Tuesday, 30 December 2014

Naira Depreciation: Speculators vs DD/SS

By Dr. Ahmed Adamu

The current Naira depreciation is as dangerous as Ebola crisis, but many undermine its potential repercussions. An elementary economics tells us that floating exchange rates are influenced by the invisible hands of Demand (DD) and Supply (SS), this effect may take certain period to manifest. However, other factors like speculation play vital role in stimulating swift depreciation of the Naira. I become suspicious of the recent Naira devaluation, and I want to believe the speculators are responsible for that.

DD and SS are the natural determinants of a currency’s exchange rate. In a lay man terms: When Nigerians went to international markets, they go with their products and their Naira and they meet Americans who also come with their product and Dollars, if at the end of the day, Nigerians bought more of Dollars (to acquire American products) than what Americans bought of Naira (to acquire Nigeria products), then Naira supply exceeds its demand. When the supply of Naira exceeds its demand, the value of Naira comes down.

The only commodity that has been protecting the Naira was the crude oil, and with low demand of the Nigerian crude oil, Naira demand has fallen down and its supply increases, which leads to down fall in Naira value.

It is obvious that Nigeria is catching up with “Dutch Disease”. A Dutch disease is a situation where a country rely solely on a natural resource sector as a source of its external earning, thereby making the manufacturing and agricultural sectors vulnerable and even more expensive than other countries’ manufacturing outputs (due to high cost of production as all raw materials are imported), and thereby low patronage. This will make the natural resource sector (oil and gas sector in Nigerian case) the only reliable economic sector. With the fall of demand for Nigerian crude oil (resulting from discoveries of alternative energy resources) and subsequent fall in crude oil price, the Naira and Nigerian economy is now in jeopardy, as there will no longer be demand for its crude oil and its currency. The manufacturing and agricultural sector are no where to absorb the shock. Therefore, Nigeria is now stranded, workers in oil and gas sectors loose their jobs, and production of crude oil decreases, more unemployment, low GDP, inflation and by extension, every single Nigerian becomes poorer by day. Students abroad pay more, people pay more to fly abroad, factors of production become more expensive.

Had it been the manufacturing and agricultural sectors contribute significantly to the Nigerian exports, outputs from these sectors would have been more competitive now at the international market, as it will be cheaper due to the low Naira value. If the demand for the manufacturing and agricultural outputs continue to increase, implying increase in Naira demand, then the Naira might redeem its lost value. But now the manufacturing and agricultural sector are not there, who will rescue Nigeria? Unfortunately, all I can foresee is continues down fall.

Nigeria could innocently be suffering as I believe speculators are responsible for the rapid and unprecedented fall in Naira value. Speculators in many circumstances, determine the relative valuations of currencies based on perceptions of key macroeconomic factors. Countries with excessive debt will often experience currency devaluation as speculators perceive greater risk. Speculators are punishing Nigeria as they foresee no future for the country’s economy given the above scenarios, hence their activities became responsible for the swift and continues Naira devaluation. People in ForEx business are responsible as they suspect depreciation of Naira in future due to the obvious reasons, and they continue to sell off Naira in their possessions to acquire other currencies, and this boost the pace of the Naira devaluation above what the natural DD and SS forces would have push it.

Now there is overflow of the Naira, and Nigerian government has to clear the market by supplying more foreign currencies from its foreign reserves, and pay more to service its debts. This leads to shrinkage of the countries foreign reserve, and by implication reducing the economic power of the country compare to many other countries.

Way forward:

1. Immediate revival of manufacturing and agricultural sector. If Nigerians can produce all they require within their country, they would never care about what value is ascribed to their currency at international market, as they will not need other currencies to satisfy their demands. This will also increase aggregate demand, GDP, and increase exports, and eventually restore the value of Naira.
2. Increase Interest rate and bank reserves: Cost of money shall be increased to reduce the Naira liquidity, and to control the resulting inflation from the Naira depreciation. Banks shall keep higher reserves to control money in circulation.
3. Reduction in expenditure: Government must cut unnecessary expenditures, and stop borrowing.
4. Reduce individual demand for foreign currency unless necessary, this can be enforced by introducing additional penalty for every foreign currency purchased within the country.
5. Pray-As they said, everything that happen to Nigeria, they will say “just keep praying” Maybe a miracle can happened. Lol We hope a miracle can happen soon.

Pls discuss….

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