Analyst pushes crawling peg to manage Nigeria’s exchange rate

As Nigeria’s monetary authority scratches its head in search of policy options to stabilise the foreign exchange market and save the plunging local currency, the crawling peg option has been recommended as the sure path for the country.

This option means that a country starts at a near market LCY/USD exchange rate and then allows its currency to depreciate (or appreciate) against the USD by close to the difference in annual inflation.

“This is the option we recommend for Nigeria,” Bode Agusto, independent researcher/consultant and founding managing director of Agusto & Co., a pan-African credit rating agency and leading provider of industry research and knowledge, said.

“Today, this means starting at a NGN/USD exchange rate of around 600/1 and then allowing the currency to depreciate by around 10 percent per year. It also means allowing knowledgeable willing buyers to do business with knowledgeable willing sellers at contracted rates. The CBN may intervene in the market when rates are significantly higher or lower than its target. Kenya and Botswana have successfully managed their exchange rates for a number of years using this option,” he said.

The naira (NGN) has a long-term rate of inflation (the rate at which a currency loses purchasing power) of 12 percent as against two percent for the USD, Agusto said, which means that, on average, the NGN loses 12 percent purchasing power annually while the USD loses two percent purchasing power annually. Given that in the long term, the weaker currency will depreciate by close to the difference in inflation, the NGN is projected to depreciate by close to 10 percent annually relative to the USD. As such, any politician or policymaker promising stable exchange rates without explaining how they would bridge the gap in long-term inflation would be making empty promises, he said.

This comes as the Central Bank of Nigeria’s efforts to stabilise the foreign exchange market are failing to yield the desired results while the local currency continues to take a beating amid demand pressure for dollars to meet the needs of manufacturers as well as those for the payment of tuition, medical fees and other invisibles.

The naira fell to a record N710/$1 at the black market last Wednesday. On Thursday, the CBN put the blame for the forex crunch on speculators, advising Nigerians not to succumb to the “speculative activities of some players in the foreign exchange market”.

Osita Nwanisobi, CBN’s director of corporate communications, said the apex bank was strategising to help Nigeria earn more stable and sustainable inflows of foreign exchange in the face of dwindling inflows from the oil sector.

Speaking on some initiatives undertaken by the bank, Nwanisobi said the Naira4Dollar incentive, for instance, saw increased volume of Diaspora remittances in the first half of the year, while foreign exchange inflow through the RT200 FX Programme grew significantly to about $600 million in the same period. He said the apex bank’s other interventions like 100 for 100 Policy on Production and Productivity, Anchor Borrowers’ Programme (ABP) and the Non-Oil Export Stimulation Facility (NESF) were also geared towards diversifying the economy, enhancing inflow of foreign exchange, stimulating production and reducing foreign exchange demand pressure.

The apex bank had last year banned the sale of forex to BDCs, accusing the operators of being a major black market providing exchange rate support to those who could not formally access foreign currencies directly from the CBN.

Recently, the CBN threatened to arrest and prosecute Nigerians using naira to buy dollars, saying “it is illegal to do so.”

Despite these efforts, however, the naira has continued on a free fall at the parallel market, with some analysts predicting it may crash to N1,000 to the dollar by year-end.

Agusto, in a recent article, “Nigeria – Exchange Rate Management”, said the exchange rate management option chosen by Nigeria is not fit for purpose and cannot get the country out of the woods.

“The current policy of pegging the NGN/USD exchange rate at 420/1 has the benefit of dampening imported inflation but it has several disadvantages. It reduces the naira amount of oil revenue that goes into the Federation Account. It also means that importers are undercharged duty on their imports,” Agusto said.

“Exporters are forced to sell their USD at the official exchange rate, thus subsidising importers. Most importantly, this policy makes imports (whose prices go up by 2 percent p.a. USD inflation) cheaper than locally produced goods (whose prices go up by 12 percent p.a. NGN inflation),” he said.

Reviewing three principal ways countries manage their exchange rates, the analyst listed pegging currency to the USD, which works for countries that earn a lot of USD, such as oil-rich Saudi Arabia (since 2003) and Qatar (since 2001), as well as Panama (since 1904) and Belize (since 1978).

“All these countries would sell USD to willing buyers at the exchange rates they have set. Can Nigeria sell USD at 420/1 to all those who want to buy? The fact that Nigeria cannot has led to the development of a parallel market that commands a large premium. At 420/1, everyone wants to buy USD from the Central Bank of Nigeria (CBN) but no one wants to sell it. This means that a rate of 420/1 is below equilibrium and is unsustainable. Nigeria has tried several times in the past to peg the NGN to the USD and has failed every time,” Agusto said.

The second option, he said, is to float the currency, that is, allow the forces of demand and supply to determine the rate at which the local currency exchanges for the USD.

“Countries that have been able to do this successfully are those who are able to achieve a long-term rate of inflation that is not significantly different from that of our benchmark currency – the USD. Examples are the UK, Eurozone, Japan, and Singapore,” he said.

The third option, he said, is the crawling peg, which he recommended for Nigeria.

On why Nigeria should not float its currency, Agusto said there would be “a lot of exchange rate volatility because of the large difference between NGN inflation and USD inflation and the fact that oil revenues, Nigeria’s principal source of USD, fluctuates wildly”.

Given the above scenarios, Agusto said Nigeria’s politicians and policymakers need to face the reality, eat the humble pie and accept that a peg to the USD, though desirable, is unattainable.

“A 10 percent annual depreciation against the USD is predictable, businesses and households that are dependent on imports can plan for it,” they said.

While adopting the crawling peg exchange rate management option, Nigeria can manage its long-term inflation downwards and significantly reduce the annual rate of currency depreciation, he said.

He said to do this successfully, there was the need to first understand the cause of inflation in Nigeria. He said inflation in Nigeria is neither caused by too much money in circulation nor by cost of inputs.

“Nigeria adds 5 million people to her population every year. This results in a significant increase in demand for food, housing, clothing, healthcare, and other things. In addition to this, over 22 million Nigerians, willing and able to work, are unemployed,” Agusto said.

“We believe that if Nigeria is better able to manage her population growth (demand) and can get a greater proportion of her people to work and produce (supply), she can reduce long-term inflation significantly. These, in our opinion, are the nuts that Nigeria needs to crack to reduce long-term inflation. Nigeria’s unemployed population is roughly the size of Burkina Faso and this is a huge security problem that needs to be cracked,” he said.