The Falling Oil Price, The Naira, Nigeria And The CBN

Oil accounts for about 83% of our exports and is the biggest source of the federal government's revenue. And now that the global oil price has been falling fast we would soon be broke -- unable to fund our planned expenses and, soon, our necessary expenses. It's same as when your salary suddenly get slashed.

image: sweetcrudereports.com

And that is not the end of the trouble the falling oil price is causing us. As a country, two forces control our exchange rate -- the CBN pegs at a range and the demand - supply pull forces CBN to keep shifting that range. The biggest source of demand for our currency is our oil export and now that oil price has fallen while the amount of oil we export has not changed, the total dollar amount we get for the same amount of oil has now drastically reduced. Translating to a weak demand for our currency. So at the foreign exchange market the amount of dollars being exchanged to Naira is no longer at equilibrium with the amount of Naira being exchanged for dollars. And as we all learned in secondary school economics, when demand drops at the same level of supply, price has to drop. And that is what has been happening to the Naira. The demand for Naira has suddenly dropped big time while the Ladipo and computer village guys are still putting up the same supply of Naira to import their wares. The natural thing that will happen is the rate of dollar to Naira will increase, and do so until some of the importers can't bear it and reduce their supply of Naira in the foreign exchange market.But this doesn't happen as drastically as the sudden jump from N155/$ to N168/$ the CBN caused in less than 24hours. 

That is the demand - supply part. Lets now talk about the CBN part. Nigeria is one of the countries that doesn't let its currency float freely. Meaning we don't let just demand and supply dictate the exchange rate of our currency. We operate a foreign exchange system called managed float. We try to influence the exchange rate by using our foreign exchange reserve to generate artificial demand and supply. When the dollar is appreciating fast against the Naira, the CBN takes our foreign exchange reserve which is in dollars and sells some to buy up Naira, creating artificial demand for Naira and mopping up the excess supply of Naira. And when it has overdone this or for some other reason the Naira is appreciating fast against the dollar, the CBN buys dollars to increase the foreign exchange reserve and increasing the demand for dollar. And this is how the CBN tinker with the exchange rate.

Currently in Nigeria, falling oil price has reduced the supply of dollars (via export) and our federal income (money available for our politicians to waste) without a corresponding reduction in the demand for dollars (for import). The market force (demand - supply pull) is weakening the naira against the dollar, and the CBN has suddenly realized that the foreign exchange reserve cannot help as it's now small (due to overuse in keeping the dollar rate artificially low over the years and funding our gluttonous government). So it's taking an ingenious step that will improve our federal income and pretend to try to not let the Naira fall further. It devalued the Naira rather than let the market forces slowly find the new equilibrium price for our exchange rate. This will increase the value of each oil dollar. It is now trying hard to discourage the hardworking businessmen in Ladipo and Computer village from importing goods. The CBN has made it harder for banks to borrow businesses money (so as to reduce the amount they have to spend on importing) and also put in place draconian procedures to follow before your business foreign exchange transactions will be approved. The CBN is doing this with the ostensible reason of preventing speculators from taking over the demand - supply lever.

Unfortunately, the CBN is frustrating the wrong people. It's the politicians who are stifling the economic growth of the country, instituting life pension for their entire family, gulping more than half of the country's income and buying dollars to bribe their fellow politicians. It's obvious that the CBN can't do anything about them, directly. But I believe that if the CBN will leave the hardworking businessmen alone, let the banks be and let the exchange rate float freely, we would be better for it. The government will be denied of the money it does not deserve and the politicians will have to sweat some more for the money they will waste on electioneering. And most importantly our real economy and entrepreneurs will not suffer for the problem they did not cause.

Change is inevitable in life. Oil prices will not forever be high. In fact, a time will come when the world would not consume oil anymore. The falling oil price should be a wake up call for us to focus on fixing the structural problems that keep putting us at the mercy of a commodity we have no control over. The CBN should not use it as an opportunity to make life unbearable for banks and businesses. It should let the politicians and gluttons in power have a feel of what it means to be broke.