Put this way, the call for the naira’s float is not a “solution” to our economy’s myriad problems. It simply removes an existing obstacle to the proper management of the economy.
I could not conceive of a better opening for this piece than the following fable.
A colleague (we will call him “Abu-Bakr” for convenience) is informed that he has won US$50 million in a lottery operating out of the United Kingdom. “Terms and conditions apply”, so the operators of the lottery let him know that he is permitted to manage this windfall only out of banks in any of two jurisdictions ― the United Kingdom or China.
Were you working off our protagonist’s vantage, which would you choose (the answer is key to unravelling the moral of this allegory)?
Of course, for the point of this narrative, Abu chooses to keep his money in London, and not Beijing.
The question “Why would this be the proper choice?” jumps straight at you. Everyone knows that China is a bigger, much bigger, economy (estimated at US$19.51 trillion in 2015 purchasing power parity numbers) than the UK is (2015 estimate using the PPP arithmetic equal to US$2.66 trillion). Besides, its foreign exchange reserves — the backstop to all claims on its assets by non-resident actors — at US$3.22 trillion (as at end-April 2016) easily dwarfs that of the United Kingdom, which stood at US$144.98 billion in the same month.
On the back of these numbers, the Chinese economy represents a much better deal than does the UK’s, it does simply guarantee that whenever I want my money, it ought to be available.
Nevertheless, the “why?” around a preference for financial services operating out of London over ones operating out of Beijing is readily answered. At bottom, the choice as to where to warehouse financial assets between a bank deposit in China and one in the UK is essentially one over the appropriateness of the respective governance arrangements behind both the pound sterling and the yuan. A vote, as it were, for the policies of the Bank of England and the People’s Bank of China, respectively.
A currency’s exchange rate is thus not simply the result of the export potential of the economy behind the currency, or the economy’s import appetite. Nor is it simply the result of demand and supply imbalances in the market for foreign exchange. However, in our case all of these variables have invited considerable attention.
Despite the relative size of the Chinese economy, concerns in the market about how the central bank in China intervenes on behalf of the yuan as part of the Chinese Communist Party’s vision of where its economy is headed means that the markets will constantly second-guess that currency’s trajectory. Pound sterling, on the other hand, has a Bank of England whose policy intent and trajectory is not only clear, but also regularly communicated to the markets. Indeed, procedure has the governor explaining to parliament each time he over- or undershoots the prevailing target for domestic price movements.
A currency’s exchange rate is thus not simply the result of the export potential of the economy behind the currency, or the economy’s import appetite. Nor is it simply the result of demand and supply imbalances in the market for foreign exchange. However, in our case all of these variables have invited considerable attention.
However, in the hubbub surrounding how a fast depreciating naira has fed-through to rising domestic prices, we can do no worse than constantly remind ourselves that the exchange rate of the naira also functions as a price. Arguably, one of the more important prices in an economy. Moreover, in this role it allocates scarce resources between competing needs. As price, it also sends signals to the managers of the economy on the respective preferences of domestic economic units.
This latter role is where the monetary policy function comes in: first, it must try to understand the price signals. After which, it must respond to the signals by designing and implementing policies that either leverage the advantages from a weak currency, or contain the negatives from a strong currency. Why is it important that a central bank has legal and administrative (if not goal) independence in pursuit of this? Because the political cycle (four years in our case) conduces to potentially inflationary spending by the end of the third year, when all attention is focused on the incumbent government’s desire to be re-elected.
An independent central bank, especially, one whose governor’s tenure overlaps that of the executive is uniquely placed to dampen this fiscal exuberance. Of course, the rationality of a central bank thus placed is helped when it also has an independent rate-setting committee in place, whose members are knowledgeable enough about the economy to call policy correctly most of the time.
It is in this context that we ought to be discussing the narrative that invites us to “float” the naira. This way we get a price that allocates our scarce resources more efficiently than the current structure where a committee of the great and good choose “critical sectors” of the economy to which to allocate scarce FX. Then we also have a price system, which signals to the country what the policy options are that we need to undertake as an economy.
Put this way, the call for the naira’s float is not a “solution” to our economy’s myriad problems. It simply removes an existing obstacle to the proper management of the economy.
Ifeanyi Uddin, journalist manqué and retired civil servant, can be reached @IfeanyiUddin.
