The Central Bank of Nigeria has been under pressure to devalue its currency as the price of oil remains low and demand for dollars hit unbearable levels. Analysts surveyed locally and internationally have called for a devaluation of the currency rather than the more extremest controls the CBN has adopted. The CBN on the other hand has responded that a further devaluation of its currency is not necessary as they are focused more on demand management whilst discouraging imports.
So who is right or wrong about devaluation and why do countries devalue?
To Boost Exports
One of the most important reasons why countries devalue is because of the immense benefits it provides for exports. When a country devalues its currency the value of the goods and services it exports are more competitive abroad thus boosting the local currency. For example, if the price of oil is $50 per barrel and a company exports 100,000 barrels they will earn a dollar inflow of $5million. If the exchange rate remains at N200 that will translate to a revenue of N1 billion for the company. If the CBN however devalues to N250 that amount rises to N1.25 billion. Devaluation has therefore brought in an extra N250 billion. They claim since the CBN is bent on encouraging exports it can only successfully do so because proceeds from exports increase when converted to the local currency as a result of devaluation.
Whilst this looks good on paper, devaluation mostly favors countries that are purely export oriented. Unfortunately, Nigeria’s export proceeds is still dominated by oil and in total forms about 10% of our GDP.
Relying on devaluation to boost exports also helps with reducing trade deficits. Nigeria still relies heavily on imports to drive local production even though it has operated a trade surplus in recent times. Data available also suggest the CBN is not fully able to capture the true value of invincible trades which largely rely on imports backed by black market dollar supplies.
Too guard the external reserves
Supporters of devaluation also point to the fact that it can help save guard the nations reserves which is under severe pressure as a result of the drop in oil prices. Using the example above, a devaluation from N200 to N250 means you now need N50 more Naira to buy $1. Therefore if the Naira side remains the same, devaluation will increase the Naira end whilst reducing the dollar required to meet each Naira. With the dollar effectively costlier demand for the dollars will be expected to fall in the short run thus introducing currency stability.
The CBN in response believes businesses who seek dollars should be able to source the greenback themselves via export oriented ventures rather than relying on the CBN to fund their inputs which largely relies on imported items. According to the CBN Governor,
“What we are trying to concentrate on right now is how to improve and deepen the foreign exchange market by improving supply of foreign exchange into the market.
And to do so, we are trying to encourage people to export and earn your export proceeds and use your export proceeds to import whatever you need to import.
We are also concentrating on how to reduce the import of items that we can produce in the country today,” he said
To reduce local debt obligations
The CBN is also encouraged to devalue as it will help reduce the amount required to fund local debt obligations. Let’s say for example the country has $30b in reserves and needs to pay a debt obligation of N100b. At N200 exchange rate it could sell $500 from its reserves at N200 to repay the debt. If it however devalues to N250, it only needs to sell $400m.
The CBN however may not be interested in this option as it has forced interest rates lower following its twin decision to cut CRR and MPR rates respectively. Interest on its loan obligations are still cheap and foreign debts only make up about 20% of public debt.
To encourage foreign investors
Another poignant reasons mentioned as a positive case for devaluation is that it encourages Foreign Portfolio Investments (FPI). It is believed that investors who anticipate a downward currency adjustment will wait out investing in an economy until devaluation takes place. Devaluation and relaxing capital controls is also the main reason why JPM yanked Nigeria off its index.
In response the CBN claims it is more interested in Foreign Direct Investments (FDI) which encourages longer term view at investment in Nigeria and exerts less pressure on currency outflows. The potential impact of relying heavily on FPI (who are short term) can be devastating if it is solely relied upon for the supply side of any aspect of the economy.
Bridge the gap between Black Market and CBN Rate
The gap between the black market and CBN rates is currently between N40 to N50 or 20%. The huge gap portends negative consequences for the economy as widening spread will somehow find its way into the real economy in terms thus negating whatever positives the CBN hopes its policies will provide.
In response the CBN believes that its policy will eventually drive away the demand for forex in the black market as its control measures is expected to reduce their supply thus discouraging unofficial trade. Those for the CBN also point to the fact that the huge disparity between the current exchange rate and official rate shows that even a devaluation will not discourage the dollarization of the economy.
Note: The article was amended to change “foreign debt obligation” to “local debt obligation” which was what the point tried to explain. Error is regretted.
