What Is The Real Meaning Of The Proposed Re-Denomination Of The Naira?

By

Ibrahim Umaru

iumaru@yahoo.com

 

Professor Chukwuma Soludo, the Chairman, Central Bank of Nigeria on Tuesday August 14, 2007 launched the strategic plan for the re-denomination of the nation’s currency. The two key components of the plan are: (a) the Naira will revert to its pre-1986 level of about one Naira, twenty-five Kobo to one United states (US) dollar (N1.25 = US $1); and (b) the highest denomination, which is N1, 000.00 now, will be N20.00 as from August next year.

 

Citing Germany and other Latin American countries as well as Ghana as models where such a policy was introduced and successful, the CBN Chairman stated that the Nigerian economy stands to reap tremendous benefits from the proposed plan, especially in the short-run and medium term. Proponents of the proposed policy identify the following as some of the key advantages: (a) the easy exchange of currencies or the convertibility of the Naira, and/or the dollarization of the domestic economy; (b) stable and reliable exchange rate regime in the long-run; (c) expansion of scope of activities on the capital side of foreign trade balance sheet, the balance of payments (BOP); (d) reduce the cost of printing and minting of Naira and coins in the long-run as fewer denominations would now be available; (e) reduce the cumbersome nature of handling currency notes by encouraging sophisticated means of payments such as plastic money (for example Visa card, Mastercard, Fastcash and other local credit cards) and wire/electronic transfers; and (f) promote exports (especially of non-oil exports) as Nigerian goods would become cheaper and attractive to foreigners.

 

Though proponents of the proposed plan recognize its probable negative effects such as disincentive to foreign investors, capital losses to holders of instruments in the capital market, increase in the cost of printing the new currency especially in the short-run, temporary increase in prices due to shocks in adjusting to the new regime and confusion on the side of the unenlightened populace, they nevertheless maintain that its overall benefits would outweigh the disadvantages.

 

It has been alleged that for Professor Soludo to have proposed the plan after rejecting same when it was presented to him by a team of independent economic experts over two years ago, there is more to the plan than he is presenting to the public. Besides, the proposed plan has since Tuesday 14 came under a barrage of criticisms from no less prominent economists than Professor Ibrahim Ayagi, Chief Olu Falae and Dr. Kalu Idika Kalu. The arguments for and criticisms of the proposed policy, against the backdrop of sketchy details made available by the CBN seem to have created an atmosphere of confusion over the true meaning, economic underpinnings and probable consequences of the plan.

 

In this piece, we explore these issues with the aim to unravel the logic, inner mechanisms and identify the channels through which the policy will impact on the economy and society. Understanding of the real meaning of the twin policy being planned by the CBN requires an explanation of the inner logic of the principle of money and its value in exchange; the knowledge that the policy of redenomination of Naira and the exchange rate are two sides the same coin; and that the two are not only inseparable but work hand-in-hand; that the inner logic of each of them cannot be comprehended without a proper understanding of the other; that the implications for the economy of Naira redenomination within the Nigerian context cannot be fully appreciated without understanding the corresponding effect of the policy on exchange rate. 

 

To provide rationale for the re-denomination plan, Professor Soludo argued that the proposals were to strengthen the Naira in preparation to it becoming West African currency of choice; and as a necessary consequence of the progress recorded so far with the other reforms as well as the relative stability in the economy. Put differently, the proposed plan is intended to reposition the Naira in line with its expected role in the West African Monetary Union (WAMU) coming into effect soon, as well as that of the Nigerian economy in the West African Economic Community (ECOWAS).

 

However, an in-depth examination would reveal that the overall goal of the proposed plan might not be far from the pursuit of Nigeria’s economic interest in Africa anchored on the ambition of the immediate past government which aims at repositioning the country as one of the top twenty (20) leading economies in the world by the year 2015. Translating this ambition into its economic terms, one can say that the ultimate goal of the policy is the promotion of export (particularly non-oil exports) growth, often regarded as a sine qua non, using Africa and especially the West African sub-region as the launch pad. Indeed, it is the belief of the promoters of this proposed plan that such an ambitious project cannot be realized without putting the Naira on a sound pedestal as a player in a kind of international monetary system dominated by the powerful currencies such as the dollar, pound and euro.  

