The continued stability of the naira in the face of declining foreign reserves generated apprehension among foreign exchange operators, who faulted the decision of the Central Bank of Nigeria (CBN) to defend the naira at the expense of the reserves. Razia Khan, an Economist with Standard Chartered Bank  however thinks differently.

Razia Khan

In an email exchange with Babajide Komolafe, Ag. Finance Editor, Vanguard,  Khan, the Regional Head of Research, Africa,  Global Research at Standard Chartered Bank, argues that the fall in reserves is not due to the apex bank’s decision to defend the naira but the excessive spending by the three arms of government.

In your view does the current exchange rate reflect the reality of the external reserves?

The current exchange rate – whether we are looking at the CBN rate or the interbank rate – more or less reflects market forces, so yes – it does reflect the ‘reality’ of external reserves.  There is no huge parallel market for wholesale buyers of foreign exchange, so one cannot argue that the current exchange rate is in any way inconsistent with economic reality.

Do you agree that the CBN has been running down the reserves to defend the naira?

No.  This seems to be a highly-flawed interpretation of recent events.  Foreign  reserves are not higher because Nigeria has not been accumulating foreign  reserves as rapidly in the past.  There isn’t sufficient evidence of a consistent, sustained spike in demand for foreign exchange  that would suggest that reserves have fallen only because the CBN has been supporting a steady naira  policy.

With oil production at its most favourable level since 2006, and with oil prices back above $90 per barrel, the issue is why reserves have not risen further, not why they have  ‘fallen’.

Every time a disbursement was made from the excess crude account to the three tiers of government, the Foreign exchange  component would have been whittled down.  This suggests that Nigeria ’s problems have more to do with excessive spending, than any attempt to maintain  foreign exchange  stability.

Let us not forget that with the US and other major economies printing money (implementing quantitative easing) to stimulate their economies, the US dollar  and other major currencies have depreciated against many emerging market economies with strong growth prospects, where comfortable current account surpluses are in place.

So the question really needs to be, why is Nigeria the exception to this general rule?  The reasons have little to do with CBN’s foreign exchange  – the root causes run deeper than that.

Do you believe that a  depreciation of the  naira  could  have prevented the decline in reserves or further decline?
This is exactly the point!  Even if the CBN had allowed the naira to weaken, there is no evidence that foreign  reserves would have been higher.  The pressure has not stemmed from an attempt to prop up the naira  at an artificial level.  The pressure on reserves did not arise only from the strength of  foreign exchange  demand against a backdrop of subdued economic growth.

If the CBN had restricted foreign exchange sales, the dollar-naira exchange rate might be 180, maybe even higher as overshooting would have been a risk, but the extent of government spending, the failure to replenish reserves, and the withdrawals from the excess crude account (ECA)  would all have meant lower  foreign exchange  reserves regardless.

Let’s not forget that under ‘normal’ circumstances, the CBN typically only supplies around a third, or slightly less, of the  foreign exchange  that is available to the market.  If reserves are lower, it cannot be because of CBN policy.

If the CBN had not defended the naira , panic would have set in, demand for foreign exchange  would have soared, the panic would have become self –fulfilling and Nigeria might have ended up with even lower reserves than it has now…but maybe with a  dollar-naira rate between 180 – 200.  Do not take stability for granted.  It counts for a lot more than most people realize.

In your view  is there any justifiable reason for the defence of the naira in the face of declining reserves?

Yes, if one takes the view that one of the most serious economic threats facing the Nigerian economy as a result of excessive spending is higher inflation, allowing the currency to strengthen or at least remain stable against a weakening US dollar   (to put it more accurately) reflects the best chance that Nigeria has of preventing imported inflation.  Inflation is the most regressive tax – it hits the poor hardest.

The CBN has a mandate to deliver not only growth, but also price stability to the Nigerian economy.  By keeping the  foreign exchange rate stable, they are merely acting in accordance with their mandate.

If the CBN has been defending the naira, how far do think they can do so if the reserves continue to fall?
In recent trading sessions, where demand has been excessive, the CBN has allowed the naira  to weaken gradually.

Let’s not forget that the naira  still trades quite far from the top-end of its +/-3% band around 150, so there is still room – within the current  foreign exchange  policy framework – to allow it to adjust gradually to the current pressure on reserves.  If reserves keep being depleted, the CBN could change the mid point of its preferred band – the important thing, to prevent expectations of depreciation becoming self-fulfilling, is to remain in control of the situation.

There would be little to gain in suggesting that the naira  could depreciate dramatically – panic would ensue, foreign exchange  reserves would fall further, the naira  would come under speculative pressure, and nothing in Nigeria ’s real economy would change for the better.  Competitiveness is not about the exchange rate, it’s about the dire state of infrastructure.

What would be the implications for the economy if the CBN continue to defend the naira in the face of declining reserves?

If they succeed in keeping inflation under control, then the Real Equilibrum Exchange Rate (REER) appreciation of the NGN would be contained.  Eventually, the hope is, that with Nigeria ’s comfortable current account surplus, reserves accumulation would resume.  As I said earlier, the question is NOT why the CBN have run down reserves to meet demand.

The question is why reserves have not been rising even faster than this, allowing the CBN to react to greater demand for foreign exchange.  The answer is probably excessive spending, resulting in pressure on reserves.