Why the President is Reluctant to Back Devaluation

CBN may invite EFCC to probe allegations of round tripping IMF relaxes stance as more countries adopt capital controls

With the clamour growing everyday for the Central Bank of Nigeria (CBN) to devalue the Nigerian naira and relax foreign exchange controls, THISDAY has learnt that a number of factors, chief of which is the lack of conviction that a devaluation would not improve dollar supply in the economy, are some of the reasons President Muhammadu Buhari and the CBN have adamantly refused to endorse the devaluation of the nation’s currency.

However, Buhari’s stance has led to a division in his cabinet and among some party leaders in the ruling All Progressives Congress (APC), some of whom believe the president should be more pragmatic in his dogmatic stance against devaluation, arguing that by not devaluing, there will be more money for the three tiers of government to share from the Federation Account to meet their obligations.

As one government official, who did not want to be named, explained to THISDAY: “Yes, there are those in government who want it, but there is stiff resistance from Buhari and the CBN.

“But those who are prodevaluation have argued that with oil prices at a 12-year low, our foreign earning have declined to less than a billion dollars a month. To top it, we have no buffers to shield us from the oil price decline.

“So they believe that if we devalue, the three tiers of government, especially states with a cash crunch, will have more money to share from oil earnings going to the Federation Account.

“And this will enable the three tiers of government to meet their obligations to their workers, contractors, and help to reflate the economy which is literally comatose at the moment.”

However, the flipside to this line of argument is that whilst the three tiers of government may stand to gain from devaluation, in real terms, they could also lose it to inflation.

According to a director of the CBN who spoke on the issue: “Yes, we understand that devaluation will create more money for all the tiers of government, but what we stand to gain from one hand, we will lose on the other hand due to inflation.”

The director, who preferred to remain anonymous, pointed out that the enforcement of transfers of federal government funds to the Treasury Single Account (TSA) has led to the accumulation of N2.8 trillion in the CBN, part of which will be used by the government to fund the 2016 budget.

“Given the experience of the federal government, states will be well advised to adopt the TSA to plug leakages, as hidden state funds in commercial banks could help them to meet their obligations also,” he said.

He added that there was no guaranty that by devaluing the currency, there will be an improvement in dollar supply through foreign portfolio investors, “whom the markets have claimed have been sitting on the fence”.

“This is hot money and there is no guaranty that devaluation will attract them to the country. Besides, even if they come back, whatever cash they inject will just be a drop in the ocean relative to the demand requirement for dollars in the foreign exchange market,” the central bank official said.

When reminded that the forex restrictions have led to a massive widening in the gap between the official rate of the dollar and the parallel market rate, resulting in rent seeking in the market, he said the CBN was not unaware of this problem and was considering inviting the Economic and Financial Crimes Commission (EFCC) to investigate banks, companies and individuals who might be engaged in the illicit practice.

“We are aware of this problem and have received some reports that some banks may be colluding with customers to engage in round tripping. Owing to the reports, we are currently considering inviting the EFCC to investigate banks and anyone caught will face the full wrath of the law,” he said.

The director added that it was for this reason the Bankers’ Committee agreed to start the publication of forex allocations to bank customers in newspapers on a regular basis.

Surprisingly, Buhari and the CBN’s anti-devaluation stance is getting support from the most unexpected of quarters, as an article published recently by the Wall Street Journal (WSJ) has shown that some global analysts, including the International Monetary Fund (IMF), are gradually accepting the argument that capital controls could serve as a shield against destabilising investment flows from foreign investors.

According to the report by WSJ, the response to turbulent financial markets might be a dose of “unorthodox thinking”, which is in line with CBN’s position in the last few months.

For instance, the central bank officially stopped the sale of dollars for 41 items, as it sought to reduce pressure on the naira and preserve external reserves.

It also cancelled the sale of dollars to Bureau De Change (BDC) operators and the use of electronic naira cards abroad, just as it has continued to resist pressure to further devalue the naira.

Dissatisfied with the central bank’s forex policy, a lot of foreign portfolio investors have continued to divest from the country’s equities and bond markets, with their exit accounting for one of the largest chunks of forex outflows from the economy.

However, the WSJ report pointed out that amid the turmoil, financial and economic policy makers are advocating a tactic once anathema to all but the most mismanaged economies: capital controls.

Governor of the Bank of Japan, Haruhiko Kuroda, it stated, seemed to deviate from standard economic thinking late last month when he suggested that China might benefit from stricter capital controls.

“Both India and Nigeria tightened restrictions on their citizens’ access to foreign currency in recent months, battling to limit capital outflows caused by the winding down of the Federal Reserve’s bondbuying programme. Controls are making an intellectual comeback, too,” the New York-based financial paper added.

Also expressing his support for the policy, Olivier Blanchard,

who arrived at the IMF as chief economist in 2008 and left the fund last year said: “The general presumption was that capital-account liberalisation was always good, and capital controls were nearly always bad. I’ve seen the thinking change, partly because it was already wrong then, and because it was particularly wrong in the crisis.”

Similarly, IMF’s Managing Director, Christine Lagarde, at a speech in Maryland recently, cited “a growing recognition that the short-term nature and inherent volatility of global capital flows are problematic”.

