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Published On: Tue, Oct 13th, 2015

Naira should be allowed to find its true value—Rewane

Mr. Bismarck Rewane is the Managing Director and Chief Executive Officer, Financial Derivatives Company Limited. Rewane who has addressed many professional and business gatherings on subjects such as foreign exchange management, liability management in a deregulated economy, tools of money market analysis and techniques of investment in public debt instrument, is an astute crusader of free market. In this interview with an editorial team of Business Hallmark he elaborates on the import of the government allowing market forces to determine true value of the naira that is in crisis. Excerpts:

 

Your view on naira devaluation is in disagreement with that of the government. Why?

Exchange rate arithmetic is more like a quadratic equation. In quadratic equation you don’t have a single answer. The answer is a range. In simultaneous equation you have two unknowns but in quadratic equation there are multiple unknowns. So, the range is that the answer is greater than or equal to. So, it is a range of answers, because you are differentiating functions. The exchange rate mathematics is such that you have a number of options. But what you want to do is to be on the equilibrium path. To misunderstand the problem is to come up with the wrong prognosis or therapy. So, the problem is not the exchange rate, but the exchange rate determining mechanism. If we say for example, we are going to have a formula which says the price of oil minus a certain amount of reserve cover, which when multiplied by the exchange rate of the naira to determine what it is at a particular date to determine the value, let’s say N150. If we are not satisfied with N150, and we then say intervene to bring it lower, we will then sell more into the market to bring the price down to N130, depending on the capacity we have.

But without a mechanism, you cannot arbitrarily determine the price, because the price is what we call an effective exchange price between two variables. So, the moment you start saying you can only buy this only when you wear a white shirt, the price is no longer the price. The price is that you have to factor in the price of buying the white shirt, the time you have to wait for the financial cost. What we are saying is that we need to have a mechanism for determining our exchange rate. Once it is known, everybody will work with it. I will come with an example: If you say the BDC rate minus ten is the rate which the CBN will sell money to everybody, if the BDC rate is N240, then the CBN will sell at N230.

What if the BDC rate keeps going up?

The fundamental issue is that I have a fixed amount of naira; once I have bought the dollar at N250 the amount of naira left to buy the next dollar is reduced. This is what we call budget constraint. There is a budget constraint. No matter what happens, you have a salary. If you decide to buy gold for your wife, what is left is what is going to be left. So you either buy gold or you pay the school fees of your child.

So, what about the effect of speculation?

Speculation will die once they know that if they push the rate up they will buy tomorrow at minus 10. And there is a carrying cost attached to holding currencies, because you are paying about 15 percent per annum interest to borrow the naira to buy the dollar and you are getting only one percent. And the dollar will not appreciate. The only way to end speculation is to allow the market price to prevail.

What about the issue of production, because the productive base of the economy is weak? You recently talked about Côte d’Ivoire and how they have moved from exporting raw cocoa to processed chocolate, which is having positive effect on its economy.

But do you know by how much percent Côte d’Ivoire’s currency has depreciated against the dollar? The Euro used to be $1.46; it is now $1.11 to a Euro. About 30 percent of it has wiped out. It makes cocoa from Côte d’Ivoire more competitive. Ghana is doing 900 tons because the Cedi is cheap. Both countries are now having primary oil production. So, we cannot run away from the fact that when there is shortage of any product, price has to increase to allocate the scarce resources efficiently. Then, you can put the safety net in to do whatever you want to do. Currencies are market driven. I do not think we need to make as much adjustment as is feared as long as the corruption in Nigeria is reduced. Why did I say that? If you have corrupt earnings you can easily use the money to buy dollars. Even if the dollar is N700, you will buy it because you did not work for the money.

There are people on Victoria Island selling cars, who keep some of these cars for two, three years on a plot of land that costs about N100,000.00 per square metre. Therefore, if you park a car on a plot of land of about three square metres, it means the rent of where the car is parked is increasing by N300,000.00 a year. And you are still selling the car at the price which you brought it in. Why? It is either you are a money launderer or a narcotic baron. They are not price sensitive. If you block corruption that everybody that has money earns it, he cannot tie his money down on forex. Nobody will go and buy and speculate on the dollar if he has worked for his money.

You don’t seem to like managed floating system. Is there any country that practices absolute free market?

