Do you remember the good old days in Nigeria? When the Naira was stronger than the US Dollar, Figure one shows Barclays bank selling $1830 for N999.
Today, imports are expensive, and one US dollar exchanges for over N510 on the black market.
Which scenario do you think is better for Nigeria, a weak Naira or a strong Naira?
The exchange rate is the ratio of exchange between the local currency and another single currency like the US Dollar (USD) or a basket of currencies. If the exchange rate between the USD and the Naira is $1:N500, then to get $1, you need N500. If the next day the exchange rate becomes $1 to 497, then the Naira has appreciated N3 and has become stronger in relation to the USD. If the rate is $1 to N502, then the Naira has depreciated by N2 and has become weaker.
The USD is the global reserve currency because of an agreement between Western nations at the Bretton Wood conference in 1944. A reserve currency is used to settle international trades. So if Nigeria wants to import olive oil from Jordan, you don’t transact in Jordanian Dinars and Nigerian Naira; instead, both nations will transact in US Dollars. The Nigerian importer will place N500,000 in his local bank. His local bank converts that local currency to USD 1000 and transfers it to Jordan to pay a local Jordanian bank. Thus if the US raises interest rates, then imports of Jordanian Olive oil will be more expensive because the USD cost went up.
When you drink Coca Cola, you are importing; even if you are in Nigeria, thus you are selling your local Naira and buying USD. When an American eats prawns from Nigeria, he is importing and selling his USD and buying Naira. Importers across the world thus use US dollars to settle trades. If you import, you have to get US dollars. How do you get US Dollars? I list the ways below.
1. Exports; where a nations exports goods and services in return for USD.
2. Foreign Direct Investment, where you attract a foreign investor to invest USD in your home nation by investing in a hard asset like a factory. E.g Heineken’s new beer plant in Enugu.
3. Foreign Portfolio Investment, where a government sells bonds or financial instruments to foreign investors in foreign currency. E.g. Nigerian Euro bonds.
4. Remittances; where citizens of the nation send US dollars back home.
5. Loans, borrowing in USD.
Is a strong Naira good?
When a nation exports, she earns USD dollars; when she imports, she spends USD dollars. Central banks can reduce or increase imports and exports by adjusting their exchange ratio to the US Dollar. If the CBN keeps the exchange rate strong ($1:N380), then imports are cheaper. If imports are flowing in, local production will have more competition and see less demand. Less demand for local goods will cause job losses and unemployment.
A strong Naira also makes local raw materials expensive. Nigerian Cocoa will become costly as a foreign buyer will need more Naira to buy; this may push Ghananian Cocoa as an alternative.
A strong Naira works best when the imports are inputs for reexport, e.g., Nigeria is importing pipes to use in the export of crude oil. China has fueled its growth and wealth by imports for exports. If imports are for final consumption, then it simply widens Nigeria’s current account deficit.
So should Nigeria weaken its currency?
A weaker Nigerian Naira means the Naira exchanges for less USD. Thus importers need more dollars, and they spend more Naira to get it. A weaker Naira makes imports expensive. If imports become costly, then local substitutes become competitive. If local goods become competitive, local employment goes up to meet demand. Thus a weak naira boosts local substitutes production and jobs.
A weak Naira means Nigerian made goods and services are cheaper in relation to the USD. Take Cocoa. If $1 is N502, then more Nigerian Cocoa will be sought because international buyers can get more per USD in Nigeria. As demand goes up, local production will increase to fill that gap.
For example, A 50cl bottle of Coca-Cola costs $1.13 in the US and N291 in Nigeria. Assume a current exchange rate of $1 to N280. When the Naira is strong, it is cheaper to import and avoid infrastructure challenges in Nigeria. When Naira is weak, the savings from exchange rate differential may not be sufficient and local production goes up.
If weak currencies create jobs, why does CBN want a strong currency?
A weaker currency can create inflationary pressures. For example, Nigeria imports PMS, and a weaker currency means PMS and other imports become more expensive and that “imported inflation” is passed to consumers. A weaker currency by boosting local employment also increases wage pressure. Workers will demand more money in an inflationary environment. These rise in local costs then force the CBN to raise or keep Monetary Policy Rates high to reduce cash in circulation. This high MPR rate is a disincentive for investment, especially for SMEs.
In Economics, there is no perfect scenario; there are only trade-offs. Nigeria can strengthen the Naira and have N50 imported sardines, lower cocoa exports, and the foreign reserves will deplete. Nigeria can weaken the currency and boost local job growth but live in fear of inflation. Also, consider foreign loans priced in USD; a strong currency means you can pay back USD denominated loan cheaper than with a weaker currency.
The real risk for Nigeria is infrastructure. Nigeria could weaken the Naira and not reap any export gains if Apapa port roads are blocked and whole parts of the nation grounded by insecurity. Exchange and Monetary policy will struggle to impact meaningfully where ease of doing business is high.
Reality, they say, eats policy for breakfast.