 

An interesting feature of the current debate on the proposed plan is the use of several nomenclatures in describing its economic logic. Whereas commentators like Chief Olu Falae, Dr. Ike Abugu of the National Association of Small and Medium Enterprises (SMEs) and Mr. Lai Mohammed (the Action Congress Publicity Secretary) refer to it as mere ‘decimalization’ which translate to nothing more than ‘a mere joggling of figures’; others see it as the ‘revaluation’ of the currency which portends good as well as danger for the economy. These divergent interpretations of the proposals have further fuelled the ambers of confusion over the issue. Curiously, the CBN has maintained a cautious use of the term ‘redenomination’ to describe the proposed plan. To understand the real meaning of redenomination, we start with the fundamentals of money as an economic phenomenon.

 

Money and its use emerged out of the fact people in modern economies need a convenient, safe and appropriate medium to facilitate the exchange of goods and services among themselves. It also serves as common denomination of the value of items and an appropriate store of their values. However, for it to be acceptable generally as a medium of exchange, measure and store of value, it has to be backed by law or institutional approval. Once passed by law (through a decree or act of parliament) as money (legal tender), the central bank being the apex financial institution is vested with the authority to print/mint, circulate and regulate its supply and help stabilize its value over time. Interestingly, it has been observed for long that its value can change over time; at some time it appreciates in value, and at other it depreciates. In order to understand the dynamics of the value of money, a distinction is often drawn between it nominal value and its real value. Nominal value is the face value of money which does not change with time. For example the nominal values of twenty (20) and one thousand naira notes are N20 and N1, 000, respectively. As far as the law and holders of these currencies are concerned, the N20 and N1, 000 notes held by different people yesterday, today and tomorrow are the same. Their nominal values can only change when the law expressly states that or when the monetary authority (the central bank) based on the powers vested in it decides to alter them.

 

On the other hand, real value of money is what money is worth in terms of goods and services. Due to the fact a particular quantity of money has the ability to command or exchange for certain good or/and service, this essential quality of it (real value) is often referred to as its purchasing power. It also goes without saying that money is worth some goods or/and services any time and at a particular place. The fact that N20 or N1,000 could buy certain amount of goods or/and services today, does not guarantee the holder that it will command or enable him purchase exactly the same amount of the same good or/and services next year, due to the possibility of changes in their price(s). This essential characteristic (real value) of money is what is sometimes referred to in economic parlance as the time value of money.

 

It is important to stress the point that at all times there exists a definite relationship (fixed ratio) between money and price of a good or/and service. This is important because for money to command or exchange for a good or/and service, there ought to a mutual agreement, between the holder (owner) of money and the holder (owner) of the good or/and service, that the value of money is equal to the price of the good or/and service. In practical terms, the real value of money is computed as the ratio between nominal value of money and the index of change in the price level of good or/and service at any point in time and at a particular place. Arising from this principle are interesting natural or logical results or consequences, especially when we shift our focus to the dynamics of money and its value in exchange and its resultant implications for the economy. To illustrate the effect of that on the real value of money, let us assume that that real value of the highest currency in August 2007 (N1, 000) is N1, 000. Likewise the real value of the highest denomination (N20) in August 2008, when the proposed policy would have been introduced will be (N20) as it will be the base period in the era of the new monetary regime.

 

The dynamics of money and exchange presents four possible scenarios:

 

Scenario 1: Nominal value of money remains constant (or unchanged); and price (and price level) of good or/and service remains unchanged between two or more periods.

Scenario 2: Nominal value of money remains constant (or unchanged); while price (and price level) of good or/and service changes (increases or decreases) between two or more periods.

Scenario 3: Nominal value of money changes (increases or decreases); while price (and price level) of good or/and service remains constant (or unchanged) between two or more periods.

