Wednesday, 22 October 2014

Nigeria: Oshikoya - the Central Bank and Boyonomics

MR. Henry Boyo is a regular commentator on the Central Bank of Nigeria (CBN) and the management of the Nigerian economy. Mr. Boyo should be commended for his consistency, persistency, and passion about his public policy perspective. Mr. Adaighofua Ojomaikre (AO) has also contributed to the perspective, henceforth, termed Boyonomics. This article tries to situate Boyonomics in the context of economics theoretical studies, empirical analysis, and global practices and experiences of other significant oil producing countries with large population including Algeria, Azerbaijan, Indonesia, Russia, Venezuela, and Saudi Arabia.
In the search for the holy grail of Boyonomics, more clarity emerged in both technical, institutional and policy terms as to the key issues this perspective on the CBN and the Nigerian economy has been trying to grapple with. The key issues that emerged are: are there oil currencies? If there are, how have they impacted on nominal and real exchange rates, and the economy at large? What is the source of these phenomena? Is it due to country-specific institutional and political economy features? What constraints do these phenomena pose to monetary policy management, especially exchange rate and liquidity management? What forms of exchange rate regime help to insulate the economy from these phenomena?
Naira as Oil Currency

It appears that the first concern of Boyonomics is that the Naira has become an oil currency, but focusing on nominal exchange rates. This is understandable: over a period of 30 years, the exchange rate of the Nigerian currency declined in nominal terms from one Naira to US$1 in 1983 to 160 Naira to US$1 in 2013. If this episode should be repeated over the next 30 years, the nominal exchange rate of the Naira to the dollar will be N25,600 to US$1 by 2043.
There is a vast economic literature on oil price and its impacts on macroeconomic dynamics, especially real exchange rate movements. Paul Krugman, a Nobel Prize Winner and an Economic Columnist for the New York Times, developed a model in his 1983 paper titled "Oil and the Dollar" demonstrating that changes in oil prices generate wealth transfer effects and portfolio reallocations which brings about exchange rate adjustments needed to bring about equilibrium in asset market. Cashin et al in their paper on "Commodity Currencies and the Real Exchange Rate," specified a theoretical framework of exchange rate determination in a small open economy with tradeable (oil) and non-tradeable (non-oil) sectors. Several empirical studies have been carried out using these frameworks. In this context, the oil currency exists when the elasticity of the real exchange rate to the oil price over the long run is positive, large, and significant. Hassan Suleiman and Zahid Mohammed in their paper "The Real Exchange Rate of an Oil Exporting Economy: Empirical Evidence from Nigeria," found that real oil prices exercise a significant positive impact on the real exchange rate, while productivity differentials between Nigeria and its trading partners exerted a significant effect on the real exchange rate. In essence, the Naira is an oil currency in real term as well. Similar findings have been found for Russia, Algeria, Venezuela, and Kazakhstan. But other studies found no oil currency or insignificant relationship between real exchange rates and real oil prices for Canada, Norway, and Saudi Arabia.
Monetary Policy Management Constraints
The second primary concern of Boyonomics is to insulate the Naira from movement in oil prices and earnings, engendered by the manner in which oil revenue earnings are injected as liquidity to the economy. The point in Boyonomics is that the prior and linear conversion of dollar revenue into Naira is the root cause of the identified problem. Mr. Boyo had repeatedly emphasized this point, while AO's article on "How CBN underdevelops Nigeria," states that '... prior and linear conversion of dollar revenue into naira harks back anachronistically to the era of commodity money when plentiful supplies of silver and gold mined in the Americas were minted into coins which boosted money supply and fuelled inflation in metropolitan European countries. The practice has ceased in the present era of fiat money."
One of the key tenets of Economics is that economic agents and policy decision makers try to maximize or minimise an objective function subject to particular constraint(s). However, there could be wrong or inaccurate objectives, wrong or inaccurate constraints, or a combination of both. In addition to having a miss-specified objective function, monetary authorities can also have wrong and inaccurate constraints, with consequences for monetary policy transmission mechanism. Monetary Economics literature has shown both theoretically and with empirical evidence how these could lead to welfare losses, even with an optimal monetary policy. Federico Ravenna and Carl Walsh of the University of California and Federal Reserve Bank of San Francisco, like others, have pointed this out in their paper on 'Welfare-based optimal monetary policy with unemployment and sticky prices: A linear-quadratic framework." Ruslan Aliyev in a paper titled "Monetary Policy in Resource-Rich Developing Economies" has also demonstrated how fiscal dominance and indiscipline can complicate monetary policy management.
In this context, Boyonomics is correct in identifying the oil currency phenomena for Nigeria; and in identifying the source of this phenomenon as the attempt to first convert or monetize oil revenue earnings in dollars to naira for prior allocation among the federating units as per institutional, and legal and constitutional requirements. These legal requirements should, however, be viewed as fiscal dominance of monetary space, imposing constraints on monetary and exchange rate policy management, especially the transmission mechanism for injecting liquidity into the Nigerian economy.
Political Economy of Oil Currency
