Need for the Dollarization the Nigerian Naira

by L.Chinedu Arizona-Ogwu

Nigeria is facing a big monetary dilemma: to allow the Naira to depreciate or appreciate.
With the carouses blooming and the birds beginning to chirp to signify the end of Obasanjocracy – a momentous era in our nation’s political history – it is probably appropriate to take a look at some of the legacies Obasanjo has bestowed on the country. One of such Obasanjo bequests is the falling Naira. Nowadays, talk about the falling value of the Naira dominates most conversations and discussions.

Since the early millennia, when the Obasanjo government, under the aegis of the International Monetary Fund, decided to float the Naira, the value of the Naira has been going crazy, and like the once fashionable obey-the-wind Afro-hairdo of yester-years, nobody seems to know where exactly the wind of devaluation will take our currency to. Like hapless and helpless drowning victim we can only hope that some where along its wind-driven journey, the Naira would pick up a friendly jet stream and land on a fertile soil. And this year being an election year, with a high probability that the government would increase money supply to “buy” votes, it seems that there would be more pressure on the value of the Naira to slide further, so my fellow Nigerians put on your “Naira belts”. Sooner or later the Naira will be “carton-plexed”!

To most people, the falling of the value of the Naira has been unfolding before their very eyes like a movie. The Naira is now, more or less, like “eri-omeji” – which spongy stuff made from the stem of plantain trees and used sometimes by rural folks to wipe off. Never mind. (If you do not know what eri-omeji is, then this is a perfect chance for you to study your Rural Nigeria Sociology 101. Hint: toilet paper). The pathetically painful thing, however, is that while eri-omeji may still play its useful centuries-old social function in our rural communities, one cannot say, ex cathedra, the same thing about the Naira and its socio-economic functions.

And come to think of this: the late General Sani Abacha (his full name is really romantic and conjures up a lot of nostalgia especially for Nigerian womanhood about the “Third Worlders”) overthrew the legitimate government of the late Dr. MKO because Basheroun could not see the wisdom in the mild devaluation of the Naira by the Doc. In the same vein, Chief Olusegun Obasanjo (also a romantic name for its OBJ’s and Okikiola’s and conjures up nostalgia about “Aremu Chain” and Matthew) overthrew the nano-economically refined expertise of Dr. Ngozi Okonjo Iweala partly because Obj thought he knew better than the Doc. as far as the Economics of the Devaluation of the Naira was concerned. One has to wonder why the sword (the green khaki-clothed guys) was (and has been) mightier than the pen (the Docs.), in both cases contrary to what the sages say. Or is it that the sages were not sagacious after all? If one juxtaposes the current rate of depreciation of the Naira vis-à-vis the rate of devaluation in the days of the two Docs that “warranted” their removal, one can only ask: Is Nigeria an interesting country or what? Well, let me talk about some economics behind the falling value of the Naira.

Before we deal with the hard questions about our Naira, it is appropriate to explain the fundamental issues about exchange rate. A lot of confusion surrounds exchange rates because most people fail to understand what is being sold in currency exchange transactions. Fundamentally, the currency markets operate exactly like the goods markets, say the market for plantain. The price of plantain at Agbor in Benin Market at any point in time is determined largely by the amount of plantain being supplied and demanded – the so-called market forces of demand and supply. Any time the amount of plantain supplied at Agbor in Benin is less than the amount demanded by consumers, the price of plantain would go up. Buying and selling plantain, though involves our local currency the Naira. However, Nigerians need foreign currency – American dollar, British pound, Japanese yen, Ghanaian cedi, Togolese franc, etc – to buy foreign goods and services and to buy foreign assets. Foreigners also (theoretically) need our Naira to buy our goods and services and our assets. Thus, the exchange rate is the price of one currency in terms of another currency. The exchange rate is the price (in Naira) per unit of foreign currency. For example as of last month, the exchange rate was N176 = US$1 and N240 = UK£1 in terms of Naira/US dollar and Naira/British pound respectively The exchange rate undoubtedly has very strong influence on the current account balance (the difference between exports of goods and services and imports of good and services), and other macroeconomic variables, and thus is among the most important prices in any open economy like ours. In addition, the exchange rate is also an asset price, so it is governed by the same principles that govern the behavior of other asset prices such as stock prices.

As said earlier, the exchange rate is determined by demand and supply forces. The demand curve for American dollar or British pound (the two most sought-after currencies in Nigeria) is downward sloping like any normal good, because as the exchange rate falls (in real terms, which is to say if the Naira appreciates), American (British) goods and services become less expensive to Nigerian consumers. The lower the price of the dollar (pound), the more American (British) goods and services Nigerians can buy, and the more dollars (pounds) they will need to make their purchases. The demand curve will shift in response to changes in Nigeria’s real gross domestic product, GDP, (or national income), Nigeria’s price level relative to the U.S. (British) price level, Nigerians taste for American (British or foreign) goods, relative interest rates in Nigeria, and the expectations about future exchange rates.