Scenario 4: Nominal value of money changes (increases or decreases); and price (and price level) of good or/and service changes (increases or decreases) as well between two or more periods.

 

Scenario 3 describes the situation Nigeria will face once the proposed plan comes into force come 2008. The effect of changes or otherwise in nominal value of money is change in the price of goods/services or (and price level) on the real value of money and its repercussion on trade can be analyzed as follows:

 

Under scenario 3, the effect on the real value of money could be of two forms as. The first possibility, which results from a fiftyfold (or 5,000 per cent) increase in the nominal value, is an increase in the time value of money indicating an appreciation of the purchasing power from N1, 000.00 worth of good or/and service in August 2007 to N50, 000.00 worth of good/service in August, 2008. The second possibility, which emanates from a decrease in the nominal value (from N1, 000 to N20 or fiftyfold or 5,000 per cent), will be a decrease in the real value of Naira, representing a fall or depreciation of the purchasing power of money from N1, 000 worth of good or/and service in August, 2007 to N20.00 worth of good or/and service in August, 2008. The immediate effect will be a depreciation in the purchasing power of money which has the potential of reducing the welfare of Nigerians!

 

For brevity, economics finds it convenient to analyze money and its value in exchange along two levels, the local trade and international trade. The former essentially deals with exchange of commodities between members of the local economy (for example Nigeria economy); while the latter involves members of local economy exchanging commodities with people living outside the local economy (international economy). While the principle of money and its value in exchange outlined above applies to local trade, the question remains: what is the counterpart principle governing exchange in the international arena? The answer to this question is not far-fetched. As a matter of fact, the same principle applies, only that the price of good or/and service and value of money in exchange in international trade is denominated in convertible currencies [globally acceptable currencies like the United States dollar ($), the British pound (£), the European euro (€) and Japanese yen (¥)] while the exchange rate serve as common denominator for the relative price of currencies.

 

To illustrate how changes in the nominal value of foreign currency (say US $) and local currency could affect their purchasing powers, let take it the current exchange rate of $1 to N125 (or an exchange ratio of 0.008) will remain stable throughout the month of August, 2007. Let us make the additional assumption that foreign currency either depreciates to $0.80 or appreciates to $1.20 in August 2008; while the local currency will be changed by CBN through a fiat fiftyfold either way by August 1, 2008, which means N100 will become N2 (N100 ÷ 5, 000 per cent). What will be the effect on foreign exchange rate and the ability of foreigners and Nigerians to buy goods produced locally or their foreign counterparts?

 

Since the CBN plans to peg the exchange by August 1, 2008 at one dollar to a Naira, which is about the same rate in the market currently (August 2007), the nominal value of the exchange rate will remain the same by August 2008. To see the effect of the twin policy on the purchasing power of the Naira once it comes into force let us use a practical example. Let us say a lecturer in Nigeria who currently (August 2007) receives N100, 000 as take-home salary wants to enhance his productivity by buying a foreign journal costing $10, taking $1:N125 as current the foreign exchange rate. He must part with N1, 250 [N125 X 10)] of his salary to get the journal, all things being equal. After paying for the journal, he/she will be left with N98, 750 (N100, 000 – N1, 250) to spend on other items. Now, by August 2008 when the redenomination of Naira takes place, N1, 000 reverts back to N20 (that is the nominal value of N1, 000 depreciates fiftyfold or by 5,000 per cent)! The implication of this will be that the lecturer will earn N200 (N100, 000 depreciates fiftyfold, or is divided by 5,000 per cent). Should the lecturer desires to pay for the same journal he bought the previous year, he must part with the same N1, 250, given that the exchange rate remains $1:N125 as intended by the CBN. The welfare effect will be that his current salary of N200 cannot afford him to buy the journal, talk more of having some money left to spend on other items he/she requires. For him to be able to buy the journal (required to improve his productivity), he will need an equivalent of his six-month (N1, 250 ÷ 200 = 6.25) salary. The end result will be a reduction in his welfare as well as his productivity, which in turn will affect national productivity and income (gross domestic product or GDP). Now once this logic is extended to other Nigerians on fixed or zero income and the consequence for the economy, the huge welfare loss of the planned policy will be enormous to contemplate!