Why have real exchange rates been effectively insulated from oil prices in Norway and Saudi Arabia, but not in Russia, Algeria or Nigeria? Maurizio Habib and Margarita Kalamova of the European Central Bank studied the oil currencies phenomena for Norway with floating exchange rate, Russia with managed floating exchange rate, and Saudi Arabia with a fixed exchange rate pegged to the dollar. Both Norway and Saudi Arabia avoided the oil currencies phenomena, while Russia did not. More importantly, they concluded that the exchange rate regime does not matter. What matter is the peculiar institutional and political economy features of the three different countries. High powered monetary growth in Norway has not been affected by shocks in oil prices. In Saudi Arabia, the sterilization of oil revenues abroad, the presence of labour market flexibility and price subsidies helped in breaking the relationship between oil prices and real exchange rate.
In Russia, the Rouble can be defined as oil currency because oil shock has been transmitted to the real exchange rate as there is only partial sterilization.
Over the years, Algeria has also witnessed volatile and depreciating Dinar currency, with a parallel market premium of 40% in November 2013 according to the 2013 IMF article IV Consultation Report for Algeria. Further, the Algerian Dinar has been found to be an oil currency by Taline Koranchelian in his paper on 'The Equilibrium Real Exchange Rate in a Commodity Exporting Country: Algeria's experience.' Algeria adopted a managed float regime since 1995. According to Taline Koranchelian, the Central Bank of Algeria holds the counterpart of most transactions on the foreign exchange market and is the main supplier on the interbank market due to the combination of three factors: (a) hydrocarbon exports account for a high percentage of total exports; (b) by law, the foreign exchange receipts from the hydrocarbon exports have to be converted into dinars directly at the central bank; (c) capital account transactions are subject to strict controls.
The political economy of oil rentier states has also been the subject of discussion in the literature and in public policy discourse including in Boyonomics. For example, Benn Eifert, Alan Gelb, and Nils Tallroth dwell on this matter extensively in their paper titled 'The Political Economy of Fiscal Policy and Economic Management in Oil Exporting Countries.' In all most all oil producers, oil rents are seen as the property of the nation or government; with the USA being one of the few exceptions. However, the outcomes of oil rents management depend crucially on the political economy of each country. Eifert identified five typologies of political economy which enables oil producing states to focus on or ignore the long-term horizons. In mature democracies such as Norway, State of Alaska, and Province of Alberta, and to a lesser extent in Botswana, oil or mineral rents are used more efficiently as political stability and broad social consensus contain rent-seeking behaviour and encourages long-time horizon, which favour savings of oil earnings externally in foreign currencies and inter-temporally. Paternalistic autocracies are found in Saudi Arabia and other GCC countries deriving legitimacy from traditional base, but with long-term horizons have managed to save for future generation, while improving living standards with oil wealth. Reformist autocracies tend to use the state to drive development and use natural resource rents to diversify the economy towards labour-intensive and non-oil sectors to improve the welfare of people as in Algeria, where unemployment rate fell from 30% to 10% between 2000 and 2011.
Predatory autocracies face minimal constraints in exploiting oil rents for the interest of a few elite. Institutionalized practices include a network of patronage and opaque system fueling corruption and rent-seeking opportunities. In factional democracies, income distribution is unequal and social consensus is elusive with political support deriving from systems of patronage. Predatory interest groups tend to capture the state leading to a flourishing rent-seeking behaviour. Nigeria has straddled the last two regimes moving from successive military predatory autocracies to factional democracies. In both regimes, concentration of fiscal resources and means of distributing oil rents encourage imprudent investment, corruption, and high deadweight loss.
Thus, the political economy of the operating environment of the CBN should be fully understood. While the institution has been created to serve as bank of last resort, it has been handicapped in its role as an independent agency of restraints by political constraints of fiscal federalism. Boyonomics has also recognized these political and fiscal constraints when AO noted that the CBN has been prevented from "actualizing its economy-energizing principal objects," as under the Federal Ministry of Finance, the fiscal "agencies used tools down the years to veer the CBN of course." However, removing these particular constraints is a political decision, not an economics decision; especially as within the current context of factional democracy, the fundamental institutional and political economy sources of distortions may violate in turn political incentive constraints as the extant political equilibrium of oil rentiers depend crucially on the distortions. This point has been recognized by Daron Acemoglu and James Robinson in their article, 'Economics versus Politics: Pitfalls of Policy Advice,' where they argue that not only that economic advice will ignore politics at its peril but also that there are systematic forces that sometimes turn good economics into bad politics, with the latter unfortunately often trumping good economics. Perhaps, in addressing the source of these constraints, they should have been part of the topical issues for the National Conference and ultimately changes to the relevant sections of the Constitution of Nigeria.
In concluding, Boyonomics is correct in identifying the key issues relating to oil currencies, its sources, and some possible impacts on Nigerian economy. This is commendable, contrary to being vilified as misinformation and misrepresentation, as some have done and usually do with the critique of economic management. However, Boyonomics should regard the issues identified as actually political and fiscal constraints to monetary policy management, which are beyond the CBN; and it appears that the proposed dollar certificate solution has also not been accepted by Nigeria's political authorities and fiscal agents. Over to you, the Minister of Finance and the Coordinating Minister for the Economy!
Dr. Oshikoya is an economist and chartered banker.

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