Devaluation In A Deficit Financing Regime Pushes Economy Into Recession

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The Nigerian economy should by now, be aligned purposely with the forward looking and clear political direction of President Muhammadu Buhari’s development initiatives for the country.  The nearly three decades of panel-beating the economy with narrowly focused monetary controls above a comprehensive macroeconomic management strategy should have been arrested several years ago.  However, corruption, self interest, and fear of a small group that has controlled the economy has prevented the obvious.  The election of Muhammadu Buhari of the All Progressives Congress (APC) as President, should have sent a signal to the Central Bank of Nigeria (CBN) to reinvent itself swiftly to function as a linchpin for strategic macroeconomic management of the economy.  The CBN should have stepped up activities to be seen as a regulatory agency that ensures all financial intermediaries support its monetary targets for credit expansion, stable output growth and price stability.


Policy Inconsistencies

Since 1966, after the fall of the first republic, Nigeria’s economy has functioned like anything but, what is studied in economics textbooks.  The formal and informal sectors of the economy have complicated the nature of the nation’s mixed economy.  Although, the economy is mixed by definition (planned economy with a mixture of public and private enterprises), there is a vibrant free enterprise sector that responds to economic policymakers’ and monetary authority’s pronouncement.  Inconsistencies in policy pronouncement and monetary targets have led to confusion and hindered the achievement of long-run price stability and economic growth.  Nigeria’s current stagflation (a combination of low economic activity and rising prices) has been a direct consequence of macroeconomic mismanagement and policy trade-offs in a monetary regime that has underestimated the psychological impact of forward guidance in applying financial tools in analyzing policy choices.


Policy Timing

The questions and comments attributed to President Muhammadu Buhari regarding the naira devaluation and foreign reserves depletion have inspired this position paper.  This is an attempt to answer President Buhari’s questions and provide practical illustrations that might help one to appreciate the economic reasons for the naira’s devaluation relative to the dollar.  The President’s remark on Monday,  June 28, 2016 at the New Banquet Hall of the Aso Rock Presidential Villa during a Ramadan dinner with the business community, that “I fail to appreciate the economic explanation [for the naira’s devaluation,]” is an incidental indictment of the CBN’s poor execution of its mandate and the Federal Ministry of Finance’s slack decision to embrace external markets for loanable funds to finance budget deficits without serious consideration on the long-run implication for the value of the naira.  Unsuspectingly, that decision was a backdoor route to a devaluation track without full disclosure to Mr. President.

Economists know that government’s borrowing to finance budget deficits, if borrowed in the domestic market for loanable funds reduces the supply of loanable funds available to finance investment by households and businesses (crowds out private sector funding), and if borrowed in the external market for loanable funds, constitutes a net capital outflow in the foreign exchange market for dollars (that is, increases the demand for dollars), and leads to the weakening of the naira relative to the dollar.  So, what should have been the solution?


Rational Expectations

CBN’s tightening of monetary policy in the first quarter of 2016 in anticipation of the National Assembly’s passing of the 2016 Appropriation Act, triggered a major slow down in economic activity.  The third and fourth quarters of 2015 Gross Domestic Product (GDP) estimates, showed significant sluggishness of the economy for a clear activist monetary policy.  The rational expectations of the business community and households was an expansionary policy that would have lowered interest rate (Monetary Policy Rate) in the domestic market for loanable funds.  Although, the 2016 Budget seemed colossal in comparison to previous budgets, it presented an opportunity for an accommodative monetary policy which would have provided a good balance of fiscal and monetary policy mix to expand output in a fairly stable price environment.

Nigeria’s businesses and households, by far demonstrated a greater understanding of budget execution in Nigeria than the monetary authority.  The CBN’s forward guidance in policy pronouncement did not only freeze economic activity but, also pushed the economy into stagflation or recession (that is, a period of falling output and rising prices).  Therefore, the only predictions that have turned out as predicted are the policymakers’ irrational anticipations of rising prices and weakening of the naira.  This is a classical case of not knowing what to do when the sailboat is off course, and there is no wind to steer the boat back on course, as the Captain is seen to be guessing for a probable solution and looking in the wrong direction.


