Managing Nigeria’s Economy: Staying the Course But Pausing to Reflect

The Nigerian government has taken several policy decisions in the last 18 months, mainly the removal of fuel subsidies and the floating/unification of the exchange rate, with dire consequences on the purchasing power and welfare of the people.

Given the dependence on fuel imports due to declining local oil refining capacity over the years, the effect of removing fuel subsidies (either partially or completely) has led to a significant increase in fuel prices with agonizing consequences for the population, largely due to the impact of currency devaluation. than the abolition of the subsidy itself.

Even after coming on board Dangote Oil Refinery, Expectations of lower pump prices and relief for citizens have dimmed with the recent increase in pump prices marking the start of refinery operations.
This is still due to the high exchange rate, despite the idea of selling crude oil to a Naira refinery, since the underlying business transactions even in the Naira are essentially still pegged to the equivalent dollar value of a barrel of crude oil in the international market where it is traded in dollars.
There is a well-established correlation between exchange rates and domestic inflation, especially in Nigeria. Therefore, as long as the exchange rate remains high, inflation will be high and since the Central Bank of Nigeria (CBN) has focused on price stability and inflation management as its core objectives, it will do whatever it deems necessary to curb inflation.
In the current CBN regime, this has come about through a strong focus on the inflation targeting mechanism using the interest rate, that is, the monetary policy rate, which has increased significantly by 850 basis points since the first quarter of this 2024.

Against this backdrop, I recently spoke with some colleagues and the main message was that, given the outcome of recent decisions and the central role of the exchange rate in our national life, it may be necessary to pause and reflect even as we “stay the course.”

Some points are highlighted below:

1. The floating and unified exchange rate solution may have achieved one of its goals of (almost) unifying official and parallel market rates to reduce arbitrage, which has been a major problem so far, and has even seen relative stability in the last couple of years. months.

However, the exchange rate above 1,600 naira is still very high as the naira is undervalued compared to other African countries (at least in terms of the extent of devaluation against the dollar over the past 18 months) as well as initial projections equilibrium exchange rate of about N600-N700 by government officials and representatives (e.g. Minister of Finance and Economic Planning, Governor of the CBN, Chairman of the Presidential Committee on Tax Policy and Tax Reforms) at various times in 2023.

The key problem remains the insufficient supply of foreign currency or the growth of reserves. It is therefore imperative that we significantly increase the supply of foreign exchange, given the low oil production (below budget and OPEC quotas) resulting from continued oil theft, pipeline vandalism, insecurity and weak infrastructure, since we cannot give what we have We don’t exist, that is, currency.

Even the argument that devaluation is beneficial for exports due to the expected competitiveness of such exported products in the international market is questioned by the low level of oil production. The situation is aggravated by the fact that our economy is essentially a single-product economy and depends on crude oil.

2. Despite the supply of foreign exchange (FX), recent issuance of domestic dollar bonds has reportedly exceeded supply by 180%, but there has not yet been any significant impact on the exchange rate.

When the idea of the bond was initially mooted, a key concern in some quarters was that while the bond would encourage local Nigerians to withdraw their dollars from residence accounts and “under the pillows” this will equally stimulate significant demand for the currency from other local Nigerians who will convert the naira into dollars to participate in the bonds, thereby creating distortions.

We cannot justifiably discourage dollarization of the economy while simultaneously encouraging the same. This was the basis for a proposal to possibly limit the use of the bonds to Nigerians in the diaspora only and aggressively market them that way, but it was ultimately launched by making them open to everyone, including local Nigerians.

Given the limited impact of oversubscription on the exchange rate at this time, there may be a need for a scoping review on whether another tranche should continue to target all Nigerians both at home and abroad, or should it focus only on Nigerians in the diaspora and other international investors. .

And also generally review the bond training points to achieve the desired goals of increasing the fresh supply of foreign exchange and lowering the exchange rate.

3. As stated earlier, there is a clear correlation between the exchange rate and domestic inflation/high prices. We’ve seen this play out over the last 18 months. While we might say that the rate of inflation has slowed, is declining, or is stabilizing, the inflation rate itself remains at an all-time high.

Therefore, given the CBN’s insistence on orthodox approaches in managing inflation, we need to consider at what point we should pause raising monetary policy rates (MPR) or even consider lowering the MPR to help bring down interest rates that remain unusually high ( due to high MPR), thereby suppressing access to credit for the real sector or making access to credit very expensive, leading to persistently high cost of products, keeping inflation high and slowing economic growth.

Without a threshold to keep interest rates in check, could we inadvertently defeat the original purpose of managing inflation?

In conclusionThe exchange rate forecast for the next six months to one year will be determined by the drastic measures that need to be taken to significantly increase the supply of foreign exchange, on the one hand, and, on the other hand, by the expected significant reduction in the demand for foreign currency as a result of local currency processing. petroleum products. If the latter does not happen, then what is the point of having a local refinery of such capacity?
In conjunction with other fiscal measures/tax policies that have just been announced, serious consideration should be given to the need to analyze the extent to which interest rate increases can continue to be used to manage inflation, as well as increased communication and engagement with citizens.
The previous questions highlight the fact that although the Government needs “stay the course” In terms of overall goals, he certainly needs to pause and think at this stage about the constituent steps to ensure that he is able to ultimately deliver the desired benefits to the majority of Nigerians who are currently at the highest threshold of endurance!

This article was prepared by Hafiz Bakare, a consultant and former executive director of a bank.