NIGERIA INSIGHT: Naira Faces Rocky Future If Abubakar Wins Vote

LAGOS (Capital Markets in Africa~) – Nigeria’s opposition presidential candidate Atiku Abubakar, who is running against incumbent Muhammadu Buhari on Feb. 16, has pledged to float the currency. That’s prompted overstated warnings of a devaluation from the central bank governor. But exposing the economy to currency volatility might do more harm than good in the near term.

• Nigeria’s trade position has deteriorated. Also, the decline in oil savings and foreign reserves would make a free-floating naira more vulnerable to fluctuations in financial flows than previously.
• Portfolio investments now dominate financial inflows and might necessitate higher interest rates, especially in times of weak oil prices. That could increase the highly cyclical nature of Nigeria’s economy.
• A more achievable and less risky reform would be to end the system of multiple exchange rates and restrictions on access to foreign currency from the central bank.

Abubakar’s promise to overhaul the economy is a welcome shift toward policy issues and away from regional politics — though the latter will still play a large role in voting. Buhari’s economic record in office has been poor. GDP growth is currently slower than at any time since the 1990s. Abubakar is calculating his emphasis on the economy will give him an edge with the electorate. If he wins, it may be only the second democratic transition of power in Nigeria’s history.

One leg of Abubakar’s policy platform is currency reform. He’s seeking to convince voters of the benefits of a free-floating naira. That effort took a blow from remarks by Central Bank of Nigeria Governor Godwin Emefiele who warned of a “massive devaluation” and it’s unclear whether Abubabkar can secure majority support within his People’s Democratic Party for the reform. He’s also seeking to change leadership at the central bank.

Black Market Discount Eliminated
It’s quite common for oil-producing countries like Nigeria to peg their currencies to the dollar. The central bank buys or sells foreign-exchange depending on supply and demand conditions in the market. Buhari’s predecessors undermined the peg by draining the central bank’s rainy-day fund, the Excess Crude Account. And in recent years, as oil prices fell, the absence of a buffer has prompted a series of adjustments to the peg.

Naira Not Overvalued Compared to Peers
The IMF’s estimation of real effective exchange rates indicate that the naira’s competitiveness has improved since 2014-2015. The official and black-market rates have also converged, in contrast to a widening gap in Angola following the most recent decline in oil prices.

So, a free float of the naira is unlikely to bring a dramatic weakening if it were implemented today. Although Morocco’s attempt at reforming its exchange-rate regime is evidence that speculation in itself can be destabilizing.

Weaker Current Account Undermines Naira
However, Nigeria’s net trade position has deteriorated over the past decade, making the currency more vulnerable to changes in global oil prices. The composition of financial inflows has also switched. It used to be dominated by foreign direct investment, but this has more than halved since 2010.

Investors have been discouraged by the slowdown in economic growth as well as the introduction in foreign-exchange controls in 2015 and the more recent spat with telecoms operator MTN Group over the repatriation of profits.

In place of FDI, portfolio inflows and other investment (loans, currency and deposits) have risen in importance. This means that the CBN may need to keep its policy rate, already at a record high of 14%, at an elevated level to maintain these inflows. As pressures on the naira are likely to increase when oil prices are low, monetary policy may become more procyclical.

Financial Inflows Have Become More Volatile
A more achievable and less risky proposition than floating the naira would be to end restrictions on access to foreign currency. At the moment, different rates apply to different types of products. This creates perverse incentives and opportunities for smuggling. The distributional impact of allowing access to foreign currencies to pay overseas school fees, but not for importing rice, is clearly regressive. Ending the practice would benefit and appeal to a wider population.

Mark Bohlund covers Africa for Bloomberg Economics in London. He has previously worked as an economist at IHS Global Insight, BMI Research (now part of Fitch Group) and the Swedish Foreign Office.

Source: Bloomberg Business News