The Economy In Quagmire

Stagflation (a period of falling output and rising prices) and deflation (a period of low output and falling prices) are the most difficult periods in a business cycle of any economy to proffer policy prescriptions.  However, monetary policymakers know the rigmarole of pulling the economy out of quagmire.  Nigeria’s current policy choices have been surprises to many macroeconomists.  For example, deficit financing in Eurobonds as a panacea to crowding out private sector borrowing in the domestic market for loanable funds seemed auspicious but, has presented double jeopardy.  The strategy has increased Nigeria’s demand for dollars and weakened the naira as the trade imbalance has magnified.  A strong export-oriented economy would have benefited from the current devaluation regime but, the struggling import substitution industries are bleeding from scarce hard currency for capital goods.  Certainly, macroeconomic solutions to a nation’s economic ills require trade-offs.  Policymakers must ensure that Mr. President is well informed about the trade-offs so that economic decisions can be properly coordinated and made in the context of political considerations.  What are the benefits of devaluation if loanable funds in naira are available for households and businesses to finance new investments but, imports of new capital equipment are exorbitant due to the high cost of the dollar?


CBN’S Mandate

CBN’s Act mandates it to maintain stable prices and output growth.   Providing stable output growth at full-employment is the ultimate goal of any  central banking system.  Though, achieving these goals sometimes result in  policy conflict.  It’s the responsibility of the CBN to find the right set of policy tools to achieve stable economic growth without inflation and unemployment. From 2009-2014, monetary authorities had put a premium on foreign currency exchange stability and risk management to oblige merchant banks to have stronger balance sheets and good governance.

The action ensured that financial intermediaries became financially healthier to support CBN’s drive towards the achievement of output growth and price stability.  That vision has not been articulated by the new monetary policy regime by redirecting its activities towards consumer and business lending.  Policymakers have been compromised with such fiscal and monetary policy initiatives like the Excess Crude Account and Sovereign Wealth Fund as the country continued to finance budget deficits year-in year-out by borrowing in the domestic and foreign markets for loanable funds.  Why did the CBN continue to underwrite long-term debt instruments as the country continued to accumulate excess revenue over planned spending budget?  Also, why did Nigeria borrow to invest in infrastructure but, chose to spend surplus revenue on consumption?

These questions and many more have shown lack of thoughtfulness and have endorsed confusion amongst elite economic policy makers.  Otherwise, one can conclude that these have been deliberate policy schemes to keep the nation into continual debt to thwart development and in the process divert accumulated savings through exotic investment schemes as the Sovereign Wealth Fund, which most Nigerians have never seen and would never likely see its balance sheet.

The pool for loanable funds comes from public saving and private saving.  It’s from this market for loanable funds that businesses and households borrow to finance purchases for new factory buildings, equipment, houses, cars, and durable consumer products.  Nigeria has no public saving because policymakers have chosen to share the surplus for today’s consumption.  How can this be changed for a better tomorrow in planning for economic development?  The current political leadership of Mr. President can set the course for a new dawn.


“… We have maneuvered ourselves into a mono-economy which led to the collapse we are seeing now.”  There is overwhelming evidence to support President Buhari’s statement above.  A glance in memory lane has revealed astonishing statistics that bear witness to the rot in Nigewria’s economic management.  In 1960, the share of agriculture to Nigeria’s Gross Domestic Product (GDP), that is, the value of goods and services was 67.0% and Crude oil sales was only 0.6%.  In 1980, the share of agriculture to Nigeria’s GDP dropped down to 30.8% while Crude oil sales rose to 22.0%.  In 2006, agriculture’s share of GDP dropped further to 24.6%, while Crude oil sales increased to 51.1%.  This trend has continued to 2016 as the country exports less cash crops and processing for value addition has diminished as well.

President Buhari’s comments and questions are thought provoking for all free-thinking Nigerians who have the economic interest of Nigeria at heart.  From 2005 to 2015, Nigeria experienced one of the greatest economic expansion of all times in its history.  The Nigerian stock market boom produced billionaires, while some ill-advised investors and speculators lost their precious savings due to the crash of 2009.  While all of these were going on, crude oil price soared.  Nigeria took in more in revenues year-in year-out than was budgeted to spend however, deficit financing continued unabated as if the money taken in from crude oil sales was not real.  What’s more, looting of public wealth continued unchecked and the economy began to crumple as the real sector of the economy was completely ignored.  Nigeria has walked herself into a deep depression and unless President Buhari acts now to turn around the tide, the politics of the economic depression shall continue to echo on the streets and subsequently at the polls in 2019.

Principal Special Assistant to the Governor of Benue State on Knowledge Economy & Investments.

–Adyorough  was special assistant on Investments to the minister of State for the Federal Ministry of Industry, Trade and Investment


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