SAVING THE ECONOMY
SAVING NIGERIA'S ECONOMY FROM FURTHER DETERIORATION
(this essay was originally written in 2021)
The aim of this essay is to offer some prescriptions to Nigeria’s ailing economy in this adverse COVID-19 environment with its hydra-headed socio-economic implications.
The negative economic impacts of this pandemic are well-known and need no highlighting here. In the last 6 years, the economy has been sailing through headwinds. It has witnessed two recessions in the last 5 years, first one in the second half of 2016 was induced by collapse in crude oil price in 2015/2016 while the recent one in Q3 2020 was triggered by a global pandemic.
Official inflation figures also show that the general price level has been rising steadily in the last 2 years. Meanwhile, in response to a steep decline in forex inflows occasioned by the covid-19 pandemic, the CBN , last year(2020) ,devalued the official exchange rate twice from 308/$1 to N360 in March and from 360/$1 and to 379/$1 in August. A further 7.6% devaluation was done by the apex bank in May this year when the CBN announced its adoption of NAFEX rates as its official price- which was N411 as at that time.
The concurrence of rising inflation, dwindling income and a weakened Naira- is an indication of a debilitated economy, that requires some emergency measures for initial stabilization while the long-term treatment options are being worked out and applied.
The federal government, as well as the central bank, has taken some steps to ameliorate the COVID-induced shocks to the economy. Some of the remedial actions taken by the govt in terms of fiscal stimulus, tax holidays and other reliefs are not relevant to my objective: my focus is on two critical areas which government needs to manage dexterously because of the adverse macro-economic implications that their mismanagement is already inflicting on the economy;
The two areas which are very critical in the immediate circumstance and which the authorities seemed to have been handling in a manner detrimental to the economy and citizens welfare- are ENERGY COST AND EXCHANGE RATES
EXCHANGE RATES MANAGEMENT
Even before the outbreak of the pandemic, there was need to harmonize the various forex rates at the various windows. The huge disparity between the official and parallel markets rates, encourages round-tripping-and communicates uncertainty in the minds of foreign investors and external trading partners. Unifying the divergent rates is the panacea to these problems.
Based on the huge decline in forex inflows occasioned by the pandemic, the CBN carried out two rounds of devaluation in 2020. A similar route was taken in 2016-2017 when the CBN had to adjust the dollar-to-naira exchange rates -twice in a bid to safeguard foreign reserves. These devaluations, with their debilitating effect on the purchasing power of citizens, are not necessary. They are mere panicky responses of the CBN to dwindling forex inflows and declining foreign reserves.
Another factor responsible for demand pressure on the exchange rates is the decision by the CBN to ban importers of some 41 items from accessing forex. Many of these items have not been officially banned the Ministry of Finance /Nigeria Custom Service. The importers of these items would definitely use unofficial routes to source forex and their activity is certainly contributing to the demand pressure at the parallel market.
WHY DEVALUATION IS NOT THE WAY TO GO!
I don’t agree that the Naira is overvalued as some policymakers and analysts would have us believe. We have a modest volume of foreign exchange proceeds through crude oil exports and diaspora inflows- which, if well managed- allows for a USD/Naira exchange rate between N250-N300.
All previous rounds of devaluation have not led to the expected unification of exchange rates. By each round of devaluation, the NAIRA loses its function as a store of value and Individuals/Businesses, in anticipation of further devaluation, will seek a safe haven in the dollar and other stable currencies. This willThis will create additional demand for dollars and this may cancel out whatever decrease in demand for forex that the devaluation might have had on the economy.
Moreover, previous rounds of devaluation (or price adjustment as the CBN would have it described) have not resulted in the much-desired unification of divergent rates. Rather, for every adjustment of the official rate, there has been a corresponding increase in the parallel market rates.
Since the CBN announced its adoption of NAFEX rates, the parallel market rates have increased to over N500 to a dollar-which means the N70-N90 gap btw the official rates and the parallel market rate has not narrowed in any way. The implication is that the no magnitude of price adjustment or devaluation will solve this problem.
Devaluation Devaluation makes the local currency cheaper to foreign buyers of a nation’s products-thereby stimulating foreign demand for domestic products. It only favours an industrial economy that produces high-quality manufactured products. And we are not yet an export-oriented, industrial nation. Besides, our major export, which is crude oil- is not traded in Naira and so , devaluing the Naira cannot lead to higher volume of oil exports. In any case, we cannot export beyond the limit permitted by our OPEC quota.
