there is no trace of how much foreign currency they have traded, to whom, where and when—nor is there a hint of the source of the total foreign currencies traded.
These concerns have confirmed the deeply held cynicism about the activities of the bureau de change: they serve as avenues for two forms of illegal currency deals. First, currency speculative attacks – some people who were privileged to obtain foreign exchange at the official rate took quick profits in the black market. Second, political scapegraces who have looted public finances easily convert same through the Bureau de Change for onward transfer or laundering to foreign countries.
With robust reforms, the illegal powers and schemes of the Bureau de Change can be held at bay – quashed or mitigated. This is achievable if powered by political will. But this “will” seems to be a scarce political capital in a country in desperate need of radical reforms, given that there are too many vested interests in favour of the status quo!
Tighten regulations
In a fragile financial system like Nigeria’s, the exchange rate should not be left to the forces of demand and supply. The government must intervene as a regulator. Free markets or capitalism flourish best in a setting of robust institutions where the custodians of power – policymakers, politicians, and bureaucrats – do not rig the rules. Unfortunately, the legal, political and financial institutions are not healthy as expected.
In Europe and North America, foreign currencies are traded through commercial banks and other authorised dealers where the buyers and sellers provide proof of their identities before any transaction is initiated and completed. Their activities are captured by the financial system.
Conclusion
There is no question that the deteriorating value of the naira is linked to significant shifts in oil prices and therefore the future value of the currency will hinge on the demand and the availability of foreign exchange. But there is apparent misallocation in the use of Nigeria’s foreign exchange. Most of it is used to pay for the importation of non-capital goods and services. For instance, available data from the World Bank and the central of Nigeria show that roughly 89 per cent of Nigeria’s 2016 earned foreign exchange from oil rent was gulped by items: food imports, debt servicing, and the importation of petroleum products.
Nonetheless, a couple of things can be done about these. First, Nigeria can leverage the current pandemic to push for debt forgiveness. Second, this is an opportunity for Nigeria to revive its agricultural production to substitute for food imports. Third, the government can fast track, in any way possible, the development of the Dangote refinery, which will be the world’s largest by the time it becomes operational. Until these are addressed, Nigeria may have to bite the bullet as the value of its currency continue to freefall.
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Twitter @dapelzg
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