Jobs. Jobs. Jobs. Part II

Balance of Payments is the record of all economic transactions between the residents of the country and the rest of the world in a particular period. The balance of payments theory of exchange rate holds that the exchange rate between two currencies is determined by the free forces of demand and supply on the foreign exchange market. A deficit in the balance of payments will lead to a rise in the exchange rate since foreign exchange demanded exceeds supply, causing a devaluation in the home country’s currency. However, a a balance of payment surplus means supply of foreign exchange exceeds demand, which will cause a fall in the exchange rate, and an appreciation of the home country’s currency.

How does this affect Nigeria? The Q3 Foreign Trade Report which you can download here provides plenty of clues. First, oil exports contributed 69% of total exports in Q3 2015. With oil prices falling faster than Chelsea’s drop on the league table, it means Nigeria is earning significantly less foreign exchange. According to the report:

The value of the nation’s merchandise exports totaled ₦2,333.2 billion in Q3, 2015; a decrease of ₦320.6 billion or 12.1%, over the value (₦2,653.8 billion) recorded in the preceding quarter. This decline was attributed to a fall in crude oil exports by ₦372.8b or 18.8% over the preceding quarter

See what happened there? The drop in crude oil prices cost Nigeria N320 billion in exports. Using an exchange rate of N200:$1 (don’t laugh), it means exports dropped by $1.6 billion.

Now let us go to see what happened to imports. According to the same trade report:

The value of Nigeria’s imports stood at ₦1,688.2 billion, at the end of Q3, 2015, a decrease of 1.0% from the value (₦1,705.7 billion) recorded in the preceding quarter.

So while exports dropped by 18% or $1.6 billion, imports dropped by 1% or $10 million. This is why the Governor of the Central Bank cannot sleep soundly; because that difference of $1.59 billion means one of three things must happen:

1. Since the supply of foreign exchange has dropped by $1.6 billion and demand only dropped by $10 million, there is now a scarcity of foreign exchange, and the price of buying it should increase.
2. The Central Bank can supply the difference of $1.59 billion by going to its reserves; this is what happens when CBN defends the Naira. The only problem here is our reserves are not infinite; we only have $29 billion in there. So you can do the numbers, if nothing changes, we would have emptied our reserves in 4.5 years defending the Naira (you can check this by dividing $29 billion by $1.59, it will give you 18 quarters).
3. The third option is for the CBN to somehow drive the demand for foreign exchange down, and reduce our import bill so it can match the drop in exports. So by not making foreign exchange available for things like toothpicks and Brazilian hair, the CBN hopes we will either acquire a taste for Nigerian products or drop the need to buy imported goods. There is one big thing they seem to forget at the CBN: the world is now so integrated that machines and raw materials needed to produce the right amount of exports, might themselves be imported. So by trying to stifle demand for foreign exchange, we might be cutting our nose to spite our face.

But there are other factors that determine the value of a country’s currency. For example, the dual impact of interest rates and inflation are important factors that influence exchange rates. Let’s assume you have N1 million to invest in two countries. In Country A, the interest rate paid is 10%, while inflation is 5%; while in Country B, the interest rate paid is 8%, but inflation is 1%. The reason you are investing is because you want to buy car that costs N1 million now, but you only plan to buy it next year. So, if you invest in Country A, you will make N100,000 from interest (10% interest rate), but the value of the car has also gone up by N50,000 (5% inflation); this means you make a profit of N50,000. In Country B, you will make N80,000 from interest (8% interest rate), but the value of the car also only goes up by N10,000 (1% inflation); this leads to a profit of N70,000. So the easy decision is clearly to invest in Country B.

Again, how does this affect Nigeria? Let’s use two easy examples, Nigeria and the United States of America. In Nigeria, inflation has remained at 9% in the last 3 months, while interest rate has come down, with the CBN reducing the monetary policy rate by 2%, from 13% to 11%. Now let us move over to the USA, where the Fed Rate went up for the first time since 2006 from 0.25% to 0.5%, while inflation has fallen from 0.8% in 2014 to 0.5% in 2015. This means that while rates are falling and inflation is stable in Nigeria, rates are rising and inflation is falling in the United States. If you were an investor who is trying to decide where to put capital to work, the answer seems pretty clear; the United States has become attractive relative to Nigeria in the last year.

Let’s go back to the real issue, how the Government will boost growth and create jobs. The President’s focus on improving infrastructure is admirable, no doubt about that. However, the Government cannot simply provide all the money needed to build roads, rail lines, increase power supply, and build adequate ports. It means a lot of the the capital needed for these projects will come from the private sector. With all the focus on job creation, if the fiscal, monetary (especially) and trade policies do not encourage investment, then Nigeria can kiss its 4.3% growth and 3 million new jobs goodbye.

This is why the current foreign exchange policy of the CBN should worry you. Forget your inability to use debit cards abroad, the real danger here is the value of our Naira will discourage the foreign investment desperately needed to boost infrastructure. As long as our major source of foreign exchange, oil receipts, remain at risk, the demand for foreign exchange will always exceed supply. In such a situation, it is difficult, if not impossible, for you to convince investors to put capital in your country. It is like keeping your pot of stew with a man ravaged by hunger for three days; when you come back for the stew, you’ll be lucky if you get an empty pot back. Apart from this, the selective allocation of foreign exchange means the biggest lever for optimum resource allocation, PRICE, is taken away. Let’s assume an investor wants to invest $100 million today in our economy; at the current exchange rate, this will fetch about N19.5 billion. However, if the investor believes the actual exchange rate should be N240:$1, it means that when he is exchanging his N19.5 billion for dollars in two months, he might only fetch $81.2 million. This means the investor would have lost almost $19 million by just investing in a market whose currency was over-valued. This is why attracting investors to Nigeria will be difficult; as long as the exchange rate is artificially supported, no serious investor will take the massive risk of putting money here. Unless crude oil prices improve or our currency is properly valued, this cloud will continue to hang over us.

So, while President Buhari might be haunted by the damage policies like the Structural Adjustment Programme (SAP) did to Nigeria, he must also recognize the current policy is a massive hindrance to boosting infrastructure and growing the economy. Apart from this, an artificial exchange rate, especially in the face of such balance of payment pressures, is a dream land for speculators. The President or CBN Governor should remember George Soros, did to the Bank of England. If you want to understand how the British Government spent over £3 billion unsuccessfully defending the Pound, and eventually lost £800 million, please read this. By defending a two-tier exchange rate system, there is a massive incentive for people to forge whatever documents they need buy sheep, sell deer and make profit. Feyi Fawehinmi’s post explained this clearly.

The final part of this 3-part post will try to provide solutions to stimulate growth and employment.