First of all, you must be on a path. There is no market that is absolutely free. That is why I said you intervene in the market at a particular level, not blindly.

What policy option will you recommend to government giving the present situation?

First and foremost, at $46 a barrel, you are not in a position to keep the currency at the same position as it was $69 a barrel. Since President Muhammadu Buhari came in the price went up to $69 a barrel. $69 minus 10 is 59, 59 minus 10 is 49. So, we have lost almost 30 percent of the value of the price of our product since he came in. But if you take it to July 2014, it is down 65 percent, to $46 from $116. We don’t have the revenue. We didn’t cause it. The markets are down. So, what have we given up since the price of oil went down from $116 to where it is? All that we have given up is that we have blocked the holes for corruption and leakages. Assuming that they were stealing $40 a barrel from $116 that leaves you with $76, from there to what we have now, we still need to make that adjustment.

What would be the appropriate range the naira should be devalued to?

It is easy. If your income is down by a certain percentage, you adjust your currency accordingly. But I am not saying we should adjust by 70 percent. We have done 26 percent adjustment since this thing started. However, our terms of trade are the most important thing. Our terms of trade have deteriorated against us by as much as 38 percent, because our import has come down, but our export has gone down much more. Your currency adjustment mirrors the level of your terms of trade.

If the government insists on not adjusting the currency, what effect will it have on the economy?

Any time you don’t adjust you create a gap. That gap will be filled one way or the other. Adams Smith did this centuries ago. Demand curve and supply curve, these are fundamental laws of Economics. When a hypothesis becomes a law, it means it has been empirically verified, so it is not subject to any argument. If the price of any commodity increases, the demand for that commodity will decrease. If the supply increases the price will fall. If the price is not where the demand is equal to supply, a gap will be created. That gap will be filled by unhealthy and dysfunctional practices, which will distort the market and create rent and arbitrage and destroy productivity.

Many people believe with the Treasury Single Account (TSA), we could be creating a gap in the financial system…

The TSA will lead to an appreciation of the naira in the short-run because you are reducing the quantity of excess liquidity in the system. But this is a temporary measure, because eventually you will use the money from the TSA to pay contractors and the money will come back to the banking system. We must always equate an economy to a patient. If you have malaria, even if you take any drug at 8 o’clock in the morning, you will feel strong and feel good, but in the evening when the sun goes down, your temperature increases. If you take the inadequate dose of medicine, you feel some initial relieve, but the relapsing fever is often the worse. So, if we take the inadequate dose of adjustment, the relapse will be much higher than we started.

But the TSA will make the cost of fund more expensive…

What did the Chinese do? The Chinese first brought the currency down by 3 percent. That was a good deal for them. However, the next day, what did they do? They brought down interest rate. So, once you allow the currency to find its true value, you can then bring down interest rate. But what you are doing is using the interest rate to defend the naira. And you don’t need it. No money needs to be defended; it reflects its true value.

JP Morgan is delisting Nigeria from its Government Bond Index Emerging Market (GBI-EM). Do you agree with its assessment of the whole situation?

Let me throw the question back at you. Did you lobby JP Morgan to include you in its bond index? It included you based on its assessment. Their index methodology is disciplined and transparent. If you don’t meet certain criteria, you cannot be in the index. They have told you well in advance that if there is no liquidity in the market, if investors cannot bring their money out and in freely, because when they put you in the index, there was a gush of money that came in. So, people mark their portfolio to markets every day. So, if they cannot get their money when they want, because settlement is 48 hours after spot transaction. Then, this is not reflective of the market, therefore, please take them off the index until when there is liquidity. It is not emotional, this is very rational.

This indicates a new trend where international organizations appear to be impatient with the economic situation in Nigeria…

No, it is not about impatience. You are not the only country in the world. 35 emerging markets’ currencies have been adjusted. So, there is nothing special about Nigeria.

Why is it taking the government so long to adjust?

It takes time to accept reality. I come from the school of market, so I believe in market. This thing happened in 1995 to 1997 in South-East Asia.

Are you subordinating nationalism to the market?