I have a proposal explained below on how the CBN can effectively manage the exchange rates without having to do any adjustment or devaluation.
THE CBN should resist the pressure to further devalue the naira. The issue that needs to be addressed is the CBN’s system of forex allocation which lacks in-built mechanisms that can prevent speculative bidders and ‘round-trippers’ from obtaining foreign exchange.
In its report on Monetary, credit foreign trade, and exchange policy guidelines for fiscal year, 2020/2021, the CBN lamented forex market pressure occasioned by speculative activities in the BDC and I&E segments of the foreign exchange market.
The solution is to devise a system that guarantees easy access to forex by genuine users.
My proposal for harmonising the existing rates and subsequently maintaining a unified, stable rates is as follows:
-to stop selling to banks in advance
-to stop allocating forex to Bureau-De-Change (BDCs). BDCs can source dollars from NAFEX-the investors/exporters window or from international money transfer operators like Travelex and Western Union
-to set the exchange rate to the US dollar at N288 and manage fluctuations around that amount within the range of N270-N305.
Adopt a direct approach in the issuance of forex in which banks and other authorized forex dealers would operate like agents within the chain rather than resellers.
Under the current system, CBN issues forex to banks using wholesale forwards, to BDCs at the retail window, to other market segments at their various windows. Under this system, the CBN operates more or less like a price-discriminating monopolist- which explains the multiple forex rates that persist within the market. Banks and BDCs operate as forex resellers to end-users.
Under the proposed approach, end-users would apply for forex through their respective financial institutions-the applications are reviewed and scrutinized by banks and then transmitted to the CBN in batches –the applications are further reviewed by CBN officials and then allotment is made for applications that are deemed successful based on CBN’s review and allotment mechanism.
Under this proposed system, banks would operate as processing agents-THE CBN would specify a maximum percentage that financial institutions could charge as processing fee
-the CBN should set up a platform through which the commercial banks can submit end-users’ applications for forex to the CBN on a case-by-case basis. Under this system, banks would only process applications on behalf of their customers via a secure e-portal. The application process must be designed to require submission by each customer documents justifying the need for forex.
For example, a forex applicant who intends to import a particular product should be mandated to submit copies of his import licenses, company registration certificate, copies of customs clearance documents in respect of previous importation and other documents that may be adjudged necessary.
-for those importing tangible goods-an instrument with conditional settlement provisions should be devised -This instrument would be issued to importers by the CBN with conditions that the instrument will be settled by the CBN at international settlement institutions if- and only if, the goods imported are the same as the ones stated in the forex application form and in the specified quantities.
An applicant for BTA must be required to submit copies of his visa to the destination country, etc.
Generally, the application requirements must be designed to satisfy two primary objectives: 1) to establish the veracity of applicant’s need for forex-2) to facilitate post-allotment verification of the use to which the allotted forex was put.
BENEFITS
The benefits that would accrue to the economy by adopting this system are too weighty to ignore.
This system will help to filter speculative demand for forex from real, genuine demand.
It will also engender transparency in forex management and eliminate abuses and fraudulent practices inherent in the current system.
It will give the CBN a firmer handle in managing foreign reserves.
Cost of Energy-
Energy is a critical factor input in any economy. Without energy, the economy would grind to a halt. Inadequate power supply from the grid has been a challenge for decades. So, the economy depends mainly on fuels –to power plants and machinery in manufacturing plants, business premises, homes/households, and vehicles and aircrafts for transportation
Being a critical input in the production of virtually all goods and services, a significant increase in the cost of energy is bound to push up the price of every other commodity.
Towards the end of 2020, the federal government announced full deregulation of the pump price of petrol l[PMS], citing drastic reduction in government revenue and the resultant inability to absorb subsidy on petrol prices. As a result, no provision was made for subsidy in the 2021 federal budget.
