The FOREX Debate: What Is Emefiele Up To This Time? – by Theophilus Opaleye

An underlying economic principle that is often lost in translation in public discourse on the operations of foreign exchange market in Nigeria is the dynamic relationship between demand, supply and price. The technical terms often used by economic and financial analysts in explaining the forex situation has robbed most Nigerians of a true understanding of the true state of the economy and the impacts on everyday life.

Nigeria depends on revenue from crude oil sales for 90 percent of its dollar earnings. Consequently, the higher the price of crude oil, the more dollars the Nigerian government has in its disposal to meet demands for manufacturing, medical tourism, services, education etc.

This scenario played out to Nigeria’s advantage from 2010 to 2014 when crude oil sold for between $88 and $102 per barrel and production stabled at above 2 million barrels per day. During the same period, the forex demands grew exponentially but the official exchange rate managed to stay just below N200 to a dollar as a result of Nigeria’s bumper dollar earnings from crude oil sales.

By 2015 oil crashed to $48 and in 2016 it went further down to $36 coupled with a drastic reduction in production as a result of renewed uprising in the Niger Delta region. Nigeria could no longer meet the demands for dollars within its economy and the relevant economic principles kicked in. The exchange rate has witnessed unprecedented turbulence as a result, going as high as N500/$ until the recent intervention by the Central Bank of Nigeria (CBN).

Nigeria is not the only country that has had to deal with this experience in the last couple of years. Countries like Egypt, Argentina and Russia have all had to devalue, or fully float their currencies since 2015 to cope with the pressure of declining crude prices at the global market. Nigeria has also devalued the Naira once but the question about a full float persists.

Unlike in many countries, the interactions within the foreign exchange market in Nigeria as well as the relationship between the exchange rate and the overall macroeconomy is atypical and unconventional. This reflects the sentiments, abuse and rent-seeking behaviours that drive foreign exchange related pricings within the Nigerian economy.

For instance, round tripping is rife both among corporate entities and individuals, while businesses that were privileged to execute critical imports via FX from the interbank market price their goods to local consumers at parallel market rates. This does not only exacerbate domestic inflation it also encumbers the comprehensive understanding of the exchange rate pass-through in Nigeria.

HRH Sanusi Lamido Sanusi, Emir of Kano and himself a former Governor of the Central Bank attested to the fact in a recent interview. As such, while the CBN is dealing with the effects of dollar scarcity brought about by the reduced foreign exchange earnings from crude oil sales, the bank also has upon its shoulders the responsibility of dealing with corruption and currency manipulation perpetuated through hoarding and round tripping.

The clamour for a complete liberalisation of the foreign exchange market and the argument against the continued presence of CBN in the FX market does not take the second factor mentioned above into cognizance. Indeed, the need to liberalise the market and fully float the Naira cannot be denied and the CBN understands this. However, a “cold-turkey” approach to floating the Naira may have adverse long-term implications for the economy.

This is where argument within the financial analysis community in Nigeria runs at a tangent. While there is a consensus on what the CBN must and should do, thoughts on the methodology and timeframe for such moves differ widely. A cobweb analysis of the impact of a complete and sudden withdrawal of the CBN from the market suggests, for instance, that given the relativity of elasticities of FX demand vis-a-vis FX supply, the exchange rate may explode rather than converge.

This is because the demand for dollar in Nigeria is presently relatively more inelastic than our dollar supply. The indeterminate equilibrium that ensues means that value of the Naira will plummet exponentially and very quickly too; even in the long-run. This angle is often completely ignored by the CBN’s most vocal critics who just want the Naira floated and without recourse to the implications.

So, the strategy of the CBN at eventually attaining an equilibrium exchange rate is a gradual fine-tuning of the FX market to rebalance the relative elasticities of FX demand and FX supply with a view to ensuring that a cobweb analysis leads to a rate convergence in the long-run.

When scarce supplies are met with limitless demands, allocation of resources in the most judicious ways are employed to ensure prices don’t spiral out of control. While in the long-term demands are either managed or supplies increased. This is essentially what the CBN has been doing over the last 18 months to ensure Nigeria does not witness a total collapse of the Naira.

This explains the countervailing actions taken by the CBN to gradually fine-tune the outturns at the FX market. These actions in many respects involve the steady but deliberate build-up of official reserves while providing the available but highly limited foreign exchange to meet the most critical needs of the economy.

The introduction of a flexible interbank exchange rate system and priority FX allocation to the importation of raw materials, plants, and equipment have significantly reduced rent-seeking and arbitrage abuses. So also, the 60:40 rule which allows for 60 percent of FX allocation to critical manufacturing ventures and 40 percent to others has resulted in a spike in the volume of locally made goods.

The CBN has also ensured the availability of the highly limited foreign exchange to meet critical demands for payment of school fees, medical expenses, business and personal travel allowances and related expenses. Without these moves, the recent injection of dollars by the CBN would have had little to zero effect on the exchange rate.

Such steady injections will hold the Naira closer to its true value in the FX market while the CBN continues with long-term reforms to tackle corruption rent-seeking and round tripping that has been the order of the day for several years.

Theophilus Opaleye is apublic finance analyst based in Lagos.

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