How CBN forex substitution policy weakens naira

The exchange rate of the naira is at the root of the suffering in Nigeria today.  As an import-dependent economy, what happens to the naira in the foreign exchange market determines the standard of living of the average Nigerian.

When the exchange rate of the naira plummets precipitously like it did in the second quarter of 2016, it takes millions more Nigerians down the poverty line and starts them on the road to starvation and malnutrition.

Between 1979 and 1983, the naira was trading at 75 kobo to the dollar. Consequently, as a poor student, I could buy Time and Newsweek magazines every week.  The cover price of each of the magazines was 75 kobo. The magazines were cheaper in Nigeria than the U.S. because the purchasing power of the naira was higher than that of the dollar.

Some 20 years down the line everything went wrong with the naira and most of us could no longer afford a number of things. As editor of a leading newspaper in 2011 I could no longer buy Time magazine regularly. It was a sad reminder of my days as a self-sponsored student when I was buying the two magazines weekly.  The cover price of Time magazine surged to N2, 000 as the exchange rate of the naira plummeted to N150 to the dollar in 2011.

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Economists differ on what brought down the naira so precariously and turned Nigeria to the global headquarters of abject poverty.  Many blame the fate of the naira on low productivity and the one-handed nature of Nigeria’s economy which depends on crude oil export for 80 per cent of its foreign exchange earnings.

That partially explains why the exchange rate of the naira has been heading in one direction since 1987.  Paradoxically, a currency that traded at N80 to the dollar when oil price stood at $15 per barrel in 1994 tumbled to N160 to the dollar as oil price surged to $105 per barrel between 2008 and 2014. Now the official rate is N305 to the dollar even as oil price is four times higher than it was in 1994.

There is something sinister about the management of the exchange rate of the naira that makes it defy the basic logic of monetary economics. Besides corruption and the one-handed nature of Nigeria’s economy, one factor that has contributed immensely to the persistent depreciation of the naira even in glowing times is something economists derisively tag as “forex substitution policy” of CBN.

CBN is the custodian of the foreign exchange component of what accrues to the federation account on monthly basis.

Under its forex substitution policy, the apex bank converts the forex component of the federation’s earnings to naira, prints its naira equivalent, add it to the local currency component of the earnings for the given month and shares to the three tiers of government on the basis of the percentages stipulated by the constitution.

Consequently, the CBN increases money supply monthly by the quantity of naira converted from the forex component of what the federation earned during the month.

Where oil price remains in the upbeat, CBN could print upwards of N400 billion in a month for sharing by the three tiers of government.

That implicitly increases money supply for that month by N400 billion.  In a situation where productivity remains static or even in a worst case scenario it plummets, the apex bank’s forex substitution policy sets an additional N400 billion chasing the same quantities of goods and services in the economy.

That on its own is a recipe for naira depreciation and inflation.

CBN’s adamant posture on forex substitution has released so much naira into the system that the excess liquidity is used to chase the few dollars in supply thus forcing the naira persistently down the precipice.

The CBN has always argued that Nigeria’s inflation is cost-pushed. But from all indications, forex substitution has conjured demand-push inflation as excess liquidity from the naira printed monthly from the forex component of the federation income floods the forex market with demand for dollars, weaken the exchange rate of the naira and fuel inflation. CBN causes demand-push inflation by creating money supply not backed by increase in production.

The solution to the problem is for the CBN to pay each tier of government in the currency in which the revenue was earned.  They would in turn lodge the forex in their domiciliary accounts with local banks.

 The banks would therefore convert the forex in their domiciliary accounts into naira and pay the two tiers of governments for their naira transactions without the CBN having to print additional naira that would escalate money supply and cause inflation.  The forex converted by the state and local governments end up in the forex reserves of the local banks which would eventually be forwarded to the CBN in exchange for the naira that the state and local governments need for their local transactions.

The apex bank believes that payment of state and local governments in dollars would worsen corruption as the forex would be easily siphoned and used to buy fixed assets in Dubai.

That argument is implausible as security agents including the CBN itself watch the flow of funds into and out of the accounts of all tiers of government.

If the CBN remains adamant about its inflation-prone forex substitution policy, it might soon be compelled to dump the policy through an act of parliament.

A bill would soon be introduced in the senate to amend Section 6 of the Revenue Mobilisation and Fiscal Commission Act of 2004 to empower the commission to monitor the accruals to the federation accounts and ensure disbursement of the accruals in the currency in which the revenue was earned.  That would end CBN’s arrogation of unconstitutional powers to itself. 

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