The Federal Government, mindful of the aggravating impact that deregulation of PMS price could have on the already-debilitating, inflationary conditions of the macro-economy and owing to pressure from organized labour, decided not to implement its resolution to completely eliminate subsidies on petrol. As expected, that volte-face by the government is already drilling holes in the finances of the federation. In the last three months, NNPC has remitted little or zero any revenue to the Federation because all of NNPC’s net revenue has been utilised in subsidizing the landing cost of petrol since March 2021
While I agree that subsidy on PMS is not sustainable and should be eliminated, the removal can be done in manner that doesn’t lead to increment in the price of PMS(in the short-term). Before I present my proposal on how to remove subsidies without necessarily increasing the pump price of petrol, it’s important that to explain why further upward adjustment of pump price of PMS will be harmful to the economy at this period.
WHY A FURTHER INCREMENT IN FUEL PRICES WOULD BE HARMFUL TO THE ECONOMY.
1. Food inflation is high and increasing as a result of persistent insecurity in the predominantly agricultural belts of the country. Increasing the pump price of PMS will further worsen the situation because of its direct relationship with transport cost-which is a major driver of food prices.
2; Unemployment is very high due to COVID –induced layoffs while household consumption is very weak. The so-called subsidy removal would further aggravate these adverse outcomes through its inflationary impact on commodities.
3 Being the largest component of the GDP, a further -weakened consumption as a result of persistent inflation and weak currency, could further aggravate the expected decline in overall economic activity.
4. A Steep decline in economic activity would adversely affect household income and corporate earnings with attendant negative effect on accruable revenue ( VAT, CIT and PIT)to Fed and State Government
This section of essay contains my proposal on how government can MANAGE the fuel price situation without having to increase the pump price of petrol.
The decision to allow independent marketers to import refined fuel is a wrong decision at this point in time. The forex requirements by oil marketers will further put pressure on the exchange rates.
ENERGY
a) Develop a proper swap deal for refined petroleum products that’s purely counter-trade(barter) which would not involve utilization of foreign exchange and wherein a barrel of crude oil would be exchanged for certain quantities of refined petroleum products. Due consideration be given to domestic consumption requirements for the end-products in determining the mix.
b)Expand the scope of the existing oil-swap deal such that the volume of yields would be sufficient for domestic consumption with 4 months buffer. The scope of the current deal is 300,000bpd which is less than the country’s daily consumption.
· c) Existing oil marketers who otherwise, would have used forex to import the shortfall, should be contracted as transporters-provided they are able to meet the standards/ requirements that government will put in place.
· Payment for freight should be made after delivery has been confirmed.
· d) A robust standard should be set for vessels-including insurance, compliance with international shipping regulations-oil marketers to be eligible for participation.
· e) Extend countertrade policy to other essential products that are imported. Countertrade is increasingly adopted by many countries to manage their foreign exchange. We should not limit it to just crude oil in exchange for refined petroleum products. We can also use counter-trade for agro commodities, industrial machinery , industrial raw materials and pharmaceuticals. This would help to staving off pressure on naira’s exchange rates with major foreign currencies.
The last point would be particularly relevant if crude oil price in the international market crashes to $50 PER barrel or below. This is a possibility that we should plan for considering the fact that COVID-19 is still ravaging many countries. Non-OPEC producers may also decide to increase supply to generate more revenue to bolster their economies.
This measure is like using a stone to kill two birds. It will completely eliminate demand for forex by oil marketers and take considerable pressure off the foreign exchange market. It will also give the federal govt the opportunity to reduce or maintain the current pump price of petrol. The volume of crude-oil utilized for domestic consumption does not count as export. Therefore, this measure can be implemented without violating our OPEC quota.
Adopting these measures will help stem the tide of inflation since prices of imported products and domestically manufactured products partly depend on these two critical input factors. -energy costs and forex rates.
These proposals are emergency measures designed for the short-term like 2-4yrs. The ultimate panacea to the nation’s economic ailments are ‘the long term treatment options’ such as import substitution through backward integration, industrialization, adequate investments in Roads and energy Infrastructure, developing domestic petroleum refining capacity - which require a gestation period of 5-8 years. Policy reversals/inconsistencies and poor implementation may extend this period further.
Like J .M Keynes famously remarked in 1923,’ In the long -run, we are all dead’
Hence, the need for short-term stabilization measures such as the ones proposed in this essay.
NB
Although Nigeria still grapple with some of the same structural and administrative challenges that she had in 2021, many of the points made in this essay are reflective of the economic realities and uncertainties of 2021, post COVID-19.
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