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Published On: Sat, Oct 28th, 2017

(Broad street watch) Perhaps Emefiele knows his stuff after all?


When Godwin Emefiele, governor of Nigeria’s Central Bank (CBN) stuck to his guns that he would not allow the naira to float in the face of dwindling oil revenues in 2015 and 2016, many economists felt that the governor was more besotted by emotion than by common sense. Indeed the CBN governors thoughts echoed that of the President, Mohammadu Buhari, who insisted that he would not, ‘see to the killing of the naira’. Economic purists had thought that both men had lost their marbles.

But with new research coming out of academia, Emefiele seems to show that he knows a few things even the great (and perhaps arrogant?) International Monetary Fund (IMF) had gotten wrong. In a recent paper published by Harvard University economists, Gita Gopinath, she notes that floating exchange rates are not the magic wands they were made out to be earlier on by monetary and neoclassical economists, indeed with the eyes of fresher research, allowing a country’s currency to float with a view to snuffing out imports and making local goods cheaper for export markets can be in some instances, a fool’s errand. The market (as many of us may have already suspected) is rigged.  In the short term the inability of the economy to adjust instantaneously to policies means that it becomes increasingly difficult for economic agents such as traders, manufacturers and consumers to act in a manner predicted by economic text books which assume that markets have millions of competing or willing consumers facing a swarm  of willing sellers.  This usually is not the case.

Take Nigeria’s foreign exchange market, for example. While there are likely to be thousands of people bidding for foreign currency, the market structure is such that the Central Bank of Nigeria (CBN) is the principal seller, thereby creating a near monopolistic market for foreign exchange; and so what?

As with all monopoly situations the supplier of goods (in this case foreign currency) can determine either the price of the goods or the quantity of the goods to be sold at the prevailing market price. Emefiele’s central bank as the primary supplier of foreign exchange, say the dollar, determines how much naira it would accept for a dollar coin; currently it is roughly N360 to a United States of America dollar. Since the CBN is the single most influential supplier of foreign currency it dictates price. Now in a perfect economic world (we need to wait for rapture to get there) the CBN would not dictate price because a full float of the currency would allow private entities bring to the market foreign currencies at prices they feel are attractive and reflect the currencies relative scarcity. In other words demand at the right price would create its own supply.

The problem here, however, is that before the inflows of foreign exchange become large enough to support economic activities needed to grow the job market, the economy would have stalled like a street worn cab with a troubled engine. Foreign reserves would have been totally wiped out and unemployment and inflation would have reached uncomfortable levels. Even government would no longer exist as we know it today as society would have reverted to a primary state of nature where the strong live and the weak die. The niceties of social transfers and societal support structures would have withered like leaves on a mango tree and become manure for a new world order that is brutish, ugly and dark. The economists mind is a great place for experiments but a bad place for untested policy.

Nigeria’s central bank in the last few months has maintained what economists have called a ‘dirty float’ where the naira to dollar exchange rate has been allowed to float within a narrow band within which the CBN has popped up more than a few times to create additional liquidity by using the country’s foreign reserves. So far the strategy (though widely condemned by many local and foreign economists) has enabled local manufacturers plan their budgets better and permitted other economic agents predict their costs and revenues more accurately. This is good, but dangerous. A decline in oil prices or oil volumes could serve as a tipping point to push the economy back into a downward spiral.

The CBN’s policies have come with hard social blowbacks. The bank’s tight monetary policy position has stopped inflation but it has also throttled national output and employment and led to social disruptions such as rising ethnic insurgency, growing rates of suicides, mounting levels of social frustration and a visible rise in crime, hard drug use and pubescent prostitution. Gopinath notes that, ‘Once you include all the other arguments for the disruptive effects of exchange rate flexibility in emerging markets, the rationale for ‘fear of floating’ is strengthened.’

Nigeria’s currency management policy has, so far, provided some relief for manufacturers and investors alike despite niggling fears that the managed float could unravel if the central bank does not stop supporting the federal government’s fiscal deficit by buying treasury instruments. The CBN’s free and wild financing of public sector deficit has allowed the Kemi Adeosun-led Treasury office finance its recurrent budget at the expense of private sector borrowing. High interest rates have nudged commercial enterprises to the sidelines of the domestic loan markets and made manufacturing growth difficult to sustain. Not surprisingly, high domestic interest rates have not led to a flash flood of foreign portfolio funds into the local money market as global asset managers remain scared of Nigeria’s country risk and fragile oil economy. In other words investors can expect that the economy will be stuck with high interest rates for some time. But there is a caveat.

Some analysts speculate that if the government is able to refinance its high cost domestic debt with lower cost dollar-denominated liabilities (the government hopes to borrow $5.5 billion by way of a multi-layered sovereign bond) then the treasury office should be able to breathe a lot easier and take its foot off the domestic borrowing gas pedal. This should see the monetary authorities reducing fiscal accommodation and hopefully reduce domestic interest rates in 2018.

Does this mean that the central bank will gradually allow the domestic currency float in the New Year? No, not likely. The CBN will more likely continue to manage a guided float of the currency with a deliberate effort at keeping the exchange rate below  the threshold of N360 to a dollar, but not allowing the naira appreciate beyond N320 to a dollar.

Gopinath may still have ways to go to convince the mainstream of the economics profession that the ‘fear of floating’ is real and credible cautionary sentiment that needs to be heeded, but as far as Nigeria’s feisty central bank is concerned perhaps this beautiful and brainy middle-aged economics professor of Indian descent has learned a thing or two from the Nigerian market paradigm. Perhaps a colourful garland for Emefiele and his knights at the round table?



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