For many years now there has been a divergence between the Naira's official exchange rate, and the parallel market rate. The "parallel market" for Naira has been called the "black market", but it is so ubiquitous and openly patronized that "unofficial market" or better yet "unregulated market" might be a better description.
The Naira is always weaker on the parrallel market and stronger on the official market, and over the years there has been controversy over the issue of arbitrage (i.e. banks, individuals and firms buying dollars at the official rate, and selling those same dollars on the parralel market). Through this arbitrage, operators exploited an artificially-created market distortion, making profits without sweat, work, entrepreneurship, production of output or employment of any factor of production. Indeed, before CBN Governor Charles Soludo changed the capital requirments of banks, forcing the recent "consolidation" in the banking sector, many of Nigeria's banks did nothing other than buy dollars on the official market and sell them on the unofficial market.
But I've always had a more fundamental question when I have thought of the dichotomy: What is the true value of the Naira as expressed in foreign currency?
For as long as I have thought about the issue of economic growth and (especially) foreign trade, I have wondered what rate to use as the basis of analysis. I mean, how do you know if the Naira is over-valued or under-valued if you do not know what the value is? And don't say the differences in the two rates are small, because in trade such small differences matter more than you think (and for that matter, arbitrage is not a uniquely Nigerian phenomenon).
Everyone assumes the unofficial rate is the "free market" rate, but what if the unofficial rate exists as it does purely because of the deliberate distortion to the market? Prices in distorted markets like monopolies, monopsonies and duopolies are not "free market" rates, and I have always thought participants in the unofficial market in Nigeria were acting in response to the (distorted) official market and not to any "free market" equilibrium. As such, I always wondered if the true value of the Naira in foreign exchange was (a) somewhere in between the two rates; (b) nearer the official rate; (c) nearer the unofficial rate; (d) somewhere higher or lower than the limits of the set bounded by the two rates.
Imagine then my interest in this Bloomberg article. The Naira appreciated 12% on the unofficial market in response to an easing of the restrictions (i.e. distortions) on the Nigerian foreign exchange market. Mind you, restrictions have been eased, not removed. It would be more accurate to say the Central Bank of Nigeria has redefined restrictions, and has been criticized by small-scale bureau-de-change operators, who believe the redefinition favours large-scale dealers, erasing the competition of small-timers by fiat.
According to one small-scale BDC operator quoted in the article, only 50 of 1,000 BDCs in Nigeria have qualified for the CBN's new exemption. One gets the impression he believes this is just another distortion, designed (as are all such distortions in Nigeria) to benefit influential players in business and politics by using regulation to give them competitive advantages. This gentleman insists that the dollar would fall more dramatically against the Naira if the foreign exchange market were thrown open to anyone because (his words): "Nobody would be interested in keeping the dollar, when everyone has.” In the context of the article, it seems to me he was suggesting that some parties who buy on the official market hoard their dollars so as to heighten the scarcity on the unofficial market.
Still, perhaps we could do with some consolidation in the sector? I would advise the small-scale operator to think perhaps of forming a cooperative with other small-scale operators, or even of establishing a separate corporate entity with the smaller operators allocating a certain proportion of shares to themselves and selling the rest on the stock market to raise additional capital. Mind you, the man has a point (more than one), and I am still uncertain that this easing of restrictions would lead to us finally knowing what the true exchange rate of the Naira is.
The Naira has indeed appreciated against the dollar on the unofficial market, bringing it closer to the official market rate. The two had diverged by as much as =N=34.00, but as of the moment Bloomberg published their article, the divergence was down to =N=12.00.
This brings me back to the thing I've wondered about all these years.
Does this mean the real Naira rate is or has been somewhere between the two rates? If all distortion was removed, would the official rate weaken and climb up to meet the now stronger unofficial rate?
What if BOTH rates are reflective of a distorted market and the true rate of the Naira is somewhere we don't even know?
This is important. I know this is not an issue that people talk about (aside from complaining about round-tripping arbitrage). You see, no matter how hard you try to bury the basic realities of the economy, they come back to bite you in the end. If we base all of our economic planning on assumptions that have no basis in the truths about our economy, then we are building ice castles in the Sahara
We cannot fix the fuel crisis or the electricity crisis if we keep pretending the price is something it is not. And we cannot figure out how to restore productivity in our industrial sector, how to maximize employment and capacity utilization, if we are operating a weird economy in which it is easier to import than it is to build the infrastructure and superstructure of productivity growth and development.
Okay, let me use an easier example. Those pre-consolidation banks that did nothing more than arbitrage were acting rationally, because it made more sense in the context of our economy to round-trip than it did to support long-term capital investment. I don't know what the true value of the Naira is, but if it reflects our true economic realities, it will probably be something that exposes the economic and competitive disadvantages of so many of the decisions we make, highlight advantages to changing our prevailing circumstances, and thus compel us to change decision-making that is rational only when supported by distortion (and oil windfalls).
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