The current slide in exchange rate of Naira to Dollar has thrown up currency experts on traditional and new media with diverse opinions.

Exchange rate is one of the factors that measures relative economic health of a nation, other factors are interest rate and inflation. The word “relative” is highlighted to show that these factors are  employed when comparing two countries, hence may vary at each currency pair.

The economic debate of N/$, requires some clarity to ardent followers of information being released.

The Exchange rate between two currencies is primary determined by demand and supply. Six factors (investopedia), guides the demand and supply structure, which I will attempt to drive home with some examples.

Except these issues are addressed, naira will continue to lose its value against dollar

1. Differentials in Inflation
   This is the persistent increase in the price of good & services in an economy over a period. Inflation rate in the USA has consistently decreased from 3.8% in 2008 to 1% in 2015. It was over 12% in year 2008 and stood at 9.6% by 2015.

Inflation affects purchasing power i.e worth or value of the currency. A rational foreign portfolio investor (FPI) with an assumption of other factors being constant ,  holding  a $ & a N by January 2015 till December 2015,  will have lost 1%  and 9.6% in the value of both currencies. And because he is rational, he’ll prefer to reduce his demand for more naira, if he’s not selling off the naira asset to avoid loss. The latter is what we are experiencing and the resultant effect is NAIRA DEPRECIATION.

As a general rule, a country with a consistently lower inflation rate exhibits a rising currency value, as its purchasing power increases relative to other currencies

2. Differentials in Interest Rates

Interest rate (cost of borrowing) is a tool used by CBN to control inflation. A change in interest rates influences the value of the currency. FPIs moves capital to take advantage of higher interest rate not available in domestic market. These inflows strengthen the value of naira against dollar. FGN and states governments have reduced borrowings from the open market. They have shifted to borrowing money from development partners and nations. Consequently, interest rate has lost traction, resulting in pool out by FPIs. This is putting enormous pressure on value of naira.

3. Current-Account Deficits

The current account is the balance of trade between a country and its trading partners, reflecting all payments between countries for goods, services, interest and dividends. A deficit in the current account shows the country is spending more on foreign trade than it is earning, and that it is borrowing capital from foreign sources to make up the deficit. In other words, the country requires more foreign currency than it receives through sales of exports, and it supplies more of its own currency than foreigners demand for its products. The excess demand for foreign currency lowers the country’s exchange rate until domestic goods and services are cheap enough for foreigners, and foreign assets are too expensive to generate sales for domestic interests.

This is the most important of all the factors, because it shows us the reasons while a currency value is strong or otherwise. In the case of Nigeria, we import everything including toothpick, soap to mention but a few while our major export earner is crude oil. As things stand now, $ will continue to be stronger than naira. However there are two action points; increase export earners and reduce import demands. Increasing export proceeds from oil is not achievable now, but we can start from reducing demand for dollar. Just to give classic examples,

(1) the Federal Government spent N1.82 trillion on importation of petroleum products between January and September last year, according to the National Bureau of Statistics, NBS.

(2)Food & beverages accounted for 17% of our total import bill last year.

Importation for these two items still exists; no amount of devaluation of naira can fix the anomaly.  Solution lies in the will power of the government to rise to the occasion by taken tough decisions where necessary.

4. Public Debt
   Countries will engage in large-scale deficit financing to pay for public sector projects and governmental funding. While such activity stimulates the domestic economy, nations with large public deficits and debts are less attractive to foreign investors. The reason? A large debt encourages inflation, and if inflation is high, the debt will be serviced and ultimately paid off with cheaper real dollars in the future.

In the worst case scenario, a government may print money to pay part of a large debt, but increasing the money supply inevitably causes inflation. Moreover, if a government is not able to service its deficit through domestic means (selling domestic bonds, increasing the money supply), then it must increase the supply of securities for sale to foreigners, thereby lowering their prices. Finally, a large debt may prove worrisome to foreigners if they believe the country risks defaulting on its obligations. Foreigners will be less willing to own securities denominated in that currency if the risk of default is great. For this reason, the country’s debt rating agencies is a crucial determinant of its exchange rate.

5. Terms of Trade
   A ratio comparing export prices to import prices, the terms of trade is related to current accounts and the balance of payments. If the price of a country’s exports rises by a greater rate than that of its imports, its terms of trade have favourably improved. Increasing terms of trade shows greater demand for the country’s exports. This, in turn, results in rising revenues from exports, which provides increased demand for the country’s currency (and an increase in the currency’s value). If the price of exports rises by a smaller rate than that of its imports, the currency’s value will decrease in relation to its trading partners.
6. Political Stability and Economic Performance
   Foreign investors inevitably seek out stable countries with strong economic performance in which to invest their capital. A country with such positive attributes will draw investment funds away from other countries perceived to have more political and economic risk. Political turmoil, for example, can cause a loss of confidence in a currency and a movement of capital to the currencies of more stable countries.

Nigeria must move towards self sustainability. This is measured by:

• Agricultural production
• Energy Resources – Oil, Gas, Coal
• Water & Land
• Demographic Resources – People & Livestock

A self sustaining economy is not pressured by the value of other currencies because it is internally self regenerating. South Korea has one of the highest per capital income but her currency “WON” trades at 1234/$. Lower exchange rate helps such an economy to increase her  share of export market to maintain domestic production level.

Countries that has gone through our present predicament worked on the structure of their economy, not much emphasis was placed on value of their currency but rather an economic master plan towards self reliance

 We do have all sustainability factors in abundance, what we lack has always been discipline to follow through our policies.  The party is over; price of crude oil is likely to trade above this level of $30 per barrel hence it is time for a well articulated policy drive

The federal government must put forward fiscal policies to address the current quagmire.

If we want a stronger naira, the time to act, produce & patronize naira products is now!

God bless Nigeria

Kayode okunola

Managing Partner

Broadview Advisory Partners Limited

Kayode.okunola@broadview.com.ng

Views expressed are solely that of author and does not represent views of www.omojuwa.com nor its associates