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By Babajide Komolafe
Foreign exchange end-users may pay more naira per dollar in 2011. It all depends mostly on  two factors namely the  stock of foreign exchange available to the country i.e  the level of  foreign reserves and how much the three tiers of government spends or decides to spend this year.

In 2010, despite falling  foreign  reserves, the naira enjoyed relative stability.  And  foreign exchange end-users did not have to pay much  more to obtain one dollar  than they did in 2009. The external reserves fell by 23 per cent to $32.4 billion from $42.4 in 2009.

The naira however remained stable within the -/+3 per cent band. With the exception of September, the official exchange rate did not go above the N150 per dollar mark, while the interbank market rate, except for September and end of December did not go beyond N155  per dollar mark.  This stability is however courtesy of  the policy of stable exchange rate of  the  Central Bank of Nigeria (CBN).

Analysts  argued  that the exchange rate of the naira should have reflected the decline in reserves. They criticized the  apex bank   for not allowing the naira to depreciate to reflect the level of external reserves. They averred that the apex bank was defending the naira at the expense of the external reserves.

This view was supported by the International Monetary Fund (IMF) mission to Nigeria in November. In a statement issued at the end of the mission,  Head of  the  IMF mission, Mr.  Scott Rogers said, 'International reserves continue to fall as the authorities support the exchange rate.'

Indeed the stability of the naira was largely due to the support of the apex bank. The CBN Governor, defended this position in July during an interview with Reuters at the 10th International Economic Forum on Africa in held in Paris. He said,  'Maintaining exchange rate stability in a time of growing global uncertainty was imperative,'  Then the  reserves had fallen by 13 per cent.

This position was however strongly criticized by analysts at Financial Derivatives Limited. In the July monthly economic report of the company they  warned  that, ' CBN's commitment of supporting the naira at any cost is having undesired effect of depleting external reserves.'

'Maintaining currency stability at all cost implies more frequent intervention in the foreign exchange market by the CBN in a bid to defend the naira at the expense of building the foreign reserves,' they averred.

The company further warned that the action of the CBN  would  occasion speculative attack on the naira i.e that people will purchase dollar for the purpose of hoarding in anticipation of sharp depreciation of the naira.

''In recent weeks, demand pressure in the forex market has amplified. A look at activities at the WDAS auction in May show that forex demand grew by 66 per cent to $3.2bn, compared to the preceding month. Most of the growth in demand for forex was speculative as the Naira continues to come under huge pressure in the parallel market.

'The spread between parallel and official rates is widening to levels last seen in December 2009 and early January 2010.'

'If this pressure persists, and we expect it to, then the nation's forex reserves could deplete faster than the CBN anticipates.  'The market will see this as a sign of weakness and an un-sustainable defense of the Naira. This will lead to a further increase in currency speculation,' they predicted.

And their prediction came to pass with chilling precision. The following month in August, foreign exchange demand rose by 55 per cent, and in September it rose again by 75 per cent. In order to save the naira, the apex bank equally increased forex supply by 19 per cent and 115 per cent respectively. This caused  the external reserves to drop by 1.4 per cent in August and 5.89 per cent in September.

While foreign exchange operators attributed this sudden jump in demand to speculation prompted by apprehension over the value of the naira, the apex bank had a contrary opinion.

In the communiqué issued at the end of its Monetary Policy Committee meeting on September 30th, the apex bank said, 'The MPC observed that the large demand for foreign exchange noticed during  the review period resulted from among others, remittance of dividends by some companies and enhanced importation of refined petroleum products due to the Federal Government sovereign debt instruments. Thus there was no evidence of speculative demand or capital flight observed in the foreign exchange market.

But in October, the CBN governor, Mallam Lamido Sanusi indicated that the depletion in external reserves is becoming a source of worry to the apex bank and that the policy of defending the naira might be suspended.

In an interview with Reuters Insider on the sidelines of the Annual meetings of IMF/World Bank board of Governors in Washington, he said, 'The current exchange rate is not a level that needs to be maintained at all costs.  My own view is that exchange rates have multiple equilibria, and equilibrium exchange rates will depend on what we see as the long-term sustainability of the reserve positions.'

He said, 'We do believe we can maintain this range (of exchange rate),' but added that replenishing the reserve level will depend to a significant degree on the level of spending by the government.

The implication of Sanusi's statement is that should the reserves continue to fall due to spending by government, the apex bank will have no option that to allow the naira depreciate.

However,  Opeyemi Agbaje, Managing Director/Chief Executive Resources and Trust Company Limited, avvered that allowing the naira to depreciate is the key to compelling government to curtail spending. '. At the very least, I think the exchange rate should have been mirroring the rate of depletion of foreign  reserves. That would have been sound policy as it would have signaled to policy makers the need to curtail spending', he said, adding that,  'Depreciating the currency would have passed the cost to those (governments) spending rather than the treasury.

He maintained that by defending the naira while the reserves was falling, the apex bank only subsidized consumption and fiscal indiscipline.

Mrs. Razia Khan of Standard Chartered Bank however did not share the view that the current exchange rate of the naira does not reflect the level of external reserves or that the CBN is running down the reserves to defend the naira. In her view, excessive government spending culminating to monetization of the excess crude account component of the reserves is responsible for the decline in external reserves.

In an email response to Vanguard, she said, 'The current exchange rate - whether  we are looking at the CBN rate or the interbank rate -more or less reflects market forces, so yes - it does reflect the 'reality' of external reserves.  There is no huge parallel market for wholesale buyers of foreign exchange,  so one cannot argue that the current exchange rate is in any way inconsistent with economic reality.

The CBN has not been running down the reserves to defend the  naira. This seems to be a highly-flawed interpretation of recent events. Foreign  reserves are not higher because Nigeria has not been accumulating  foreign  reserves as rapidly in the past.

There isn't sufficient evidence of a consistent, sustained spike in demand for foreign exchange rate that would suggest that reserves have fallen only because the CBN has been supporting a steady naira policy.  With oil production at its most favourable level since 2006, and with oil prices back above $90 per barrel, the issue is why reserves have not risen further, not why they have 'fallen'.

Every time a disbursement was made from the excess crude account to the three tiers of government, the  foreign reserves component would have been whittled down.  This suggests that  Nigeria 's problems have more to do with excessive spending, than any attempt to maintain  foreign exchange rate stability.'

Let us not forget that with the US and other major economies printing money (implementing quantitative easing) to stimulate their economies, the USD and other major currencies have depreciated against many emerging market economies with strong growth prospects, where comfortable current account surpluses are in place.  So the question really needs to be, why is Nigeria the exception to this general rule? The reasons have little to do with CBN FX policy - the root causes run deeper than that.'

The import of these is that government spending will largely determine the level of reserves and by extension the fate of the naira in 2011. With government spending expected to rise especially in the first half of the year, owing to spending occasioned by the general election, only a sharp rise in crude oil prices, maybe above $110 per barrel, will save the external reserves and also the naira from going down.