Why is the CBN not floating the naira? By Uche Uwaleke



In an apparent reaction to a widely reported statement by Alhaji Atiku Abubakar, the presidential candidate of the Peoples Democratic Party, that he would get the Central Bank to float the naira if elected into office, the CBN Governor, Mr. Godwin Emefiele had, during a press briefing following the meeting of the Monetary Policy Committee in January, warned that doing so would plunge the economy into crisis.

He was quoted as saying that “the MPC reviewed it and concluded that it would be wrong. It is as good as saying that we should go back to the era of Structural Adjustment Programme (SAP) in Nigeria.

The implication can better be imagined. It will certainly lead to capital flight, lead to massive depreciation of the currency and ultimately to currency crisis and I think we should all know that it is a road to perdition to ever go in that direction”.

Good company

On this overarching issue of ensuring a single market-determined exchange rate, Mr Abubakar has good company in the International Monetary Fund. In March 2018, the Executive Board of the IMF concluded the Article IV Consultation with Nigeria and recommended, among others, the removal of ‘distortions in the foreign exchange market, which should be unified and contribute to strengthening reserve buffers’.  

Indeed, proponents of naira float argue that by implementing a complete float, the true value of the naira will emerge leading to the convergence of the official and parallel market rates.

A unified exchange rate, which is one attribute of a well functioning forex market, finds theoretical support in its ability to respond to market forces, reduce market distortions and encourage foreign investments in the long run.

Unfortunately, Nigeria has a peculiar case: the interplay of market forces in the forex market, lopsided in favour of demand, can only result in a very high equilibrium price.

The liquidity challenge

Even if currency floating solves the problem of multiple pricing and arbitrage; it does not address the liquidity challenge.

According to the recently published CBN Q4 2018 Economic Report, ‘Foreign exchange inflow and outflow through the CBN amounted to $14.51 billion and $14.60 billion respectively, resulting in a net outflow of $0.09 billion’. Because the country imports fuel, raw materials, food and virtually everything, commodity prices will hit the roofs from pass-through effect of high exchange rate and the CBN will be compelled to further tighten monetary policy.

Granted that government revenue will increase from the naira value of oil exports, but the cost of servicing government’s huge domestic debt will also surge following increased yields on government securities. What is more, a higher exchange rate resulting from naira float will also make the servicing of foreign debts more expensive. Further, huge sums will be needed to implement capital projects contained in the 2019 budget which is dollar-dependent. A unified exchange rate is capable of increasing the pump price of fuel and accelerating inflation.

The oil subsidy (NNPC under-recovery) provision in the 2019 budget is $1 billion or N305 billion. So, a naira float will not only increase the cost of fuel subsidy but also widen the fiscal deficit in the 2019 budget.

CBN’s considerations

Clearly, a reluctance to float the naira, on the part of the CBN, is largely informed by these considerations as well as by the pursuit of the primary objectives of exchange rate policy in Nigeria which are ‘to preserve the value of the domestic currency, maintain a favourable external reserves position and ensure external balance without compromising the need for internal balance and the overall goal of macroeconomic stability’.

Drawing from the experiences of other countries, the introduction of a currency float in an import-oriented economy comes with negative consequences. A case in point is the IMF-induced currency float in Egypt.

The Egypt experience

In November 2016, the government of President Abdel Fattah al-Sisi yielded to pressure from the IMF to float the Egyptian pound as pre-condition for accessing a $12 billion three-year loan. Expectedly after receiving the first tranche, Egypt’s foreign reserves jumped to $23.1 billion at the end of November 2016 from $19.1 billion a month earlier according to the Central Bank of Egypt.

Although, the gap between the official and parallel market rates narrowed considerably, it was at a very high price: from a pegged exchange rate that had the Egyptian pound officially trading at EGP8.8 to the dollar, the Egyptian pound bled so much that a few days after its floatation, it officially traded at EGP17.8 per dollar compared to EGP17.98 per dollar in the parallel market.

A report by Bloomberg named the Egyptian pound as Africa’s worst performing currency in 2016 chiefly because ‘the nation took the dramatic step of allowing it to trade freely in an attempt to stabilise an economy struggling with a dollar shortage’.

That was not all. The floatation brought in its wake high inflation and interest rates. According to the Central Bank of Egypt, the Consumer Price Index reported by the Central Agency for Public Mobilization and Statistics (CAPMAS) registered an annual increase of 19.43 per cent in November, compared to 13.56 per cent before the currency float in October, the highest annual inflation rate in nearly a decade.

The Monetary Policy Committee affiliated with the CBE had increased the prices of basic yield (which is the leading indicator for the direction of interest rates on the Egyptian pound in the local market) by 3 per cent in November, along with the CBE’s decision to float the pound which saw lending rates spike from 10.25 per cent to 15.75 per cent.

Till date, the country is still reeling from the spillovers of that action. According to the World Bank, ‘headline inflation remained at high levels of 21.6 percent during 2017/2018’ while the Egyptian pound currently trades around EGP17.4 per dollar.

The takeaway from the Egypt experience is that a currency float comes with adverse consequences the severity of which depends on the state of a country’s economy. What is clear is that the relatively diversified economy of Egypt and the IMF support facility helped to cushion the destabilizing effects.

‘Floatation a scary option’

On the contrary, the defective structure of the Nigerian economy and the fact that the country is not seeking any loan from the IMF should make floatation a scary option for the CBN.

It bears repeating that much as currency floatation offers countries the advantage of maintaining an independent monetary policy, a key success factor is a well functioning financial market that is deep enough to absorb shocks with minimal volatility in exchange rates.

In addition, financial instruments must be available to hedge the risks posed by a fluctuating exchange rate. This is not yet the case with Nigeria. Therefore, any attempt to float the naira now will spell doom for an economy still recuperating from the devastating effects of five consecutive quarters of negative output growth. 

It must be pointed out that the recovery of crude oil price in the international market made possible the introduction of the Investors and Exporters window by the CBN in 2017, which has contributed immensely to exchange rate stability and the convergence of rates across the segments of the forex market. The average exchange rate at the investors’ and exporters’ window, the BDC and the inter-bank segment of the forex market as disclosed in the CBN Q4 Economic report, were N364.27/US$, N362.52/US$ and N306.70/US$, respectively. By implication, forex market liberalization is a gradual process the pace of which should be dictated by prevailing economic conditions. 

It goes without saying that a weak currency is not in the interest of a mono-product country such as Nigeria especially now that the federal government is turning attention to foreign borrowing to bridge budget gaps.

It is often argued that a country can boost growth by weakening its currency because doing so promotes exports but this strategy is not a one-cap-fits-all recipe.

The Nigerian economy is import-dependent with very little non-oil exports. This is the crux of the matter and currency free float will not change this narrative. The way forward therefore is to reduce the country’s import dependency and strive to join the league of net exporting countries. Only then, will a naira float make economic sense.

Uche Uwaleke of Nasarawa State University Keffi is Nigeria’s first Professor of Capital Market and the President of the Association of Capital Market Academics of Nigeria.

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