Analyst’s memo to Tinubu harps on value, confidence for Naira

• Fiscal, monetary policies must be complementary
• Inflation targeting a must, avoid surprise inflation
•  Address dominance of monetary authority
• Select Nigerian banks should manage FX reserves

Ahead of his inauguration as president, Business a.m. has learnt that President-elect Bola Ahmed Tinubu and his team have been inundated with tonnes of position papers and memoranda from a myriad of independent sources offering strong positions on what and how the incoming president should tackle a number of issues that have kept Nigeria’s economy down for at least eight years.

Business a.m. understands from sources close to the president-elect and his team that they are in receipt of several memoranda on one of the most people-resonating issues of the Nigerian economy, the Naira and its exchange rate against other international currencies, in particular against the dollar, the pound sterling and the Euro.

One position paper by an analysts group based in the United States led by the experienced banker and international financial expert, Franklin Erebor, and seen by Business a.m., is calling on the president-elect and his team to put in the front burner of consideration, shoring up value and building confidence in the naira as key to restoring credibility and respectability to the domestic currency. Erebor has worked across a stream of banks in Nigeria, including Chartered Bank, Diamond Bank (now Access Bank), Zenith Bank, FCMB, First Bank and United Bank for Africa (UBA) plc. 

Recognising foreign exchange management and, consequently, the value of the naira as issues and challenges in Nigeria, the group outlined what it calls “steps and policy actions that can help in achieving the two-pronged issue of confidence and lifting the value of the Nigerian currency.

Starting from a macroeconomics point of view, the group stated that “monetary and fiscal policies must be seen as complementary and not competing aspects of economic policy as we have seen in recent years.” 

They explained that “although fiscalist are virulent in their theoretical disquisitions, fiscalist are monetarist in the long run, to the extent that the fiscal deficits they create are funded by pump-priming that elevate the price level with feed through to the foreign exchange market. So, rational economic agents must see that there is fiscal and monetary discipline so as to elicit their confidence.” 

They argued that fiscal expansion, either through an increased level of government spending or a reduction of taxes, when combined with monetary tightness “will lead to a real appreciation of the domestic currency in a world of high capital mobility,” something they described as being consistent with the Dornbusch and Mundell-Fleming models. But they cautioned on the nature of financing fiscal expansion.

According to the memo, when fiscal expansion is financed by issuing money, it is more likely to lead to a depreciation of the currency. This has been the case with the outgoing government which only recently got its “ways and means” borrowing through the Central Bank of Nigeria (CBN) approved for securitisation for 40 years by the National Assembly.   

“We have had a dominance of the monetary authority (with ways and means of N23 trillion) relative to the fiscal authority in recent years, which has precipitated the consistent depreciation. This has to be addressed,” the group said in the memo to the Tinubu team.

The memo also advises the incoming government to pursue the policy of inflation targeting and a total avoidance of surprise inflation. The group said this is “to engender trust and for rational economic agents that see the activities of government as game theoretic to re-establish trust.”

Models of speculative currency attacks always have a confidence crisis at their core, the memo stated, adding that this is elevated by the time-inconsistency of the actions of economic managers. 

“This time-inconsistency pushes the economy from the saddle-path based on fundamentals and economic agents attack the currency. You can look at models of speculative currency attacks by Maurice Obstfeld and the variant by Paul Krugman,” the memo advised.

Accordingly, the memo suggests that the monetary authority of the incoming government “must be seen in truth and deed to be transparent and send information signals that address the information asymmetries with the market/economic agents.”

Pursuing the theme of engendering confidence in the naira, the memo advocates that the populace must see that the foreign exchange revenue base of the nation is expanding and progressively diversified from a monolithic product – crude oil, adding that the government would need to “create positive industrial spillovers through agglomeration economics from industrial conurbations.”

“Regular publications to this effect will engender confidence, as expectations have a lot to do with confidence building,” the group stated.

In disagreeing with the CBN policy of creating a list of banned items from accessing foreign exchange from the official window, the memo called for an aggressive management of the foreign expenditure bill, noting that  “instead of an exclusion list of items not eligible for foreign exchange, there should be an outright ban on those items after a thorough scrutiny and in consonance with national strategic priorities.”

The group said in the alternative, the government can impose prohibitive duties on these items or an optimal combination of duties and an outright ban. “This is important as the demand for foreign exchange from the parallel market on items on the foreign exchange exclusion list, builds up pressure on foreign exchange demand and distorts the signalling of exchange rate in the domestic economy. This signalling affects confidence.”

