Nigerian currency is overvalued says Africa Economist, John Ashbourne

LONDON (Capital Markets in Africa) — I would say that the currency remains overvalued. Nigeria’s balance of payments position has changed quite radically since the price of oil fell so sharply, and the currency has yet to fully adjust to this. Given low oil prices, relatively high inflation, and generalised dollar strength we would have expected that the naira would have weakened over the course of the second quarter. Indeed, almost every other SSA currency has fallen over the past month, and there isn’t any really substantial reason why the naira should be an exception. Indeed, as an oil exporter, it should be under the same pressure as the Angola Kwanza (AOA) and Ghanaian Cedi (GHS). The fact that it has remained stable is more a sign of government support than any underlying, sustainable strength. So the currency is certainly overvalued compared to where it ‘ought’ to trade.

I understand the rationale behind these policies, but I have two concerns. First, I wonder how effectively this policy could possibly be enforced. It forces all FX traders and importers to justify what they are using FX funds to import, and requires that the CBN has some mechanism of verifying that they are telling the truth. It’s difficult for me to imagine that this could all be implemented very efficiently. Think about how much smuggling and subsidy-defrauding already happens now. Second, if the rules were effective then this would probably just lead to shortages and higher prices. Of course moving towards local production is a very important goal; arguably the most important for Nigeria over the medium/long-term. But a sudden hike in import price/shortages – which would be the effect of limiting importers’ ability to buy these foreign goods – will not help. Nigeria simply doesn’t have the capacity right now to produce some of these goods (e.g cars). For others, like rice, the country does have a domestic industry but couldn’t possibly raise production quickly enough to meet demand.

Over the longer term, I think that the best thing that the bank could do is allow the naira to fall by 10-15% (perhaps gradually), as this would provide a boost to domestic production, make the economy more competitive in the long run. It would also take away some of the fear of devaluation; a lot of potential investors are convinced that the currency will weaken, and are holding off until it does. Sending the signal that the adjustment is complete and devaluation is behind us might tempt them back in. But the current system doesn’t look sustainable or credible; and that is a real deterrent.

By John Ashbourne, Sub-saharan Africa Economist, Capital Economics