Thoughtful analysis, but I’ll have to take exception to your criticism of the current FX policy by…
BlackMaria
11

No.

The starting point is to understand that this is just another subsidy that Nigeria cannot afford. And then to ask what can be done to make it more affordable.

The price of FX is what it is in the market and by allowing people to buy it at an official rate that is lower, the government is effectively providing a subsidy. That subsidy becomes costlier everytime the exchange rate moves against you.

Because the government cannot afford to continue to provide the subsidy as it is currently set up, it is insisting on managing demand and this is stifling the flow of trade across the system because of various restrictions as part of ‘demand management’.

By devaluing (I’m starting to dislike that word because it seems to give many people the impression that an exchange rate is something that exists in isolation and therefore a government can decide to hold on to unilaterally without consequences) you are simply accepting the fact that the market for Naira-Dollar (for example) has moved so much that you can no longer continue to support the volume of demand you are facing given what the spread caused by your subsidy is doing to the supply side.

You can keep subsidising (since like I mentioned Nigeria has decided a two-tier market is the way to go, and it has its reasons) but you need to reset the price at which you will continue to do it given you clearly cannot afford it at the current spread (reflecting your self-imposed subsidy). You can’t have everything you want all the time.

To the question of how devaluation helps. The crucial pieces to remember are what I’ve said about spreads and foreign investors. Let me see if I can do a better job here:

You need foreign exchange because your reserve position is too low for comfort. You’re meeting some demand but there’s no supply coming in.

Think of filling up a sink. If you then open both the drain and the tap (and keep them working at roughly the same rate) you don’t need to worry too much about the water level. Here, the tap is only dripping through but try as you might, there’s a limit to how much you can block the drain.

So you need to do something. Hopefully that point isn’t in dispute.

Restricting the demand side will only take you so far. It only extends the timeframe to when you will eventually run out of dollars and does nothing about bringing in more supply. So it’s not really solving your real problem, which is that you have a lot less dollars coming in these days with oil prices having more than halved and foreign investors having either pulled their capital from the stock market or stemmed the inflow of private investments and FDI.

Foreign investors have foreign exchange. They have what you need, aka supply. They are holding off on bringing it in because:

  1. the amount of Naira you are offering them is less than fair value (and of course any serious investor has to go through the government to access volume). Remember fair value is not for even the Nigerian government to determine — it is up to the markets and the market is saying dollar is N270.
  2. even if they liked you enough for whatever reason to accept less than fair value, you obviously cannot continue to subsidise parts of your economy at N199 forever, so the day will come when you have to accept that, and suddenly when it’s time to repatriate their capital, they will have less dollars than they brought in. They’re not in the business of losing money and the world is a big place, so for now, they will take their money elsewhere (even keeping it under their pillow is a better decision).

Let’s not lose sight of the fact that what you need is dollars (otherwise you wouldn’t need to be on this starvation diet you describe) and that is the one thing they certainly have. They won’t bring it until you devalue. You need to stimulate the supply side. I hope that’s now clearer.

As for the demand side, again, back to spreads. What logically happens when there are 2 prices for anything is people want to buy at the price that is cheaper. So there will be higher pressure than there should ordinarily be on these precious reserves that are already too low for comfort.

If you raise the price at which you are offering dollars to the part of the economy that y0u have decided to subsidise (aka if you devalue), 2 things will happen to reduce demand side pressure:

  1. some people will decide that the new price is too rich for their blood and will bow out of the market completely. It’s called ‘willingness to pay’. Businesses will go back to the drawing board. Some will innovate/become creative and others will go out of business. That is fortunately or unfortunately the nature of trade. Everything has a cost attached to it, and sometimes things are too expensive.
  2. some of those who are still willing to pay at the higher price will be less bothered about getting supply from the CBN if the spread is low ‘enough’ to give them comfort that they are not leaving too much value on the table and will have more tolerance for going elsewhere.

Another crucial thing is you can begin to relax your current restrictions on business and those businesspeople who rely on making quick and smooth international payments through the banking system can continue to run their businesses at the pace that their partners abroad require. There are few companies abroad that are so dependent on their volumes from Nigeria that they will put up with severe delays to payments indefinitely.

With regards to ‘insatiable appetites’ for dollars, the argument about people using their cards to do what they like abroad falls down the second you understand that the CBN is no longer funding the banks’ settlement of MasterCard and Visa balances, but still obviously there’s a problem somewhere. The banks are settling those balances at rates close to the parallel market, the issue is volume of FX coming into the system overall.

The argument is also faulty because it assumes that people like dollars for its own sake. Nigeria does not have a problem with uncontrollable inflation, so the reason for that ‘insatiable demand’ is generally not because people are looking for a better store of value. The economy was growing and to acquire the means to help it continue to grow (trade), sometimes you needed to pay for things in dollars, so demand for dollars grew. There was no problem because we were supplying enough of what the people who have dollars (foreigners) needed at a good price (oil), so demand didn’t outpace supply too much (spreads between official and parallel markets were a lot lower) and the naira-dollar exchange rate was reasonably stable at whatever level.

N1000/$ that you mention sounds dramatic, but if that is a stable number, and you don’t have a crazy spread between parallel and official rates, what you should worry about is how you can make Nigerian goods and services more competitive abroad and not that the number is arbitrarily ‘high’.

We can have a big debate about the state of Nigeria’s manufacturing and the level of import dependency, but it will only be a debate. The way to address it is not by stifling those same manufacturers by restricting their access to capital.

Everyday Nigerians are complaining that their Uber payments are being declined and their voices are loud but really the real pressure is on businesses who cannot move their enterprise as quickly as they need to because of various restrictions to access (setting aside the issue of price). When that goes on for too long, the economy slows down and people start to lose their jobs. This is already happening.

It’s a complete red herring (and dangerously divisive of the CBN) to suggest that the reason reserves are under pressure is because of private consumption by people who can afford to buy books on Amazon or take their families abroad on holiday. And sadly you’ve now repeated a version of the same argument.

There are other things you can do to ease demand and attract supply of dollars. Industrial capacity, exportation and infrastructural development are of course good things that I have talked about but none will happen even nearly overnight. The one thing you can do in the short term is devalue.