People & Money

Whither the naira’s exchange rate, there the crystal ball

The invitation to call the direction and pace of policy changes next year, is simply an ask to gaze into the crystal ball.

As the CBN continues to rewrite monetary economics, the old hymnal no longer matters… we will have to wait until the central bank offers up new policy tools for managing domestic monetary conditions. Until then, the invitation to call the direction and pace of policy changes next year, is simply an ask to gaze into the crystal ball.

One of the more difficult invitations I get these days is to come describe to a room of business leaders where, in my view, the Nigerian economy will be over the next 13 months. The facts are never in contention. Clearly, by year-end, the local economy would have grown faster than earlier forecasts by both the International Monetary Fund (IMF) and the World Bank ― i.e. much closer to what had seemed at the time overly optimistic estimates by the Federal Government. Much of it because any improvement in the economy this year is always going to be exaggerated by last year’s unusually dismal performance.

How to interpret all of these, however, is a different matter ― especially for managers who need to agree on their investment and currency hedging decisions ahead of the new year? In the design of an outlook for the next year, three aspects of this year’s growth matter. First is the fact that despite this faster-paced recovery, businesses have continued to experience a drop off in final demand. A great number having retooled their operations to reflect this fall in demand ― by selling goods and services in more discreet single-use packaging ― have also held off new major investment. Second, despite oil prices having remained very high all through this year, Nigeria’s revenue from the export of hydrocarbons has dropped off.

Also Read: Nigeria is no stranger to reform

The worries adverted to by this second condition are as much about how important oil revenues are for the economy, as they are about the longer term implications for the economy of a secular decline in output capacity in the upstream oil and gas sector ― an outcome that is unlikely to be reversed next year, if ever. Beyond either of these considerations, though, over the next plan cycle, we are invited to look critically at government’s spend. “In summary, Nigeria’s fiscal position is deteriorating”, is how the World Bank put it in a recent comment on the economy. With consumer spending distressed ― one consequence of the relentless rise in prices that the economy continues to suffer from ― businesses responding to this by paring back investment plans, and the Federal Government struggling next year just to keep provincial governments funded, where will growth come from in 2022?

With foreign exchange earnings likely to drop off next year, and on the back of this development a deceleration in the growth rate of the balance on the gross external reserve, would the Central Bank of Nigeria (CBN) finally let market forces determine the naira’s exchange rate?

In all likelihood, once the base effect that we are witnessing in 2021 wears off, we would be back to scraping the economy off the bottom of just about every log. For most businesses operating in the country, the outlook for the exchange rate is the unasked rider to this predicament. With foreign exchange earnings likely to drop off next year, and on the back of this development a deceleration in the growth rate of the balance on the gross external reserve, would the Central Bank of Nigeria (CBN) finally let market forces determine the naira’s exchange rate?

At this point in the “question and answer” session, I relate my favourite allegory on the Nigerian economy.

Globally, this year, demand has recovered faster than supply. This has, accordingly, put upward pressure on prices in developed economies. However, despite the strong commitment to price stability of central banks in those economies, they have held off putting up their benchmark interest rates to reign prices in. Partly, this is out of a concern for the possibility of rate rises throttling the nascent recovery enjoyed by the economies this year. In part, too, most commentators are persuaded that price pressures will ease as the kinks in the supply chain are worked out through early next year. Still, rates have remained high and increasingly fraught. Indeed, large parts of the commentariat now fret that higher rates threaten a negative loop that feeds into high wages and then back into prices.

…this process is as much about a clearly articulated monetary policy strategy, where central banks’ price stability goals are realised through tightening monetary conditions, and how clearly central bankers communicate the planks of this strategy. While this may make central banks look predictable and boring, it makes it easier for businesses to plan.

Thus, central banks in Europe and north America have pared back their bond buying programmes, and now look set, later next year, to raise rates. In the end, this process is as much about a clearly articulated monetary policy strategy, where central banks’ price stability goals are realised through tightening monetary conditions, and how clearly central bankers communicate the planks of this strategy. While this may make central banks look predictable and boring, it makes it easier for businesses to plan.

The same cannot be said of our local circumstances. As the CBN continues to rewrite monetary economics, the old hymnal no longer matters. As with Turkey’s advance along the path of the new economic heterodoxy, where high interest rates are implicated in the rise of domestic prices, we will have to wait until the central bank offers up new policy tools for managing domestic monetary conditions. Until then, the invitation to call the direction and pace of policy changes next year, is simply an ask to gaze into the crystal ball.

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