Devaluation: Maximising the gains or minimising the losses?


Since December 2015, I have been under personal pressure and, quite paradoxically, restraint to join in the debate on anti-corruption and good governance. Many commentators were advising President Muhammadu Buhari to concentrate on governance and avoid the distraction of concentrated energy on anti-corruption. My position at the time was to cast my lot in support of the President. The reason is that a strong anti-corruption drive and good governance are not mutually exclusive, and Buhari should be given the chance to prove his mettle. In this piece, I will still give a little attention to this issue, but my major worry now is on a statement reportedly credited to the President’s office that Buhari had vowed not to devalue the naira as that would amount to killing the currency. Part of the statement as quoted says: “President Buhari said that proponents of devaluation will have to work much harder to convince him that ordinary Nigerians will gain anything from it (devaluation).”

It is not my intention to convince Mr. President; far from it. That’s the work for his advisers and cabinet members. Rather, it is my intention to let him know that in the current situation that Nigeria finds herself, the right question is not about whether the so-called “ordinary Nigerian” (a concept that is to me nebulous) will gain anything from devaluation but whether the inevitable losses that are associated with currency overvaluation can be minimised.

If Buhari does not know, the current overvaluation is hurting the economy and by implication the common Nigerian that he seeks to protect. The common argument is that we are an import-dependent economy and devaluation will trigger local price rises and therefore harm the poor. The big question is: Who profits from a currency overvaluation? It is the rich and the elite who have access to official foreign currency and not the poor. The moment the foreign exchange market is in disequilibrium, the products the poor buy are usually priced at the parallel market exchange rate while the rich, who corner the available foreign exchange at the over-valued (or subsidised) rate, earn a rent from arbitrage. Without mincing word, let it be equivocally known that the ordinary Nigerian will gain nothing from an over-valued exchange rate: the supposed gain or benefit is nothing more than an illusion.

In the remaining part of this essay, I will try to restate some basic economic principles, which I am sure Mr. President and his advisers know very well but are failing to face up to. I will relate them to the subject at hand, which is the naira exchange rate as well as the determinants of the strength of a national currency. I will try to read the mind of Buhari as to why he is opposed to devaluation and infer that any attempt to ignore or defy basic economic principles is an incentive for sharp or corrupt practices which he is trying to fight. Not only that, it will also amount to the postponement of the day of economic doom except, as he prophesied, the recovery will come sooner than later. Maybe, I should add here that I believe very strongly in Nigeria and daily prays for her good, but I do not ask God to do for us what He has already equipped us to do.

One of the first basic lessons in economics is the law of supply and demand. It simply states that the higher the supply of a product, the lower the price will be, if demand is kept constant. Conversely, the lower the supply, the higher the price will be at the same level of demand. When the demand for a product rises while the supply level is constant, the price of the product goes up, other things being equal. On the other hand, a lower demand at a constant level of supply will create a glut that will force prices down. This is how the forces of demand and supply play out in an ideal or free market situation. But we know that realities often differ from the ideal, hence some market interventions to achieve a pre-determined or a preferred market goal.

Applying this simple principle to the case in hand, we have a situation of drastically reduced dollar supply with increased (not even constant) demand. This is the case at both the official and the parallel markets. The normal response would be an increase in the price of the dollar in naira terms (or in more technical parlance, a depreciation). This phenomenon is playing out in the parallel and autonomous dollar markets, where the prices have soared to between N288/$1 and N302/$1. Quite strangely, the relevant authority (i.e. the Central Bank of Nigeria) has kept its own price at N199/$1, giving a premium of more than 50 per cent. Meanwhile, the bank has no buffer stock to cushion the market pressure; rather, it merely turned the eye and kept the rate constant. The last time I remember Nigeria trod this path was during the dark Abacha days, and we know how much distortions and dislocation this caused the Nigerian economy. Is it that we learnt no lesson from history?

I also recall a spurious public debate on exchange rate devaluation that former military dictator, Ibrahim Babangida, called in the mid-80s. Trying to hold on to power and enjoy a populist stance, he threw a clearly technical subject to laymen to debate. What was the result? People went emotional, albeit ignorantly, and rejected naira devaluation. Nobody wants the naira dead! But it was only a matter of time: the devaluation that we got was much higher than what was rejected. We are on the path of the same foolish pride again, and we will soon discover that what we are branding as a poison meant to kill our economy (or currency) is a medicine that other serious economies- managed by informed, rather than ignorantly sentimental professionals-sometimes deliberately takes to correct their imbalance and improve their competitiveness.

For Nigeria and in my view, the right response is not to ignore the market sentiments completely, but to manage it in order to forestall a possible market failure. The right response is not the administrative gymnastics that the CBN is displaying now, but a well-informed and technically proficient initiative that will educate the executive arm about the parlous state of the economy and the need to properly align the naira exchange rate. To avoid devaluation, the right response ought to have been to allow the exchange rate to depreciate to reflect market sentiments. Failure to depreciate the currency will inevitably force devaluation. It’s only a matter of time. The only way for the exchange rate to remain as it is today is to have more dollar inflows. And what are the possible sources of such inflows? The first is export of goods and services – and we are doing very little in non-oil exports at the moment, having been conditioned to a mono-product mindset with the huge inflows from oil exports.