UAN as reserve, and burden of naira maintenance

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Media correspondents and the reading public often pose questions on the economy to this column.  My responses to two of such inquiries will form the content of today's piece.  Comments on CBN Governor, Lamido Sanusi's, recent revelation to Reuters

News Agency, of the imminent choice of the Chinese Yuan as part of Nigeria's reserve profile will be followed by this column's observations on recent announcement by CBN Deputy Governor, Finance System Stability, Dr. Kingsley Moghalus that N150bn is expended annually to maintain the naira.

So, we begin with an examination of Sanusi's notice, and implication of having Yuan as part of our reserves, on the Naira and Nigerian economy.

Well, the Reuters report is in keeping with the unfortunate tradition of Nigerian leaders disrespectfully ignoring local in favour of foreign media, for publication of important policy statements!  It is unlikely, for example, to find the Governor of the Bank of England or Chairman of the U.S. Federal Reserve readily providing advance notice of imminent policy changes such as this in the first instance on foreign media.

Central Banks the world over have responsibility for ensuring that a nation's reserves are held in forms, which would protect the value of their savings.  Indeed, every CBN Governor has assured Nigerians of their recognition and awareness of this responsibility, but actual spread of the holdings were never overtly defined, to facilitate evaluation of CBN's choice of instruments.

Nonetheless, the continuous denomination of Nigeria's reserves in dollars over the years may suggest that the intent to diversify was more in lip service than committed action!  Nigerians have suffered tremendous loss in purchasing power of their naira denominated incomes when their realistic expectation was naira appreciation in consonance with rapidly rising dollar reserves.  Thus, for example, we have the paradox of a naira rate of N80=$1 with a paltry reserve base of $4bn in 1996 (i.e. four month's imports cover) and N130=$1 in 2007-8 with a comparatively much heavier reserve base of about $50bn and over 30 month's imports cover!

In addition to this anomaly, naira purchasing value further suffers when other world currencies such as euro, sterling and Chinese Yuan appreciate against dollar;  thus, Nigerian industrialists, who source raw materials from Europe, for example, have to fork out larger naira sums for euro denominated imports, whenever euro rate appreciates against dollar, even though euro FOB prices may not have changed.  So, in view of the distressed state of the U.S. economy, and its large debt burden, one can safely predict that dollar may suffer further loss against other major currencies.  In this event, Nigerians will unwittingly inherit imported inflation because of the naira's direct pegging to the dollar. 

Thus, Sanusi's current decision to adopt Chinese Yuan in our reserves portfolio is an attempt to reduce the extent of the impact of such dollar depreciation on the value of our reserves!   The current strength of the Chinese economy and currency makes Chinese Yuan, an obvious choice for reserve diversification!

On closer examination, however, some critics may consider Sanusi's notice, a non-event, as the Chinese also hold trillions of dollars in bonds and reserves, and it would not be in their interest to witness any significant depreciation in the value of the American greenback!

Indeed, the Chinese may prefer to maintain the relative weakness of Yuan against dollar in order to ensure that Chinese exports remain cheaper!  It is unlikely therefore, that the Chinese would promote a stronger value Yuan and may, in fact, as self interest, actually ensure the Yuan remains at current rates or better still depreciate against the dollar!  If China pursues this obvious strategy, Nigeria will again be the loser, as the Yuan component of our reserves will also lose value!

The problem of naira value is not so much the product of international currency markets as much as the product of a domestic foreign exchange market, which has been consciously skewed against naira by CBN's monopoly of Nigeria's dollar reserves.  So long as CBN maintains this stranglehold on both naira and dollar supply, naira would suffer loss of value with rising dollar reserves and similarly suffer greater value loss with depleting dollar reserves; a case of heads we lose, tails we lose!  It is no surprise, therefore, that in spite of 'debt forgiveness' Nigeria became listed among the world's poorest nations about the same time we had reserves in excess of $50bn in 2006 - 2008!!

As for the way forward, it may now be necessary to consider holding some of our reserves in currently more stable instrument of precious metals such as gold or better still, in investment in rapid infrastructural enhancement.  Indeed, some critics may wonder why we keep relatively huge dollar reserves with little or no yield, while we return to the international capital market to borrow same dollars at rates of up to 7% (e.g. the latest $500m Eurobond).  It is also irrational for CBN to gleefully sell our dollars at face value to bureau de change, while our government borrows dollars at a relatively high cost!  The deindustrialisation of our country is assured by such contradictory policy directions and actions of the monetary authorities.

