Nigeria’s forex wahala

The writer here had good points:

Price, as he points out is one of the best mechanisms for optimum resource allocation. In plain English that means that the price of something tells you how much of it you can afford, in much better way that your Pastor or your government preaching about it can.

Domiciliary Accounts are holding huge amounts of forex at a time of forex scarcity, and are failing to provide the ‘float’ or liquidity support they can be to supply.

Uncertainty leads to postponed capital investments. If most people expect a devaluation to occur, delaying it means that anyone who finds herself unable to hedge the future rate of exchange, will wait for devaluation to occur. This will depress growth.

Devaluation has, in many way real ways, already occurred. Most people — with most defined in terms of percentages, are not buying at the CBN rate. All that is happening, the writer however did not say, is to prioritise who gets forex. This is a subsidy to ‘preferred sectors’. To see government choose preferred sectors is scary, as that can completely distort an economy. However, it is still a fact that, what is happening is that the main supplier of Forex has decided to forego some of its value to support what it sees as priority sectors. It has defined priority sectors as those which have manufacturers which add more local value to goods than imported products.

It’s hard not to snark at this bit…

I have not seen any data set that supports the assertion that devaluation automatically leads to higher inflation.

Look harder, my man. Start here, or here, or here or here or here…..

In simple, non- inside baseball terms, if you reduce the buying power of the Naira significantly, you will need a lot more Naira to buy the same quantity of goods or services. This is called inflation.

Inflation is a killer for a developing economy.

1. Inflationary spirals are real. The vulcaniser reacts to an increment in the price of patching material by increasing the cost of patching tyres to the motorist. As cost of goods and services increase for the motorist, he either successfully demands higher wages or see his disposable income disappear, which at aggregate does not exactly make for economic growth, especially in an economy that is informal sector driven.
2. Inflation affects poor people disproportionately. It wipes out their meagre savings. It leaves them vulnerable to job losses. It can depress aggregate demand for the most substitutable services and goods, which are often the ones provided by the informal sector.
3. In Nigeria, it costs around 23% to borrow from a bank and up to 240% to borrow from a microfinance bank. The cost of borrowing will go up with inflation and the effect will be instantaneous, and will filter through in quick order to even informal credit systems.

Why will inflation follow devaluation? It is a bit obvious is it not? There exists what economists call a ‘pass-through’ from devaluation to inflation.

A lot of our intermediate inputs in many sectors are imported. An easy way to illustrate this point is to list a lot of things that ordinary people consume, and point out how they will be affected. Bear in mind, the common sense principle that producers will always try for full cost recovery in pricing. Nobody wan short.

• Petrol and Diesel. Right now, falling fuel prices are countered in Nigeria by depressed value of the Naira. With devaluation, pump prices in Nigeria will go up and it will have a broad and instant impact on the economy.
• Transportation. Fuel prices will drive transportation costs up.
• Food. A significant portion of the cost of food for urban dwellers is transportation.
• Recharge cards. Telco costs will go up as a result of increased cost of running base stations.
• Manufactured goods. A lot of the intermediate inputs in Nigerian manufacturing are sourced abroad, and devaluation will drive up costs.
• Etc Etc

It’s not all as straightforward as the foregoing implies of course.

My own view is that, neither devaluation nor demand management will solve the real problem, which is inadequate export earnings, leading to forex scarcity. That’s the big and complete picture.

People who should know better should really stop pretending that either solution will not be painful.

PS: Please tell your middle class friends that, unless oil prices go up, imported goods are going to become more and more unafforable, whether the currency floats, devalues or is rationed.