The supply curve for American dollar or British pound is upward sloping because as the exchange rate rises (depreciation of the Naira), Americans (the British) will get more Naira for each dollar (pound) traded. Which is similar to saying that Nigerians will get fewer dollars (pounds) for each Naira traded? This makes Nigerian goods less expensive to American (British) buyers – or American (British) goods more expensive to Nigerian buyers. As Americans (British) buy more Nigerian goods, they will need to supply more dollars (pounds) in order to get Naira. Among the variables that will shift the supply curve include U.S. (British) GDP, relative prices in Nigeria, Americans’ (British) taste for Nigerian goods, relative interest rates in Nigeria, and the expectations about changes in the interest rate. This is it! This is all that you need to know about exchange rates! But is it not very confusing? Let us see if we can minimize the confusion and drive home the factors behind the determination of exchange rates with a simple illustration or two.

Suppose Nigeria and the US trade in beer – we could exchange a certain amount of Star Lager Beer (SLB) for a certain amount of Budweiser (Bud). Suppose that in terms of value, one six pack of SLB could be exchange for two six packs of Bud. Man, Star tastes great and smooth! Suppose that one six pack of SLB costs N240 and that one six pack of Bud costs $3.00. Thus we can calculate the exchange rate as follows 1 six pack of Star Larger Beer = 2 six packs of Budweiser; at N240 per six SLB and $3.00 per six Bud. Therefore N240 = $6.00 which means N80 = $1.00 or N1.00 = $0.0125.From our example, as a result of the relative increase in the value of the American good (Bud), the value of the Naira declines (the value of the dollar increases). How does inflation affect the exchange rate? Let still use or SLB-Bud example above. In the absence of inflation, and given the respective prices of SLB and Bud, the exchange rate (from our simple example) was unanimous.

The given simple exercise has been undertaken under the assumptio

n of a floating exchange rate regime. A floating exchange rate is freely determined by the forces of supply and demand, without government intervention. When the exchange rate floats, equilibrium occurs at the price where the quantity of foreign currency (dollars or pounds) demanded equals the quantity supplied. In this case an increase in the demand for dollars (pounds) or a decrease in the supply of dollars (pounds) leads to an appreciation (in increase in the value) of the dollar (pound) and a depreciation (decrease in the value) of the Naira. A decrease in the demand for dollars (pounds) or an increase in the supply of dollars (pounds) on the other hand leads to depreciation of the dollar (pound) and an appreciation of the Naira.

There are other types of exchange rate regimes, namely the fixed exchange rate and “dirty” float or managed float exchange rate regimes. Under manage float, a country’s central bank buys its own currency to prevent depreciation, and sells its own currency to prevent an appreciation. Countries may choose to intervene in the foreign exchange markets when high exchange rate (appreciation) makes their goods more expensive and thus harms export-oriented industries; when falling exchange rate (depreciation) leads to a general rise in domestic prices (inflation); and when volatile exchange rates make trading and investment arrangements risky.

There are three types of exchange rate movements: very short-run changes, short-run changes, and long-run trends. In the very short-run, exchange rate changes are caused by decisions by banks and other financial institutions to move billions of currency from one country to another. These decisions to move “hot money” are made in split seconds in response to changes in relative interest rates and expectations of future exchange rates. In the short run exchange rate changes is caused by economic fluctuations (particularly fluctuations in GDP). In the long run, according to the purchasing power parity (PPP) theory, an exchange rate will adjust until the average price of goods is roughly the same in (both) countries. The PPP theory (in its absolute form), in simple terms states that the exchange rate between two countries’ currencies equals the ratio of the countries’ price levels, as measured by the money prices of a reference commodity basket. However, the existence of non-tradable goods (such as haircut), high transportation cost, and artificial barriers to trade does not allow for such smooth price adjustment between countries. An important economic implication of PPP theory is that the currency of a country with a higher inflation rate will depreciate (lose value) against a country whose inflation rate is lower.

Given this background in Economics 101, I hope our understanding of the driving forces behind the value of our currency is enhanced. If we think we need to strengthen the value our Naira we just have to take policy actions that address the demand and supply forces of foreign exchange. Let me reiterate some of the factors here: high inflation rates, current account deficits, persistent government budget deficit, capital flight, negative or low interest rates, increased money supply etc. These factors are complexly intertwined with one another. For example, increased money supply (without a corresponding increase in output) causes inflation, which in turn can have a negative impact on interest rates etc. The bottom-line is that the value of any currency is determined by economic fundamentals – sound macroeconomic management.

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