IMF and the limits of forex reform
by Uche Uwaleke
January 18, 2017 | 12:27 am| | | Start Conversation
In its policy paper on ‘’macroeconomic developments and prospects in low-income developing countries- 2016’’ released on 12 January 2017, the International Monetary Fund described as ‘domestic policy failure’ the current efforts by the Central Bank of Nigeria to manage scarce foreign exchange urging the monetary authority to discontinue forex rationing and improve on its ‘poorly managed policy adjustment to lower commodity prices’.
As a matter of fact, this is not the first time the IMF would be calling on the government of Nigeria to move towards market determined exchange rate as a panacea to the country’s recent currency crisis. Following the sharp decline in oil prices in the second half of 2014 which resulted in significant erosion of export earnings, widening fiscal imbalances and depletion of foreign reserves, the CBN had in November 2014 adjusted the official foreign exchange rate and band. This move, which in effect saw the local currency devalued from N155/$1 to N168/$1, was hailed by the Fund as a ‘bold policy action’ in a statement by its Executive Director for Nigeria following 2014 Article IV consultation. The statement equally added that ‘as the oil price fall appears more permanent than temporary, additional policies will be needed, including greater flexibility in the exchange rate’. In February 2015, barely three months after the naira was devalued, the CBN accommodated further – cancelling its dollar auctions and targeted a new fixed exchange rate of N197/$1.
The forex crisis persisted even after the second round of devaluation leaving the CBN with very little options which included the use of capital controls and forex rationing. In response, senior IMF officials, including Managing Director Christine Lagarde, urged Nigerian government to allow the naira to fall to absorb some of the shock to the economy from a plunge in oil revenues.
In March, 2016, the Executive Board of the IMF concluded the Article IV Consultation with Nigeria and ‘underscored the need for credible adjustment to the large terms-of-trade shock, including through greater exchange rate flexibility and speedy unwinding of exchange restrictions to facilitate an exchange rate consistent with fundamentals’. The position of the IMF was further stressed in a statement by Christine Lagarde during her visit to Nigeria in which she urged the government to increase the VAT rate, ‘manage the cost of fuel subsidies’ and adopt flexible exchange rate policy. Apparently, this advice was heeded because shortly after her visit, the CBN announced it was abandoning its currency peg for a flexible exchange rate policy. The Fund applauded this decision saying it was necessary to reduce fiscal and external imbalance. Its Director of Communications Gerry Rice described the measure as a ‘significant macroeconomic adjustment that Nigeria urgently needs to eliminate existing imbalances and support the competitiveness of the economy’.
This latest forex policy was aimed in part at tackling the widening gap between the official and parallel market rates with a view to discouraging arbitrage and round tripping. Unfortunately, this objective has not materialized as the official rate still lags the parallel rate by a wide margin. The Fund reasons that by implementing a complete float, the true value of the naira will emerge leading to the convergence of the official and parallel market rates. Again, Nigeria has a peculiar case: even if floating solves the problem of multiple pricing and arbitrage; it does not address the liquidity challenge. Because the country imports fuel, raw materials, food and virtually everything, commodity prices will hit the roofs from pass-through effect of high exchange rate and the CBN will be compelled to further tighten monetary policy. Granted that government revenue will increase from the naira value of oil exports, but the cost of servicing government’s huge domestic debt will also surge following increased yields on government securities. What is more, huge sums will be needed to implement capital expenditure contained in the 2017 budget which are dollar-dependent. So, in the final analysis it is nothing but a zero sum gain.
On this overarching issue of the IMF-induced currency floating, the case of Egypt comes readily to mind. Following similar currency crisis in Egypt, the IMF mounted pressure on the government of President Abdel Fattah al-Sisi to implement austerity measures and financial reforms including cuts to fuel subsidies, the application of a new Value Added Tax (VAT) and the floating of the Egyptian pound as pre-condition for accessing a $12 billion loan. On 3 November 2016, the government caved in by floating the Egyptian pound. The flotation helped Egypt obtain a $12 billion, three-year loan from the Fund out of which $2.75 billion was immediately made available. Expectedly, Egypt’s foreign reserves jumped to $23.1 billion at the end of November 2016 from $19.1 billion a month earlier according to the Central Bank of Egypt (CBE). Although, the gap between the official and parallel market rates narrowed considerably, it was at a very high price: from a pegged exchange rate that had the Egyptian pound officially trading at EGP8.8 to the dollar, the pound bled so much that a few days after its floatation, it officially traded at EGP17.8 per dollar compared to EGP17.98 per dollar in the parallel market. A report by Bloomberg named the Egyptian pound as Africa’s worst performing currency in 2016 chiefly because ‘the nation took the dramatic step of allowing it to trade freely in an attempt to stabilise an economy struggling with a dollar shortage’.
The floatation also brought in its wake high inflation and interest rates. According to the CBE, the Consumer Price Index (CPI) reported by the Central Agency for Public Mobilization and Statistics (CAPMAS) registered an annual increase of 19.43% in November, compared to 13.56% in October, the highest annual inflation rate in nearly a decade. The Monetary Policy Committee affiliated with the CBE had increased the prices of basic yield (which is the leading indicator for the direction of interest rates on the Egyptian pound in the local market) by 3% on 3 November, along with the CBE’s decision to float the pound which saw lending rates spike from 10.25% to 15.75%. There were also other challenges, such as the investors’ problem with banks demanding that they pay for the exchange rate gap before and after the flotation from letters of credit issued to cover imports.
The takeaway from the Egypt experience is that a currency float comes with adverse consequences the severity of which depends on the state of a country’s economy. The relatively diversified economy of Egypt and the IMF support facility is helping to cushion the destabilizing effects. The defective structure of the Nigerian economy and the fact that the country is not seeking any loan from the IMF should make floatation a scary option for the CBN. The IMF should realize that a model that works for Egypt may not find application in Nigeria. The Fund’s one-size-fits-all recipe has often been criticized not least because it is without consideration for local factors. The results have often been damage to the economy rather than recovery.
The Nigerian economy is import-dependent with very little non-oil exports. This is the crux of the matter and currency free float will not change this narrative. Therefore, any attempt to leave the exchange rate completely to market forces will spell doom for an Economy already bleeding from all sides. Rather than recommend market determined exchange rate for an economy struggling to exit a recession, the IMF can assist the country’s diversification effort by making Nigeria an unconditional beneficiary of its zero interest rate concessional facility for low-income countries which the Fund announced during the IMF/ World Bank 2016 General Meeting in Washington, United States. Indeed, there is a limit to forex reform a haemorrhaging economy can accommodate.
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