So picture an account, call it current account, and one side of the current account label it “Debit”, on the other side of the scale label “credit. “So“Debit” are Imports and Payments made, Credits” are Exports and Payments received….got the picture?
Now under the current accounts, create another account called “Foreign reserves”
Then Under the “foreign reserves” account put a the Naira to USD exchange rate…
Ok here is the relationship, when you import or the FGN makes payments like paying Joint Venture cash calls, you debit your current account, however when you export or earn receive payments like taxes, you credit your current account. Let’s assume you have a net credit or current account surplus, ok.….
Ok that current account surplusthen flow into the Nigeria’s foreign reserves. So when we sell crude oil, it’s an Export, a payment received. We net-off say imports of cars, an import, a payment made, and get a balance, that current account balance goes and sits in the foreign reserves.
Remember we sell oil in US Dollars and pay for car imports also in US dollars, thus what hits the reserves are dollars.
Now the Central Bank of Nigeria as the nation’s bankers manage the foreign reserves. “The Federation”, Federal Government, State and Local Government have a sharing formula for the US Dollar in the foreign accounti.e. the net or exports and imports. When they want the money, CBN gives them Naira, and retains the US Dollars. Thus the dollars from the net of exports and imports is retained by CBN and now owned by the CBN, the states get Naira and is shared via FAAC or ECA.
So as you can deduce, if exports go up, foreignreserves goes up, if imports goes up, foreign reserves goes down… (I am being simplistic)
Now to exchange rate, when we sell oil, we are paid in dollars, but when we import we are spending those dollars also. So if we export more than we import, we get more US Dollars and thus there is less pressure on the US Dollar, but if we import more, we need more US Dollars, this puts pressure on the dollars reserves. So again we see, imports means more US Dollars is needed to fundpayments for import.
So to make Naira rise in value, one way is to reduce imports (or increase exports), because that means less dollars to import got it? (I am being simplistic)
So we now see a relationship developing…
More exports means we earn US Dollars, US Dollar reserves rise, the US Dollar falls and Naira rises.
More imports means we spend US Dollars, US Dollar reserves fall, the US Dollar rises and Naira falls.
So does Nigeria export more than she imports? The answer is we yes, we export more. We have a current account surplus i.e. we have exported more than we have imported. However the problem is we have a positive current account for years because we have relied on one main export commodity, crude oil. Yes non-oil exports are rising but crude oil has guaranteed a positive balance of trade.
So remember or relationship…”More (oil) exports means US Dollar reserves rise, the US Dollar falls and Naira rises, “
So what happens if oil prices fall?
Well if oil prices fall, and we export same quantity of oil, then our revenues from oil will shrink. With less US dollars in Foreign Reserves, the US Dollar demand rises and Naira falls….which is exactly what has been happening recently…… $1 to N230, our foreign reserves down. In fact, Nigeria is projected to post her first current account deficit in nearly 20 years, according to UK-based global research engine, Economist Intelligence Unit (EIU).That why CBN is seeking to curb a fall in the foreignreservesand fall in Nairaby banning many items from the CBN funded US Dollar market.
The projection now is that dollar demand will rise, and this will reduce value of Naira, thus as imports come in they are more likely to cause imported inflation.
So what should we do?
1. Expedite the process of stopping petrol imports by increasing local refining of petrol. The available data from the Bureau of Statistics indicates that fuel accounts for over 40%of Nigeria’s total foreign exchange expenditure on imports annually, one commodity 40%!Wehave not added rice yet. Pass the PIB so that more investors can enter the downstream sectors, build small modular refineries to refine petrol locally. The problem with the petrol subsidy is that the petrol is imported, not the subsidy itself. So if we stop importing fuel, the value of our currency will rise in relation to the US dollar.
2. Literally ban imports as much as possible, especially thing we can make here, soaps, food, not to forget toothpicks. Don’t just ban, go to the local manufactures of soaps, food and toothpick and give then incentives to drop their cost of production to enable them compete with foreign imports, eg pay them 100% rebate for their cost of diesel, offer then Export Expansion Grants. The goal is to make sure a locally made bar of soap is half the price of an imported soap.
3. Push non-oil exports aggressively…especially agriculture process. It’s not easy but it’s necessary.
4. Expand the tax base, diversify government away from sharing oil income.
5. Make it far easier for Nigerian to receive remittances from abroad. This will reduce pressure on CBN funds. Remittances to Nigeria from abroad in 2014 was $21b, far more than FDI and even what the federation shares from oil sales. If Nigeri a can allows that fund to flow freely in, then more will come.
6. Attract more Foreign Direct Investment and Foreign Portfolio Investment, we have the market, we speak English, we are nearer to Europe and America than Asia. We need to be aggressive and offer incentives to companies to come to Nigeria and invest. One way is to progressively work to improve our score on the “Doing Business in Nigeria” index and eliminating multiple taxations, a company like MTN pays “levies” to Local, state government and Federal governments plus two compering regulators just to set up a telecom mast.
7. Consider devaluation, I must say this is a last option and advise given grudgingly but the Naira moves in correlation to the Oil price, if oil prices have fallen then Naira seems overvalued, according to the BusinessDay, Nigeria had spent till date, a total of $3.4billion to “defend” the naira since February 2015 when it officially devalued the currency…….Think of what $3.4b can do in Education.
In Summary, Nigeria is simply paying the price for overdependence on one main forex generating export. The policy of “get oil, sell oil, share oil has to stop”…we should replace it with“get oil, sell oil, pay 10% of gross sales to Sovereign Wealth Fund, then share oil money”. The drop in oil prices creates a large deficit because we have no other savings or forex generator
It’s our problem, we can fix it…
Mr Kalu Aja is a financial planner…he currently leads a Private Equity firm based in Abuja where he writes from.
Read: Breaking News