Myths about devaluations

THE naira issue has been the topic of debate for a while now. Should we devalue or not? Can we cope with the effect of a devaluation? What happens if we don’t? And so on. The first myth to debunk is the false idea that if you exchange a bigger number for a smaller number then the currency with a bigger number is weaker than the currency with a smaller number. You typically hear people say: “Wow, one dollar is exchanging for 16 rand. The rand is weak. The dollar is strong.” That kind of thinking is faulty mostly because it doesn’t take into account the purchasing power behind the currency.
For example, if an individual living in the US earns 300 dollars a month, then that is technically identical to an individual in South Africa earning 4800 rands a month, given that 1 US dollar exchanges for 16 rands. So long as that exchange rate holds then the rand is not weak or strong, it’s just the rand.
A weak or strong currency is currency that is changing, or that everybody expects to change soon. For example, if the naira changes from 150 to the U.S dollar to 165 to the US dollar, then during the period the change is taking place the naira is relatively weak and the dollar is relatively strong. The same applies if the currency is expected to change soon. If everyone expects the naira to change from 197 per U.S dollar to 300 per US dollar, then the naira is weak relative to the dollar. The weakness persists as long as the expectations about the change persist. If the change eventually happens, the naira moves to 300 to a dollar, and everyone believes that is the end of it, then the naira is no longer weak. It is just the naira.
The second myth to dispel is the idea that a country whose currency weakens consistently over time cannot grow. This could not be further from the truth.
The poster child of why weakening currencies do not imply slow growth is South Korea. South Korea grew its GDP per capita from about 1100 US dollars in 1960 to about 24,500 in 2014. What happened to its currency over the period? In 1960 1 US dollar exchanged for about 63 won. Today 1 US dollar exchanges for almost 1200 won. In short over the period where South Korea has “developed”, its currency has also weakened consistently.
Similar patterns can be seen for some of the other fastest growing economies over the period, such as Chile, Vietnam, and Indonesia. The majority have grown relatively quickly even with weakening currencies. In fact, many countries try to weaken their currencies to boost growth. One of goals of Abenomics, a fancy name for policies implemented by the Japanese Prime Minister, was a devaluation of the yen to boost growth. China was accused for years of artificially weakening its currency. Bottom line, a currency that loses value over time is not the doom it is made out to be.
Devaluation = Uncontrollable Inflation?
The third myth is the idea that devaluations lead to runaway inflation, an idea that is not technically true. To be clear devaluations do lead to inflation but not nearly as much as people think.
For example, the South African rand has devalued by about 40% in the last year yet inflation has ticked up by less than 1 percentage point to 5.2 per cent from 4.4 per cent a year ago. The Russian rubble has devalued by 126 per cent since the middle of 2014 yet inflation has gone from eight per cent in mid-July of 2014 to about 13% today, although it peaked at around 16 per cent. A significant increase, but nowhere near catastrophic.
Finally, the naira lost about 20 per cent of its value between October 2014 and March 2015. Despite the devaluation, inflation, which was about eight per cent then, is still below 10 per cent. If you add the fact that the dollar prices of some of our largest imports, fuel and wheat, have fallen to almost record lows then the inflation worry is minute.
So the reality is, devaluations do cause inflation but not that much. Despite devaluation, the Central Bank still has lots of tools at its disposal to keep inflation in check. Ironically, according to some studies, the black market premium, i.e. the difference between the official exchange rate and the black market exchange rate is a bigger driver of inflation than devaluations.
Does Nigeria have an import problem?
The final myth to bust is the idea that Nigeria has an import problem. You typically hear statements like “How can we be importing everything from toothpicks to fish. It is unsustainable.” Often left out of such statements is the fact that we have a N90tn economy. And you cannot have a N90tn economy that does not import. Is it odd that a N90tn economy would import N100bn worth of building materials or N26bn worth of shoes? No it’s not.
According to comparable data compiled by the World Bank, Nigeria imported only about 12.5 per cent of GDP in 2014. Of the 160 countries for which the World Bank has data available, Nigeria had the lowest imports to GDP ratio. Côte d’Ivoire imported about 38.9 per cent of GDP in 2014, Ghana imported about 48.9 per cent, Mauritius imported about 63 per cent, Belgium about 83.1 per cent and Ireland about 95.4 per cent of GDP.
So according to the data, we do not have an import problem. Even if you assume that 50 per cent of our imports go unrecorded, that still leaves us at a healthy 25 per cent of GDP, which is still not a problem.
However, we do have an export problem, highlighted by the fact that crude oil accounts for 90 per cent of our recorded exports and crude oil prices are volatile. Recognising this key difference between an import problem and an export problem is very important because it determines the kinds of policies that should be implemented. Import substitution policies and policies that look to limit imports probably won’t work because they do nothing to tackle the real problem, which is an export one.
• Obikili holds a Ph.D in economics and works as a researcher and consultant. He has published peer-reviewed articles in various international academic journals and blogs frequently on Nigerian economic issues. Follow him on twitter: @nonso2.

Comments

Popular posts from this blog

HOW TO REGISTER FOR SAFETOKEN

How To Get Help In MMM Nigeria - Mavrodi Mondial Moneybox