The group says it calls for a cohesive fiscal and monetary coordination as the exchange market premium (official NAFEX at N462 relative to parallel market rate at N745, for instance), evinces deep macroeconomic instability.

The group also had suggestions with regard to managing foreign exchange flows, advising that “there should be a prohibition or restriction of Foreign Portfolio Investments (FPI) into the capital market as this is destabilising for a country that does not have a convertible currency as the exit of such FPIs put pressure on the domestic currency.” 

Besides, the group noted that FPIs also create financial bubbles by driving asset prices to levels that are not reflective and supported by fundamentals, adding, “Thus, if the domestic currency is convertible, then the exit is exchange rate neutral but not so for a non-convertible currency like the Naira. Interestingly, it is those providing FPIs that keep saying the Naira is overvalued, to create the optics and feed/stoke the rhetoric and narrative for a devaluation! FPIs should only go into Gilts as they do not create a bubble in that respect,” the memo pointed out.

The group said that where prohibition is not contemplated, a limit should be set for it, “so as to moderate its distortionary effect.”

The incoming Tinubu government should also have robust platforms that will attract foreign direct investments (FDIs) into growth and export-based industries, the group wrote in its memo.

“Relatedly, the Commercial Department of our embassies and foreign missions in G20 countries should be focused on and have a structured approach in attracting FDI flows – this was a major lever for the exponential rise of FDI flows to Singapore,” the memo put forward. 

For FDI flows, the memo calls for “Advocacy for legal and institutional reforms to create an enabling environment for business incubation and growth as well as to attract FDI flows,” noting that this would address what the memo called “the Lucas-Paradox” as global FDIs only flow into countries based on comparative risk-adjusted rate of returns. 

The memo’s authors would also like to see increased supply of foreign exchange to the market through intra-day trades which will re-establish flow, reduce hoarding and ipso facto re-establish confidence. 

“In substance, the monetary authority must desist from sudden-stops in foreign exchange flows as this encourages hoarding and speculative demands, with salutary effects on potential transaction and precautionary demands. This sudden demand in the face of a constricted supply will cause the exchange rate to overshoot,” they pointed out.

The memo disagrees with the current mode of foreign exchange allocation. Putting forward the examples of tuition and board abroad, it stated that “where this is, say $25,000 the allocation given is a maximum of $15,000. Where do you expect the balance to come from? Thus, foreign exchange allocation should be total, based on the invoice from the school. These are the little things that feed into the overall confidence. This is the standard practice in other climes like CEMAC, UEMOA, etc.”

It also called for select international Nigerian banks operating in Organisation for Economic Cooperation and Development (OECD) countries, to be given a percentage of the foreign reserves of the nation to manage, based on strict eligibility criteria and risk-based. 

“This will give them the capacity to have more contingent trade claims like Letters of Credit, Deferred Letters of Credit, guarantees, etc. and manage the flow of funds. That Nigerian banks are managing some portion of the reserves also reduces the country’s risk premium from international banks given the rating of Nigeria. This will reduce our foreign exchange outflows, and with the elimination of country risk premium, reduce transaction cost and domestic inflation,” the memo stated.

The memo noted that the key ingredient for confidence is transparency, which on its own and where practised consistently, reinforces trust and credibility, adding that the populace must trust the monetary authority. 

“The monetary authority can earn this trust and credibility through discipline, institutional arrangements that keep it to its avowed commitment, a rule-based approach for interest rate, like the Taylor rule (it’s enhanced form as in the Augmented Taylor Rule (ATR) with macro-prudential policies), a money growth rule like the Mccallum rule, a feedback rule and a GDP rule. This will resonate with economic agents and they will view all interventions by the economic managers as time-consistent, thus reinforcing confidence, trust and credibility,” the memo explained.

The incoming government is alerted to the fact that it is not enough to just wish for a strong currency. It is therefore reminded to take note of the key determinants of exchange rate and to get ready to manage them effectively and efficiently. These are listed as: inflation differentials; interest rate; current account deficits/balance of payments; terms of trade; public debt; political stability and economic performance; recession/economic growth; speculation: – competitiveness – labour market conditions and also if you have hit the Arthur Lewis frontier with increased wage rate and productivity differentials; relative strength of other currencies; government intervention; and availability of huge reserves of natural resources.

The moment noted that corruption remains a major issue and told the incoming government that, “people must see that issues relating to stemming the recrudescence of corruption are addressed and in a timely manner.”