Mr President, Don’t Make Us a Market, By Taofeeq Ayinde & Semiu Akanmu

President Buhari, consequent to your government policy pronouncement on foreign exchange (forex) in the last Presidential media chat, the most popular reaction disagreeing with your adopted policy is those demanding that our forex should be totally floated. This implies that the “invincible” forces of demand and supply of dollar should be made to determine the price at which Naira equates to United States Dollar. Re-echoing the Miltonian school of free market thought, Feyi Fawehinmi shared this sentiment in his essay titled “Mr President, Make Us a Market.” We want to demand otherwise: Don’t Make Us a Market.

 

Photo Credit: Naij.com

We have carefully perused Feyi Fawehinmi’s submission. It’s clearly refreshing and interesting. However, it appears too disentangled from the reality of developing economies, and especially how management of flexible exchange rate (otherwise known as dirty float) operates. It equally repeated the myth of “free market.”

Even though the theoretical literature tries to draw a line between fixed (i.e. where the government pegs the value) and floating exchange (i.e. where market determines the value) rate, the operations of the exchange in real world is a mix of both –with varying degree. This is so because Balance of Payment Equilibrium (i.e. when autonomous receipts from exports and the sale of securities abroad equal autonomous payments for imports and the purchase of securities from foreign residents) –an offshoot of exchange rate stability –remains the cardinal macroeconomic objective and economic business of every government in this globalized world. To do otherwise, as Feyi’s essay suggested, is to make your government irresponsible.

It is also instructive to note that both fixed and flexible exchange rate regimes are two extremes in the continuum of exchange rate stability. There is really nowhere in the world where exchange rate is just allowed to operate so freely and enjoy a free movement at the mercy of market forces. The developed economies, which are erroneously seen as practitioners of free market, also tamper with free operation of exchange rate by undertaking a sterilization control. Sterilization control is the use of counterfactual measures in the domestic economy to nullify unfavourable exchange rate transactions abroad. This has been the strategy of developed nations to tamper with the free operations of flexible exchange rate regime. Therefore, in practical sense, free market is a myth.

Now, if advanced economies are tampering with unfavourable exchange rate, how can Nigeria; a developing and poorly diversified economy, allows a free movement of its currency? As an alternative, managed float regime, which your government has adopted, though with excessive demand control which is understandable at the moment, is preferable. This strategy had been with Nigeria for so many years now and the price differential between the inter-bank and black markets –which is the major point of the policy antagonists –has not been this much. This suggests that the aspersion should not be cast on the managed float regime but rather on the degree of our central bank’s interventions. The current degree of government intervention has been the highest in history.

Can we then blame the central bank of Nigeria for this high level of control and intervention? No! We say “No”, on these following grounds:

Exchange Rate Equilibrium is not Mean reversion: Feyi agreed that floating exchange will amount to sharp drop in naira value but believed it will revert back to its former value; with time. No, Sir! This is the classical position which has never been empirically supported for a less-diversified economy. This can never be the case for a developing economy such as Nigeria. Historical evidence even suggested that what we will have is a rather new equilibrium of a higher level of exchange rate. Naira will settle at higher value against dollars, and this will definitely hurt importers of “essential items” that our economy needs, as you rightly highlighted.

Between Arbitrage and Efficiency: Arbitrage is obtaining profit in exchange rate trading due to the inefficiency of the market. Market inefficiency is when the market does not fully incorporate available information into its pricing system. It can be weakly inefficient (if private information is not incorporated) and strongly inefficient (if both private and public information are not fully incorporated). Arbitrage is a common feature of financial market. In the short-run, it appears the buyers are having a field day of buying in the cheaper market (inter-bank) & selling it in a dearer market (black market), i.e. arbitraging.

We want to state categorically that this is a short-run phenomenon. By the time the black market have succeeded in selling all they have and then need to convert all the dollars to naira (people would have been forced to cut away excessive demand for dollar), they have to buy at the rate obtainable at the inter-bank market. As such, both markets will clear and the inefficiency of the market would have been "forced" efficient. By this time, the rates differential in both markets would be cleared. The CBN only need to properly control the supply of money in the economy. One of these is through the Treasury Single Account (TSA). Stoppage of corruption infestation: Whereby people, who are not covered by the government’s forex subsidy policy, manage to obtain dollar at inter-bank price to sell to black market.   No underground economy should exist in any part of the country. All arms of the government and especially the legislature should also be integrated into the TSA system.

Freedom to free purchase: We want to state that this is a long-aged myth that must be discarded. Nigeria still remains a mixed economy where the means of production, distribution and exchange of goods and services is still concentrated in the hands of private individuals and public entities. Away from that, the regulatory, re-allocative and redistribute roles of the government, irrespective of the economic system, still demands government intervention in determining what to use your money to purchase –especially when it is toward pareto-efficiency. This preaches that the greatest good is to the greatest number of persons. It is the first principle in welfare economics.

We hope that your administration take us to a Welfare state!