 

It is important to stress that the only scenario where the proposed plan will have the desired effect would be when all transactions, costs (including that of production and importation) and prices, as well as exchange rates are adjusted fiftyfold downward as it were in the Naira. Needless to say, aside from the fact that this requirement will be a tall order for the government to accomplish, it raises some sociological questions: is it possible to convince every member of the society (Nigeria) to appropriately adjust his/her price or cost of everyday transaction by fiftyfold so that the above requirement could be met? How would trading partners react if we should arbitrarily revalue (fix) the foreign exchange rate fiftyfold above the existing rate in consonance with the requirement for the workability of the proposed plan? Can inflation be tamed under a condition of weaning business confidence arising from the twin policy of ‘devaluation’ of the Naira and the arbitrary appreciation of the exchange rate? Indeed, the government will surely need a magic to realize all that.

 

From the preceding analysis it should have become apparent that the prima facie for the proposed plan of redenomination of the Naira is to devalue the Nigerian currency to a certain extent so as to achieve a two-pronged macroeconomic objectives, namely: (a) promotion of exports (especially  non-oil) by making goods and services produced in Nigeria cheaper and attractive to foreigners; a necessary condition for a stable, virile and strong economy on the African continent, and West-African sub-region in particularly; and (b) to discourage importation and consumption of foreign goods, by way of making them direr and less attractive to Nigerians, a necessary condition for an inward-looking strategy and stimulating sustainable growth in the real sector of the economy (manufacturing, agriculture and petrol-chemical industry). We have earlier indicated that one of the underlying rationales for the proposed plan to re-denominate the Naira is reposition the Nigerian economy to play its anticipated leading role in the ECOWAS, more so now that its currency is billed to be the common currency in the West African monetary zone. But perhaps more important a rationale is the basic structure of the Nigerian economy which for a long time has remained mono-cultural, import-dependent, and characterized by weak industrial and infrastructural base, low agricultural productivity, high rate of unemployment, and endemic and wide-spread poverty, in spite of two major economic reform programmes carried out since 1986.

 

Now, the fundamental question that need be answered is: what are the chances that the plan proposed by CBN will in any way help to achieve the stated objectives highlighted above, considering the somewhat ‘structural rigidities’ that appeared to have prevented the economy from experiencing desired growth? The fact that the plan will likely have profound impact on the macroeconomy is scarcely in doubt; but as for the magnitude and direction of the impact as well as the extent to which it will influence the socioeconomics is what is required to be explored. Even from hindsight and experiences of other countries who had experimented with the policy, such as Ghana and the Latin American countries, the twin policy of re-decimalization of local currency and readjustment of the foreign exchange rate, the immediate effect will be the devaluation of the Naira. Once that happens, can inflation be tamed under a condition of weaning business confidence? Indeed, the government will surely need a magic to realize all that.    

 

Also in the short run, there is likely going to be a rapid growth in inflation resulting from increase in prices as producers of local goods and services and traders of foreign merchandise adopt the only adjustment available mechanism to try to cushion the ripple effect of the disguised ‘devaluation’ of the Naira as well as the increases in the quantity of naira they pay for the foreign currencies in which their imported items are denominated. In turn, the increased costs of production and imported merchandise will make the much desired exportable Nigerian manufacture and other commodities direr, thereby making them in the long-run less attractive and uncompetitive compared with foreign-made in Africa and the West African sub-region in particular.

 

Another possible fall-out which would possibly occasion the ‘devaluation’ of the Naira will be the reduction in the welfare of Nigerians, especially in the short- and medium run, now that the nominal value of Naira will command less quantity of goods or/and services in the post-implementation period than it used to, the welfare of Nigerians is likely to be adversely affected, thereby further making the already not-too-good socioeconomic situation (Table 4) in the country to deteriorate.

