Home Column Nigeria is in a foreign exchange quagmire

Nigeria is in a foreign exchange quagmire

by Business News Report

The recent devaluation of the Naira has again brought the vulnerability of the average Nigerian to the fore. Almost every housewife today tells the husband that the exchange rate of the Naira to the dollar has gone up. This is because in the market place, traders adjust prices along the day’s exchange rate swing. Many are wondering why this should be so. In finance, an exchange rate between two currencies is the rate at which one currency will be exchanged for another. Foreign exchange is bought and sold in the foreign exchange market at a price that is called the rate of exchange. More specifically, the exchange rate is the domestic money price of foreign money, establishing equivalence between dollars and British pounds sterling, dollars and French francs, dollars and Naira, and so on.
It is also regarded as the value of one country’s currency in terms of another currency. For example, an inter-bank exchange rate of N197 to the United States dollar means that N197 will be exchanged for each $1 or that $1 will be exchanged for N197. Exchange rates are determined in the foreign exchange market, which is open to a wide range of different types of buyers and sellers where currency trading is continuous.

Foreign exchange is supposedly a monetary instrument to facilitate international trade between one country and another. The scenario playing out in the Nigerian market place shows that Nigerians have tied their livelihood to the dollar. Local production and imported products are now being priced with reference to the fortunes of the dollar. Increasingly, the economy is being dollarised with the monetary authorities unable to do anything about it.

This is so because Nigeria has over the years become so dependent on imported goods that local production has taken a back seat. Each time the currency drops in value, Nigerians are quick to blame the government and the Central Bank for the falling fortune of the Naira. Yes, government has failed in the past to put in place policies that encourage local production but the government and the citizenry have to share the blame. For a productive and export-driven economy, exchange rate depreciation is an incentive to produce more in order to get a larger share of the international market. Devaluation makes local goods cheaper than imported goods. For countries like Japan, Korea, China and America, devaluation is of much benefit to their exporters as their products become cheaper and more affordable abroad. Citizens of these countries are more concerned with an over valued currency.

In Nigeria, the reverse is the case, because of the country’s low productive base, low non- oil export and over-dependence on foreign exchange earnings from oil, devaluation is an economic pain because the goods and services produced by Nigerians are less sensitive to changes in price, (exchange rate). The price and volume of crude oil exported by Nigeria are determined externally. Price of crude is determined at the international oil market and the volume produced is determined by OPEC. The amount of foreign exchange inflow from crude is not sensitive to depreciation or devaluation. It is the same story with non-oil exports that have no value addition.

In economics, the increase of supply of foreign exchange to Nigeria is mainly dependent on the response of foreign demand for exports from Nigeria. Ordinarily, upon devaluation, the foreign exchange price of exports falls. When foreign demand is elastic, this decline in export prices will stimulate an expansion in the quantity exported that will be sufficient to enlarge total receipts of foreign exchange despite the lower prices in terms of foreign exchange. However, because the response of foreign demand for Nigerian goods is low, total receipts of foreign exchange become smaller.

Generally speaking, the demand for manufactured products (especially “luxury-type” products) has higher response to devaluation than the demand for agricultural and other primary products produced in Nigeria, which is often inelastic. Many primary products satisfy basic needs and their consumption is relatively insensitive to price changes. The same is true of intermediate goods that are purchased as raw materials, semi-finished, and the like, when these goods contribute only a small share to total costs of production. Such products face a derived demand that tends to be inelastic. The demand facing a product with many substitutes is likely to be more elastic than a product with few or no substitutes. That is why in a country like Nigeria, devaluation cannot be of benefit to the economy.

So long as Nigeria continues to use its foreign exchnage earnings to import petroleum products, cars, rice, fishery and poultry products, the demand for foreign exchange will continue to rise and outstrip supply, and the value of the Naira will continue to fall. This is because the sensitivity of the demand for foreign exchange depends mainly on the degree of changes of the domestic demand for imports. When higher import prices in domestic currency cause a fall in the quantity of imports, then devaluation improves the balance of payments on the demand side which is not the case in Nigeria. At the very worst, when the quantity of imports stays the same, depreciation has no effect on the balance of payments as far as foreign exchange demand is concerned.

When the foreign exchange price of imports does not change after devaluation (import supply is perfectly elastic), then the elasticity of import demand fully determines the demand elasticity of foreign exchange. Nigeria can only come out of this present quagmire if it begins to refine crude here in Nigeria, make the auto policy work such that Nigeria like Brazil in no short time begin to export cars and other manufactures, produce rice locally, become self sufficient in fish and poultry among others. Only then can Nigerians begin to think of a strong naira exchange rate.

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