Devaluation or no Devaluation

Dear Speculators,

Regardless of what the President, Federal Government and CBN think of devaluation at this point in time, naira devaluation must occur this year. The economic fundamentals support an immediate devaluation of naira. The major exporting products of Nigeria are crude oil and commodities. These products are currently trading at a record low in international market. They account for over 90% of foreign earnings in the country (CBN, 2015). As both products are predominantly transacted in dollar and other foreign currencies, the ability to convert these foreign earnings to our local currency has greatly reduced. If Nigerian imports fail to change as a result of no real change in the exchange rate, this will lead to high pressure on the naira. Between 1985 and 2014, dollar has risen at a compound annual average growth rate of 19.68% against the naira and no new economic information suggests a change in this trend (WDI, 2015). Dollar is currently the best performing currency in the global market and is at record highs against currencies like pound sterling, euro, rouble, yuan, yen and there is no reason why naira should be any different (Bloomberg, 2016). CBN has resulted to wasting hundreds of millions of dollars daily obtained from our foreign reserves to defend the current peg of naira to the dollar. This is because the monetary authority has chosen to wrongly view devaluation as only an export promotion policy claiming "we have nothing to export". Nevertheless we have continued to witness sharp naira depreciation in the parallel market as a result of currency speculation and uncertainty about the country's monetary policies. Although the export promotion concept is not incorrect, it does not take into cognisance its effect on imports.

 After a currency devaluation, the exports of that particular country appears to be cheaper in the world market and imports coming into such country appear to be more expensive. In import oriented economies like Nigeria, this can trigger a rise in inflation if nothing is done about the situation. According to economic theories, when prices of normal goods and services go up, demand for these products and services tend to fall, ceteris paribus. This means that the volume of imports into the country should fall given that there is no or minimal changes in income growth in Nigeria. The need for these products though will remain unchanged. This will induce entrepreneurial Nigerians to seek to produce close substitutes locally. Considering the increase in the price of foreign goods, the high cost of local production as a result of low economies of scale will then make local prices more competitive with foreign prices. This visible change will induce more Nigerians to purchase less costly locally made products. The increase in national demand of locally made products will provide our local industries with the necessary economies of scale leading to a further reduction in the market prices of their products. This increase in production capacity will be facilitated by an increase in the labour force (reducing unemployment) and an increase in capital requirements (increasing investment opportunities for the financial sector). The excess produced will then be exported at a cheaper price to the world market (considering that currency devaluation has already taken place and local industries are achieving economies of scale).

It should be noted that Nigeria is still one of the most difficult countries to conduct business according to World Bank Doing Business Report 2014. This problem can be addressed with reasonable fiscal and monetary policies that provide a business friendly environment.
The notion that currency devaluation will lead to economic hardship is false. Instead it will force the country to look inwards and increase its local production. We by no means insinuate that Nigeria will be able to produce all that it imports. Instead we believe that there are several products that we unnecessarily import as a country and this causes an issue of unfavourable balance of payment. We subscribe to David Ricardo's theory of Comparative Advantage in International Trade. We desire that inter-regional trade become an element that organically drives the Nigerian economy and African economy.

In conclusion, we expect to see between a 15-20% official devaluation of naira to the dollar before the end of the 3rd quarter this year. As large as our foreign reserves may be, it is limited and that is a big constraint on the exchange rate manipulation of central banks. Naira should be allowed to float freely in the currency market, finding its equilibrium exchange rate. The devaluation will reduce the pressure on naira and open the gates to the foreign direct investments which are still tied abroad waiting for the devaluation problem to be rectified in Nigeria before investors can feel at ease with investing in Africa's largest economy.

Signed:
Emeka Ucheaga,
Managing Partner,
Emeka Ucheaga Advisory