BY KATELYN BUDD
Katelyn Budd is a second-year MA student in the Latin American Studies program.
The recent appreciation of the US Dollar is bringing back memories of past emerging market currency crises, from Mexico’s 1994 Tequila Crisis to Thailand’s 1997 shock that threw all of Southeast Asia into recession. Despite recently depreciating currencies and increasing debt burdens in emerging markets, the specter of these so-called first generation currency crises is no longer relevant for the majority of countries, most of whom abandoned exchange rate pegs years ago. The exception is Nigeria, which is reverting to disastrous economic policies popular during the time of its current president’s last stint in power, in the 1980s. By choosing a strong peg, the president and the country have seemingly learned none of the important lessons of the first generation currency crises.
President Muhammadu Buhari took office in July 2015 in an election that was heralded as a victory for peaceful democratic transition. He focused his campaign on security issues and eliminating corruption but waited over five months to appoint a finance minister and still has yet to announce his economic platform. Buhari continues to support the currency controls and the exchange rate peg even in the face of slow growth and a drop in international investment, calling any potential devaluation “unhealthy.” Unfortunately, Buhari’s adamant assertion that the Naira remain overvalued is reminiscent of his economic policies when he served as the country’s dictator. He was previously in power from 1983 to 1985, before Nigeria’s economy started to grow rapidly and before investors took interest in the country.
The banded peg used by Nigeria is set by the Central Bank and keeps the Naira between a range of values in relation to the US dollar. As of January 2016, the range was set at 197 to 199 per US Dollar. Previously, when oil prices were high (oil export revenue is over 90% of Nigeria's export revenue), the peg was sustainable. In fact, many investors cited the low currency volatility as an example of economic stability in Nigeria. The country has enacted sound policies in the past, including successful central bank inflation targeting that brought down inflation rates from over 14% in 2012 to 8% in 2015. Unfortunately, as both oil production and oil prices have dropped, the exchange rate band came under pressure. Despite calls by the IMF and other international institutions to abandon the peg, the Central Bank has continued to support it, selling on average $100 million in reserves per day in the beginning of 2015 to maintain the peg. Nigeria has almost six months’ worth of imports in reserves available, but they are quickly disappearing. Concerned with the rapid decline of currency reserves, the government banned the purchase of foreign exchange by importers. These restrictions, as well as the removal of the country’s bonds from JPMorgan’s Government Bond Index (GBI-EM) in September, have led to capital flight. The country already experienced a low growth rate of only 2.35% in June, the lowest in over ten years.. As a result, the Central Bank was forced to devalue the Naira twice in the last year.
Figure 1: Interpretation of Central Bank data.
Nigeria has the potential to prevent a crisis from happening before they run out of reserves. A purposeful devaluation or abandonment of the peg would benefit Nigeria by allowing its exports to become more competitive. Continuing to defend the currency peg is a mistake and one that Nigeria will pay dearly for. In perfect economic conditions, with high oil prices and high investor confidence, the peg was a force of stability. Unfortunately, in today's macroeconomic climate, defending it may become Nigeria's downfall and prove to the world that they have not learned from the painful experiences of other emerging market countries.
Sources:
2014 Article IV Consultation, Nigeria. International Monetary Fund. [Accessed 11 November 2015]. Available: https://www.imf.org/external/pubs/ft/scr/2015/cr1584.pdf
2015. “Nigerian Bonds hit by JPMorgan Index Eviction” Financial Times. [Accessed 20 February 2016] Available: http://www.ft.com/fastft/2015/09/09/nigerian-bonds-slide-after-jpmorgan-index-exit/
Bala-Gbogbo, E. 2015. “Nigeria's Fines on MTN, Banks Shows Buhari Under Fiscal Stress” Bloomberg Business. [Accessed 10 November 2015] Available: http://www.bloomberg.com/news/articles/2015-11-02/nigeria-s-fines-on-mtn-banks-shows-buhari-under-fiscal-stress
Central Bank of Nigeria [Accessed 9 November 2015] Available: http://www.cbn.gov.ng/
Wallace, P. 2015. “Africa’s Biggest Economy Defying Currency Critics Chokes Growth,” Bloomberg Business. [Accessed 10 November 2015] Available: http://www.bloomberg.com/news/articles/2015-10-30/africa-s-biggest-economy-defying-currency-critics-chokes-growth
PHOTO CREDIT: "Project Nigeria: Day 3: Lekki Market" in Lagos, Nigeria by Shawn Leishman is licensed under Creative Commons License 2.0.