Lately, CBN's Dr. Moghalus also decried the fact that N150bn is required to produce, store, transport, protect and destroy naira notes!  The question is why is naira maintenance cost so high? 

Well, currencies all over the world have to be maintained as normal course of business; but it is evident that the quality of material of fabrication and velocity of circulation of the currencies would determine the relative cost of maintenance.  Thus, if majority of the population operate outside the normal banking system, this would imply that currency handling  would be more commonplace, and worse still, handling, carriage and storage may be done in unhygienic ambience such that notes quickly become dirty, with rapid wear and tear to make regular replacement inevitable.  In any case, the smaller the purchasing value of currencies, the greater will be the velocity of circulation and consequently, the more rapid would be its deterioration, especially if the material of construction is predominantly paper based.  Incidentally, the more expensive polymer notes have also not fared much better in terms of durability.  

However, it is likely that our currency maintenance cost would be significantly reduced if naira purchasing power was much higher such that primary kobo coins become relevant once again.  As it is, the increasingly worthless value of naira denominations has driven the kobo coins out of the market and their roles have been replaced by more fragile currency forms!

A related question often asked is whether or not high cost of maintenance also affects naira value, government debt, interest rate, trade deficits and economic growth?   The answer is that currency forms are not directly affected by these factors, but currency purchasing power (value) could be impacted by these variables.

However, the most significant factor influencing currency value is inflation!  Thus, with abiding inflation over the years, the once almighty 'Muri'  note (N20) with its 'awesome purchasing power', when it was first introduced some thirty years ago, can today, only purchase  what possibly ten kobo used to buy at that time!  The steady inflationary spiral necessitated bigger and bigger denominations until the advent of N1,000 note, which currently buys less than the N20 Muri note on introduction.  In the event that the CBN has also decried the increasing cost of cash handling operations by the commercial banks, (over N300bn/year), the revelation of an additional N150bn CBN maintenance cost brings the estimated total cost of cash maintenance to close to almost N500bn (over 10% of the 2011 budget). 

CBN altruistically hopes to reduce this huge cost with its cashless programme and limits to cash withdrawals.  Ultimately, CBN may inevitably introduce N2000, N5000 and N10000 notes as naira purchasing power continues to dwindle, thus inadvertently increasing the velocity of circulation and propensity to rapid deterioration of the paper and polymer notes currently in circulation.

We should be asking questions on the total cost of the attempt to put primary coins back in the profile during Soludo's tenure, and how much was spent to promote acceptance; why were the coins rejected by the public ab initio, and why did banks disobey CBN's directive to keep certain percentage of their funds and payments as coins?!  That exercise was a significant drain on the nation's revenue, but sadly, no one has been held accountable for such recklessness.

However, in view of the preceding, what can be done to reduce cost of currency maintenance?  Frankly, the rigmarole on the naira profile will continue until the managers of our economy recognize the concept of value in the sustainability of an appropriate cost-effective currency profile.  If the authorities adopt the strategy of higher denomination profile, the end of that road will never be in sight, as N1 million note may be required and regrettably, this note value may not buy what the current N1000 can command.  Incidentally, billions of naira were expended to modernize and improve the capacity of the Nigerian mint during Soludo's tenure.  CBN assured that new improved mint could meet close to 80% of Nigeria's currency requirements, with the possibility of producing currencies for third party West African neighbours.  Obviously, on hindsight, these were empty promises; it would be of interest to know the cost trends for naira maintenance in the last three decades!

But having said that, what is the way forward for the Nigerian economy?  This would be to tame inflation to below, say, 5%.  However, I recognize that this will remain impossible with the ever-present plague of excess liquidity consciously created by CBN's capture of our dollar revenue and substitution of humongous naira sums every month.  The scourge of excess liquidity will make it impossible for lending rates to come down to benevolent lower single digit.  If CBN bows to superior argument and adopts the instrument of dollar certificates for payment of dollar component of monthly allocations, the ever-present ghost of excess liquidity will be laid to rest; interest rates will fall drastically, inflation would be reined and naira value would begin to appreciate.  The currency profile can further be consolidated to accommodate primary kobo coins with a redenomination of naira such that the highest naira note would once again be N100.  In this context, hard wearing primary kobo coins would do what they are supposed to do and neither poor handling nor increased velocity would deteriorate their quality or reduce their acceptability as they would command more value than the current range of N10, N20, N50, N100, N200 and N500 notes, and the cost of currency maintenance for both CBN and the commercial banks would be greatly reduced.