She said emerging markets and countries such as the US that are the largest sources of international capital flows should consider new regulations and tax policies that curb short-term debt flows and stimulate longer-term equity investments.

The current support for capital controls builds on a change of course at the IMF half a decade ago. After long urging countries to free the movement of capital, the fund surprised markets and economic policy makers by endorsing and even recommending the use of controls in some cases to slow destabilising inflows of investment.

The fund was in part influenced by the lessons of the financial crisis, when a handful of advanced economies that were entirely open to global capital flows were hit hard. Iceland and Spain both experienced deep recessions when the foreign investment that had driven booms in their economies evaporated.

According to WSJ, similar lessons were drawn by some observers during the Eurozone crisis. Greece and Cyprus, both facing sudden outflows over fears their banks would fail, put strict restrictions on bank transfers to stop money from leaving.

Switzerland, meanwhile, has struggled to keep its economy balanced amid massive inflows. Those flows put pressure on the Swiss franc to rise. A stronger currency pushes down consumer prices that have been falling for most of the last four years, making it harder for the Swiss National Bank to fend off deflation.

A strong franc also hurts Swiss exporters by making their goods less competitive in global markets. The central bank sold huge quantities of francs to keep the currency from appreciating until deciding a year ago it couldn’t sustain the effort, allowing the franc to rise sharply.

Capital controls have major downsides, nonetheless. For one, they can make it hard to attract inward investment, because investors may fear they won’t easily get their money back out. They also can be hard to kick.

After its collapse in 2008, Iceland imposed capital controls that helped stem colossal outflows, but also crimped investment and financing for Icelandic companies. Seven years later, the country only now is inching towards eliminating them.

But there is growing support for the idea that limits on money flows may be necessary. Any economics student will have read about the so-called impossible trinity that supposedly binds policy makers’ hands.

It holds that a country that wants to control its own monetary policy, such as interest rates, can’t also have both a fixed exchange rate and a free flow of capital. Financial and economic orthodoxy thus held that countries should allow exchange rates to float and keep themselves open to movements of international capital.

Helene Rey, an economist at the London Business School, believes the trinity is actually even more impossible than has been thought. In a 2013 paper presented to the influential Jackson Hole, Wyoming, gathering of monetarypolicy makers, she argued that the tumultuous global financial cycle showed that countries hoping to control their monetary policy could have neither fixed exchange rates nor a free flow of capital.

That view appears to be spreading. Benoit Coeuré, a member of the European Central Bank’s executive board, has referenced Ms. Rey’s work in two speeches over the past year. Last November, Mr. Coeuré said capital controls were “once again part of the policy discussion”.

Some of the change is evident in the financial policy already. Poland, for example, has effectively halted new lending in foreign currencies for most people. Many Poles had taken out mortgages in Swiss francs and were badly hurt by the franc’s striking appreciation a year ago, which made their loans more expensive to pay off.

The increasing focus on those sorts of “macro-prudential” measures to limit financial instability can have the same effect as capital controls, Mr. Blanchard said.

“If you forbid someone in your country from borrowing in another country’s currency, that’s macro-pru,” he said. “But stopping a foreign bank from lending in your country is called capital controls.”

Expectedly, the debate has come to a head with China, reported WSJ. In the past, policy makers in high-income countries could argue somewhat dispassionately about fluctuations in capital flows that rocked emerging markets.

But now that the swings in flows are hitting the world’s second-largest economy, how China responds is the rest of the world’s problem, too.

“There is a real contradiction between what China needs for internal balance—lower interest rates, significant credit easing via unconventional channels—and what the exchange-rate consequences of such easing mean for both Chinese and global external balances,” said Karthik Sankaran of the Eurasia Group, a consulting firm.

Capital controls could help Chinese authorities use monetary policy to stimulate the economy without causing the exchange rate to tumble.

“This makes it a lot easier to deal with those situations where the demands of internal balance and external balance point in opposite directions,” Mr. Sankaran said.

Recently, Beijing imposed some added controls in an effort to halt a huge outflow of funds from China. The moves include curbing the ability of foreign companies in China to repatriate earnings, and forbidding foreign asset managers, including hedge funds and private-equity firms, from raising yuan-based funds aimed for overseas investment, people with direct knowledge of the matter said.

History has also shown that capital controls played significant roles in stabilising economies centuries ago. For instance, the Border Guards 1300 Act made it increasingly difficult to export metals from England. A 1381 King Richard II statute condemned “the great mischief which the realm suffereth when gold and silver leaves the country”. Prohibitions were lifted in 1538 by King Henry VIII.

Also, between 1914 -1944 when World War I and the Great Depression disrupted the international order based on the gold standard, John Maynard Keynes argued for permanent restrictions on capital flows.

Then between 1968 – 1971 when the Bretton Woods system collapsed, fixed exchange rates were abandoned and the IMF enforced a new orthodoxy: money should flow freely across borders.

But between 1997-2016, as Asian currencies plunged during the region’s 1997 financial crisis, Malaysia spurned the IMF and slapped capital controls. Iceland followed suit in 2008 as investors tried to yank their monies from the country. This was followed by Greece and Cyprus, forcing the IMF to state in 2010 that controls could be useful.