 

But perhaps more fundamental are the factors which in the final analysis will determine the workability or otherwise of the policy, some of which are:

 

Government’s ability to tame rising prices by way of controlling their determinants: one of the conditions that must hold if at all the policy makers are to hope the proposed plan will work is the ability and temperament of policy implementers to tame rising prices of goods and services in the domestic economy. To do that it will be imperative for them to control the point-sources of inflation in Nigeria, such as rise in the costs of production; and the near absence of alternative local sources to imported raw materials and requisite capital goods. With the economy’s weak industrial base, undeveloped iron and steel as well as petro-chemical industries, weak backward and forward linkages between manufacture, agriculture and services sectors, one wonders how all this can be achieved in the short or even within the medium term.

 

Government’s ability to change the import-dependent consumption pattern of Nigerians: central to the successful implementation of the proposed policy is the reorientation of the consumption habits and pattern of Nigerians in favour of locally manufactured goods and services. This is important as the theory of consumer preference tells us, if near or perfect substitutes to imported commodities are not made available at reasonable rate, Nigerians would be willing to pay higher prices in order to maintain their tastes and protect the joy/satisfaction they derive from the imported goods and services rather make do with substandard ones produced in the country. By the way, an important question to ask is, is it possible to fundamentally change people’s taste, consumption pattern within the present context in the short run or even within the medium term? The answer may not be far from no.

 

The need to reorient the focus of domestic production: this is another crucial requirement for the successful implementation of the proposed policy. To achieve this, it requires new technologies, new industries, the expansion of industrial space and an inward-looking pattern of industrialization tailored to meet the domestic needs of Nigerians at the same those of the export market. Obviously this will not be achieved either in the short-run or within the medium term.

 

 The need to enhance the capacity utilization of the real sector: to bridge the huge gap in excess demand for foreign goods and services that would be created by the implementation of the policy, there will be the need to increase the capacity utilization of the real sector of the economy. Incidentally, the low productivity in agriculture, weak manufacturing base and a near non-existence of the petro-chemical industry as well as the poor performance of supporting infrastructural base will make the desired significant improvement in capacity utilization of the real sector unrealizable both in the short-run and within the medium term.

 

The ability of Nigerian industries and traders to compete with other foreign goods and services abroad: The ability for Nigerian goods and service to compete favourably with their foreign counterparts, especially in the West African sub-region will largely depend on the acquisition of new efficient and cheaper technologies, drastic reduction in the cost of doing business in Nigeria [which is currently adjudged to be one of the highest on the continent, rehabilitation of old the infrastructure and development of new functional one, as well as competitive pricing. While some of these conditions are policy issues which require a long gestation period before they are become functional, others are clearly beyond the control of the domestic economy.

 

It therefore appear that the CBN is in a hurry to accomplish within a short term what has taken other countries careful planning, commitment and decades to establish. We have demonstrated elsewhere that the Nigerian economy has in the last eight years performed appreciably well especially in the area of macroeconomy, but poorly in the socioeconomic sphere and ecological department. To transform Nigeria into a formidable economic engine room in the sub-region, what is required at the moment is the consolidation of the gains of the current reform pogramme and the urgent need to address the problems of those departments that the implementation of its national economic empowerment and development strategy (NEEDS) seemed to have done poorly in the last seven years. To this end, the following are recommended: (a) urgent steps to diversify the economy through the systematic modernization of the agricultural sector, and designing an industrial policy which places emphasis on reinvigorating the manufacturing sector as the hub of the economy. In line with this thrust, the strategy should be the promotion of linkages between the various sectors of the economy, so that the objective of meeting up with the needs of local markets will be at the same time be at the core of objective of creating jobs and wealth, and the reduction of poverty; (b) government should pay more attention to the modernization of old and provision of more infrastructure, especially but not limited, to electricity generation and distribution; human capital development; standard health facilities and services; and water supply. Since majority of the population resides in the rural areas, special attention should be given to the development of an economically functional and productive rural infrastructural base to harness the huge development potentials of the sector.

 

 

Ibrahim Umaru, Department of Economics, Nasarawa State

University, P.M.B. 1022, Keffi-Nigeria.   

E-Mail: iumaru@yahoo.com