Towards a market-determined naira exchange rate

IN his 2009 budget speech, President Musa Yar'Adua said that his administration would in the medium term use present market-determined monetary management for its macroeconomic objectives of ensuring a single-digit rate of inflation and appropriate levels of naira exchange and interest rates as well as to deploy open market operations in managing the volume of money supply. Apparently informed by failures in the past, he did not set any target indices. However, about the day the President spoke, the naira exchange rate was being officially manipulated.

Feigning indignation at the then diving naira, the Senate summoned the Central Bank Governor Chukwuma Soludo on December 16, 2008 to explain the drop of 13 per cent in the value of the naira from N116/$1 in the last week of November to N134.50/$1 in mid-December. But Soludo's real mission at the Senate was to dress up the administration's decision to devalue the naira which had earlier been conveyed in camera to the Council of States as a fallout of the interplay of supply and demand for foreign exchange.

Even so, the Senate ignored the so-called market-determined exchange rate engineered by the apex bank when it pegged the naira exchange rate at N125/$1 (a fact that was implicit in the President's budget speech) as against N117/$1 for the 2008 budget before hurriedly passing the 2009 budget barely 24 hours after Soludo's presentation.

Why should government engage in dissembling? Evidently the naira exchange rate may still change by the time both chambers of the National Assembly approve the 2009 budget depending on any lowered perception of crude oil price movements vis-?-vis the announced benchmark oil price. The apex bank, as customary, will thereafter dance around the final budget naira exchange rate throughout 2009 in order to project the illusion of a market-determined stable naira exchange rate.

Very importantly, Soludo's presentation offered the public a glimpse of the innards of the present brand of market-determined system of fixing the naira exchange rate, which happens to be a sham. Although Soludo espoused that the apex bank operates a flexible naira exchange rate that responds to changes in supply and demand, Nigeria's foreign market is abnormal. Its main features are worth sketching. Anomalously leading the supply side that traditionally involves exporters and foreign direct investors is the CBN itself, the statutory regulator of the financial sector and instituted bank of last resort, which monopolistically controls 90-95 per cent of available foreign exchange. The CBN therefore decides what and when to sell foreign exchange.

To the demand side have been shoved the three tiers of government after they have been prematurely dispossessed of their oil export earnings. Heavily laden with advances of purported naira equivalents substituted by the apex bank for their withheld Federation Account (FA) dollar proceeds, the three layers of government muscle demand and outprice genuine end-users of foreign exchange. For instance, informed of the imminent naira devaluation at the Council of States, state governors forsook national interest which they are under oath to always uphold and instigated a speculative and fraudulent rush for dollars that has reduced the country's foreign reserves from $64 billion to $58 billion in less than two months.

Nigerians suffered unmerited double jeopardy when the CBN used such insider-dealing upsurge in demand for dollars to explain government's preconceived naira devaluation. Besides, pushing the monthly tsunamic naira advances to the governments (ahead of any due settlement to third parties) into the banking system facilitates creation of bank credits that fund exaggerated and spurious demand that consistently overshoots available supply of foreign exchange. Such conditions predispose the naira to depreciate constantly thereby rendering the naira exchange rate perennially unstable.

In addition, the auction market system encourages unnecessarily high naira bids for available dollars, which the apex bank routinely rejects contrary to the principles of an auction. In effect, the CBN as an interloper dollar monopolist simultaneously decides the quantity and the price at which it sells foreign exchange, which is an economic aberration. Hence, rather than being market-determined, the naira exchange rate down the years has been whimsically fixed and it remains artificial. As a variable that has extensive economic impact, the artificial naira exchange rates, which completely undo the core objects of the apex bank, are responsible for the long-running poor state of the economy.

The CBN Governor has argued that devaluing the naira stabilised the naira exchange rate and the economy as it facilitated the sucking of hundreds of billions of naira from the system with the dollars sold. What happens when the next tranche of naira advances arrives? Anyway, under the present system a stable naira exchange rate is imaginary. Also sound economic infusion of foreign exchange, far from suck, actually injects funds that promote enhanced economic activity. The apex bank governor additionally claimed that a devalued naira would permit capital inflows, check frivolous imports, conserve foreign reserves, protect the domestic production sector and expand exports. History refutes such claims: the country has not derived any of those benefits despite the monotonic devaluation of the naira from N0.5464/$1 in 1980 to N134/$1 in 2004. The subsequent temporary halt up last October did not improve matters nor will the now renewed devaluation make any positive difference since the naira exchange rates have been and remain artificial. Likewise, the argument that devaluing the naira would prop budget revenue is fallacious because the measure will only generate increased but diluted naira advances, which are not realised revenue on which the quality of budget implementation largely depends. This counterproductive option gives away the administration as less circumspect.

Yet, the elusive benefits which Soludo cited (they should include zero-hugging inflation, single-digit lending rates at levels prevailing in successful economies and fast expanding employment) are realisable given a truly market-determined naira exchange rate. Towards that end, the CBN should become a stand-off regulator like its counterparts in focused economies. As the sole beneficiaries and bona fide owners of FA dollar proceeds, the three tiers of government, under orthodox economics, belong to the supply side, where they would be relied upon to supply a steady stream of dollars in excess of their official import needs to the financial market in staggered search of naira to enable them to carry out government business. The recommended use of CBN domiciliary dollar accounts and absolute denial of access to dollars in cash stamps out the notorious penchant for speculative and fraudulent diversion of FA dollar earnings as well as cuts out loot-facilitating and smuggling-promoting bureaux de change from handling official foreign exchange.

On the demand side, appropriate regulatory framework would channel available foreign exchange to genuine end-users to fast-track desirable investments, stymie frivolous imports and help conserve foreign reserves. Nigeria is intuitively a dollar-surplus economy: even amidst falling oil prices, dollar earnings will outstrip requirements for import components of real investments and genuine capital outflows. Hence given disciplined fiscal and sound monetary management, the country would ordinarily enjoy rising external reserves and a strong, stable and realistically market-determined naira exchange rate that would facilitate cheap capital and intermediate imports for vibrant and competitive domestic production.

Such a thriving production base, predominantly private sector-driven, would rapidly develop forward and backward linkages locally and propagate extensive employment opportunities. This is the direct road to the much desired diversified Nigerian economy, national prosperity and generation of sustainable non-oil tax revenue.