The Naira Exchange Rate Conundrum, By Olusegun A. Oyediran

In a nutshell, naira devaluation or a flexible exchange rate mechanism that erodes naira currency value is not in the best interest of Nigeria at this point in time.



A widely-held axiom is that export-dependent countries prefer lower values for their currencies, while import-dependent countries prefer higher values for their currencies. The desire of Nigeria, a country belonging to the latter category, for a higher value for its naira currency is therefore not an exception to the rule.
The Buhari–Osinbajo administration is faced with how best to manage the dwindling foreign exchange earnings amidst competing demands, both transactional and speculative. Pressures from within and outside sources are being mounted on the federal government to outrightly devalue or perhaps allow the market forces to determine the appropriate value of the naira. Among the proponents of the floating exchange rate mechanism or market-pricing of the naira is Mr. Olu Akanmu, whose recent article enumerated various challenges currently being faced or are likely to happen if the FG’s forex policy is not reversed to the market-pricing approach.
First, a relevant question is, what determines the exchange rate in the economy? The interplay of demand and supply forces will be the immediate response. Sure it is true. From the currency demand perspective, evolving trends over time have shown that three approaches have been useful in studying the exchange rate mechanism, and these are: goods, assets market, and microstructure models. The first, a dominant paradigm prior to the 1970s, is premised on the purchases and sales of goods and services, with the intuition that trade surpluses will result in the appreciation of the currency value, and vice versa.

Importantly, the microstructure models best fit the Nigerian data where private information, traders’ heterogeneity, and opaque trading mechanisms prevail.

The empirical failure of the first approach, led in 1972 to the emergence of the second – the assets market approach. The distinguishing feature here is the incorporation of the purchases and sales of assets as a basis for currency demand. In effect, these assets-based exchange rate models are garbed in speculative “efficiency” that assumes all relevant foreign exchange information is publicly available in the market. Empirically, the second approach also failed to explain the exchange rate movements, not necessarily as a result of false premises, but rather due to the inclusion of some inappropriate features or assumptions.
Consequently the relaxation of three key assumptions in the assets-based models led to the emergence of the microstructure approaches, and these are that: all relevant foreign exchange information are publicly available, all market participants are homogeneous in behaviour, and trading mechanisms do not matter in pricing. These microstructure models have been shown to perform satisfactorily with trade data (see Lyons, R.K. 2001). Importantly, the microstructure models best fit the Nigerian data where private information, traders’ heterogeneity, and opaque trading mechanisms prevail.

In essence, in the Nigerian case this translates to enacting policies that curb excessive forex demand – which the administration is vigorously pursuing as a necessary component of its anti-corruption drive.

Second, given the Nigerian case of high demand and low supply of foreign exchange which is causing market disequilibrium, what is the FG’s best response to the naira exchange rate conundrum? An appropriate answer is best understood using the analogy of “a leaking roof, and the house owner” or that of “a purse with a hole, and the family head”. In the interim, the best response in both cases is to block the holes where the haemorrhage is taking place. In essence, in the Nigerian case this translates to enacting policies that curb excessive forex demand – which the administration is vigorously pursuing as a necessary component of its anti-corruption drive. In a nutshell, naira devaluation or a flexible exchange rate mechanism that erodes naira currency value is not in the best interest of Nigeria at this point in time.
Third, any country where its citizens are mostly consumers with voracious appetites for foreign goods and services and who seldom create and build wealth but depend on rent-seeking and government patronage; and whose elites are mostly the type of homo sapiens that are ravenous and pro-socially deficient, and lack confidence in the nation’s economic viability as shown in their penchant to transfer their legally- or illegally-acquired financial resources outside rather than investing them in productive ventures locally, can only attract foreign predators under the euphemism of foreign investors. Importantly, Nigerians of all shades and spheres of influence should: think Nigeria, build Nigerian businesses, and keep our hard-earned forex earnings within Nigeria (except only in overtly necessary cases).

The administration deserves nothing less than the maximum support from every Nigerian citizen in the arduous task of rebuilding the nation.

Finally, supporting the pro-social policies of the current administration neither makes one a Buhari apologist nor an APC stooge. Rather it is only an unpatriotic person that keeps silent in the face of the tyranny of the rent-seekers and corrupt-minded citizens, who continuously mount pressures and campaigns of calumny against the current administration, which are aimed at the key actors like Buhari, Osinbajo, Adeosun, Sagay, Hameed Alli etc. to demoralise and make them buckle under strain from their toughest policy decision to “confront corruption in high places”. The administration deserves nothing less than the maximum support from every Nigerian citizen in the arduous task of rebuilding the nation.