Is our exchange rate just?

I know we have all struggled in the past few years to access foreign currencies to meet our legitimate need to consume products that we do not produce, and in the process, we have had to figure out what is a fair exchange rate. A few of us dabbled into economics in the hope of making sense of the multiple exchange rates, or in an attempt to predict what it might be in the future. We now have as many opinions of what the exchange rate should be than we have verified twitter handles, and even more recommendations on what government should do.

The question I am attempting to answer is the fairness of our various exchange rates, and by implication, the mechanisms for arriving at them. In so doing, we may even begin to reconcile the argument of those who say we must export more and those who have called for moderating our demand for foreign exchange ( that we must import less ).

The image that best captures our exchange rate conundrum is the scale of justice, with the right side representing imports (goods and services) and the left representing the value of our exports. This is a simple analogy — the technically accurate description would include capital inflows as part of our export (since it represents money coming into the country ) while repayment of loans will be included in our import since we are paying out, amongst others.

Anyway, ignore the complication, a simple basket of imports on the left and export on the right will do. Imagine you put exactly the same amount of goods on both sides, the scale will remain balanced and you will have no reason to change your exchange rate, unless you wish to positively manipulate it like China to encourage more exports and save the earnings as reserves. Or like the U.S. to contain domestic inflation (which is what happens when the Federal Reserve raises interest rates).

Now here’s the personal exercise — make a list of all the things you have put in your right side basket, all the goods you consume that are imported. I suspect it will be a very long list, and one that you can’t possibly fit into one page. Then do the same for the left, all the things that you produce that are exported. For most of us, the left side is empty or has just a handful of items that we don’t directly export.

How does your scale look? Heavily weighted to the right I am sure, with the left side hopelessly in the air, nothing to hold it down. Of course we don’t expect our scales to be balanced at the level of the individual, we must aggregate for the country. And luckily for us, there’s a small number of people who export far more than they import, the Oil & Gas men and women. And for as long as they keep up, we could continue to import the long list of items in our baskets. And whenever there’s a hiccup from global oil price or domestic production bottlenecks, we feel the chill.

Over the years, we balanced the scale by exporting debt — we borrow to balance the payment in the hope that our economy will become diversified and we can payback. Unfortunately as you borrow, you also have to service the debt, thereby weighing down the import basket (debt service is money going out, same as importing garri from India). Eventually, you get to a point where your import basket has totally overwhelmed exports, and with oil production at an all time low, population at an all time high and with demand for foreign goods unrelenting, the trend is accelerating.

Now picture the scale. Is our exchange rate just? Should the scale continue to tip upward (devaluation ) as we continue to pile up consumer items that do not contribute to our ability to produce or export? What happens when we can no longer borrow to tilt the scale of exchange back to temporary balance?

I promised I was going to attempt to reconcile those who passionately argue for increasing export (rather than demand management ) and those who propose we manage our demands within our export earnings. Maybe that was an over promise, or an unnecessary promise- they are both correct and need no reconciliation. We must do both.

First, we must understand that we have a limited amount of foreign exchange we can access in the short to medium term, and that limit is the outcome of years of mismanagement of our economy, with external debt that did not improve domestic competitiveness, leading to a mono-export economy where most of our export proceeds continue to come from oil. Diversifying from oil is sadly not a year’s job so we must plan for the proceeds we have now, and the financial assets and liabilities we can exploit (including asset disposal and debt). And if we accept that we can’t miraculously grow earnings or borrow more, we must then moderate the demand for certain categories of import so we can maximize the import of production goods. The call to moderate demand is not because we import too much, it IS because we don’t export enough to pay for more.

As for the call to export more, isn’t that the only way to prosperity? We have to understand that to be competitive is to export, and to be uncompetitive is to become ‘import dependent’ — export is by implication the basis for and the measure of economic prosperity. But exporting more is the product of a system that creates valuable skills (education), leading to innovation (and entrepreneurship) in an environment that enables productivity. The call for export is a call for a wholesale reform of governance, for transparency and for ease of doing business. Just like demand management is the government telling the people to behave better, exporting more is the people telling the government to do their job.

On the call for demand management, I have always insisted that a minority of our people will respond to the moral suasion to consume less. For the vast majority of economic agents, they will respond to cost and opportunity cost, they will act in their best interest. We must therefore be willing to increase the cost of the economic activities we wish to discourage (such as expensive wines and imported croissants ) and improve the reward for the alternative, such as investing the money in treasury bills. By refusing to increase the cost of import over the years, we created a demand that we are now unable to fund, and only by allowing exchange rate flexibility can we clear the market. We are in no position to earn more, to borrow more or to sell assets in the shortrun.

Before anyone make the impressive leap from exchange rate flexibility to free float, let me restate; countries see taxes, interest rate and exchange rates as powerful levers to drive economic activities and should never give up the right to use them as required. Nobody is floating anything, everybody is managing something. But to use a lever is to first have the ability to move it in either direction — for only then are you truly in control. Taxes and interest rates can move in either direction, include negative interest rates and tax refunds. But when it comes to exchange rate, the only currency we can NOW control is our local currency. You can release it or recall it. And Nigeria today has a hangover from putting too much Naira in the market. The moment you use up your reserves, you give up the opportunity to use supply of foreign currencies as a lever to manage exchange rate, you must now take the more difficult road of higher interest rates, lower fiscal deficit, taxes and special banking reserves.

But that’s a whole new topic — how we have too much Naira chasing too few goods ( inflation ) and limited dollars (devaluation).

So what can we do now?

First we must pump less Naira into the system — no more overdraft from CBN. We must take out money from the system, requiring higher interest rate ( with the attendant cost of borrowing) and lower credit to the economy. And we expect to see moderating demand in response to the willing-buyer, willing-seller price discovery mechanism, with lower demand for final goods and more demand for intermediate goods. Ultimately, we will see an improvement in supply arising from higher export and capital inflows to take advantage of better priced local assets.

But all of this requires that our government recognizes that we can no longer bear the current cost of expansive governance, and that we tailor our coat according to our cloth. If we fail to trim the excesses of our government, we can be sure that our people will continue to demand for more foreign exchange than we can supply, and the scale of commercial justice will continue to tilt towards a weaker currency.

Abubakar Suleiman

11 February, 2024