No! There is economic patriotism which I strongly believe in and there is economic realism. The truth is that when price adjusts to reality production increases. And the economic wellbeing of the country will improve. In the end, what do you want to achieve? You want to increase the Gross Domestic Product of the country, so that the welfare of the people is better off; so that people can invest and create jobs. If you think by creating distortions in economic activities you are going to reduce output and I think by adjusting I am going to increase output, I am the more nationalistic person. I will give you an example. The Securities and Exchange Commission (SEC) said it will allow stocks to drop to as low as 1 kobo, then it suspended it. Let’s assume it dropped to 1 kobo. There have been 150 stocks that are 50 kobo that have not traded. Is that a market? Who is fooling who? Nobody is buying it and nobody is selling it. I’m saying that if it had allowed those prices to come down, market capitalization would have gone down, but turnover would have increased. So, those stocks which prices are presently 50 kobo if the true prices were 10 kobo, people would have bought more. There would have been more activities and stock brokers would have been happy. And after a while, the index will improve. But they said no, so, the market is stranded at a level and ready to invest. It is important that you know that where you have a situation where prices are not effective prices, and people don’t produce at optimum, you are creating an illusion of price stability, which doesn’t exist.

In the long term yes. But in the short term, there are a lot of anxieties because we are an import dependent economy and there is insufficient attention to productivity. How will the country cope with the hiccups that would be unleashed on the system?

If hypothetically you hear today that the price of oil is $20 per barrel and therefore the total earning is now $10 billion instead of the $98 billion, which we had two years ago, what will you do? You will give up something. Are you going to give up things because you are compelled to do or give up strategically so that investment can come into that area where there is shortage? Indonesia and Nigeria were depending 90 percent on oil. Indonesia now depends only 20 percent on oil. They allowed their currency to find its true value. People came in to invest. People came in to build power stations. The government alone cannot meet the requirements of this country. We have tried all kinds of partnerships.

Now, we should allow the currency to find its true value. We have been arguing about the Petroleum Industry Bill (PIB), we don’t want to throw away the silver. The price of oil went all the way from $116 to $40, now we have been going cap in hand, begging the oil companies and they are saying they are not interested. So, doing the right thing at the right time is very important. There must be pain. You can either decide that your child is in bad shape so you must give the child an injection, because every time you give him tablet, he throws up. Are you going to allow the child to die? No, you’ll give him injection. There is what we call invasive procedure, surgery required. You are going in. You have to make up your mind. The alternative is slow but certain death.

We discovered that there is often divergence between views of experts who are outside and those experts who are in government. Why is this so?

First of all my views will never diverge. My views will be determined by the facts on the ground. You see, there is no one solution. You are looking for an optimal solution. But what is the most efficient path that will lead to minimizing resource cost but will also increase returns? I believe strongly that a combination of options based on our situation and based on the forecast that oil prices will remain low for some period before they pick up and as a the country we can’t afford the luxury of experimenting.

With the picture you have painted do you think banks will still make profit at the end of the year?

The profit margin of banks is not our objective. Our objective is to create an economy that is efficient and has output. The banks have been making profit all these years, what has been the impact on the ordinary man. I have nothing against banks making profit. As a matter of fact, banks’ profit will increase under this arrangement. But right now the banks are constrained, they can’t trade. Let the most efficient survive.

The new government has not announced any policy direction. What will be your advice on the right path that it should take?

The transition team gave a comprehensive report. Just follow that. Don’t do any other thing. Everything I have been saying is in the transition report. Its report recommends that some of the state assets should be sold; create liquidity and stimulate the economy, move from recurrent to capital. Make the oil companies have investment and production arms. Allow the money market to be at equilibrium so that there would be some efficiency there. There would be international investment coupled with increased output and growth. Block the leakages and wastes and sell off those silly assets that are not producing anything. No emotion about it and move in that direction.

But it seems the government is not ready to sell any of its assets…

I think sooner or later, the reality will dawn on everybody. The options are getting clearer. The reality is right before us. The five stages of grief states clearly: first thing when you hear of the loss of anybody, you are in denial; you say no it cannot be true. The second stage is anger. The third stage is depression and suicidal tendencies, paranoid, fighting everybody around. The fourth stage is maybe this is true and finally, is acceptance and capitulation. The time between stage one and stage five of grief if it is brief, you can deal with it and make progress. If you stay in denial for too long, at the end, reality will still come.

You sound like a prophet that is so sure of his prophecy?

I am damn certain that market never fails. I am sure that price and value will find equilibrium in Nigeria. Everybody will come to accept it.

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