NAIRA LOSSES VALUE

THE PERSISTENCE DEPRICIATON IN THE VALUE OF THE NIGERIA NAIRA/CURRENCY IN THE INTERNATIONAL MARKET AND WAYS OF MANAGING THE NAIRA

CHAPTER ONE

INTRODUCTION

STRUCTURE AND TREND OF NIGERIAN’S EXTERNAL TRADE
There have been considerable changes in the composition and direction of foreign trade between Nigeria and the other countries since its independence in 1960. The trend or direction of trade refers to the destination of exports and origin of imports. Nigeria’s exports consist mainly of petroleum, and other unprocessed and semi-processed raw materials. The imports consist of manufactured consumers goods, industrial raw materials and capital equipment. The transportation of goods is undertaken mainly by foreign vessels.

During the colonial period, trade was carried out mainly with Western European countries England, France and Germany. Since independence in 1960, there has been an expansion of market to include United State of America, Canada, Japan, China, Taiwan, Russia and Poland among others.

INTERNATIONAL TRADE
Trade between nations is known as “International Trade”. The term International Trade refers to the exchange of goods and services that take place across international boundaries. No country in the world today is self-sufficient or is able to produce everything its people want. Moreover, natural and human resources are unevenly distributed among countries. Nigeria, for example, has an abundant supply of petroleum while Zambia is richly endowed with copper. The United States and most West European countries, on the other hand, have an abundance capital, technical know-how and skilled manpower. In order for each country to get the commodities it has not been endowed with, it must trade with other countries that have them.

Through international trade, a country can obtain those things that it cannot produce. There is, thus, an international division of labour or specialization. Every country tends to specialize in the production of a commodity, or commodities for which it has the greatest cost advantage over the other. In other to know what is happening in the course of International Trade, governments keep track of the transactions among countries. The record of such transactions is made in the balance of payments account.

BARRIERS TO INTERNATIONAL TRADE
There are many barriers to international or foreign trade. The following are some of them.

1. Currency
The problem of differences in currency leads to foreign exchange conversion. This impedes easy flow of goods.
2. Distance
The relatively great distances between countries, the delays in the servicing of orders and protocol checks lead to increased costs of trade generally.
3. Tariffs
The imposition of customs duties and quotas creates artificial barriers to trade
4. Language
Differences in language create communication barriers and impede foreign trade.
5. Ideological Differences
People who do not see eye to eye with each other usually do not work well together. So, ideological differences can hinder trade transactions between nations.

LAW OF COMPARATIVE COSTS
With regard to international trade, the principle of comparative costs states that the world production of goods and services will be greater and total satisfaction maximize if each country specializes in production of those things for which it has the greatest advantage over others (or can produce at the lowest comparative costs). For example, Nigeria and Britain would both gain by buying cheaply from each other what they do not have or what they produce at home at relatively greater cost. This is the principle of comparative costs. If all nations specialize in the production of those things in which their comparative advantage is greater, then the total world trade will be greater than when all nations try to produce everything for themselves. Through specialization and exchange, the standard of living of the people of the world will generally be higher.

CHAPTER TWO

NAIRA IN INTERNATIONAL MARKET

NIGERIA’S TERMS OF TRADE
Nigeria exports barrels of crude oil, cocoa, tin, and some other commodities, to the rest of the rest of the world. At the same time, Nigeria important machinery, milk, ink, writing paper, services of experts and so on, from export, Nigeria is able to buy a certain amount of imports. It follows that a certain amount of exports has to be exported to the rest of the world before Nigeria can import a certain quantity of imports. This rate of exchange between Nigeria’s export and the imports it gets from the rest of the world is Nigeria’s terms of trade. In other words, the terms of trade of any country is the rate at which its exports equate its imports at any given period.
The terms of trade changes from time to time, it follows the prices of traded commodities. If the price of motor in Japan increases, Nigeria will have to sell more barrel of oil (assuming that there is no change in the price of crude oil) in order to buy the same number of cars. In this case, the terms of trade of oil rises in favourable to Nigeria. If the price of oil rises in favour of Nigeria, Japan will have to sell more cars to buy the same amount of crude oil from Nigeria. In this case, we say that the term of trade are favourable to Nigeria, as it exports the same amount of crude oil but gets more motor cars from Japan.
Therefore, if a country gets more imports for a given amount of exports, the terms of trade are favourable to the country. If on the other hand, if the country gets less for the same amount of exports, the terms of trade are unfavourable to the country. The terms of trade are an important determinant of the balance of payments.

MEASUREMENT OF TERMS OF TRADE
We use index numbers of prices of exports and imports to determine the terms of trade. The terms of trade are therefore expressed as the ratio of the index of export prices to the index of import prices, that is:


Rate of Exchange = Price index of exports/Price index of imports


THE FOREIGN EXCHANGE MARKET
Money as a medium of exchange assumes a more complex position and role in international trade. We have identified currency (money) in the introduction as one of the obstacles to international trade. This problem arising from different national currencies led to the creation of the foreign exchange market.
The term “Foreign Exchange” means foreign currencies bought or sold for the purpose of transferring funds or purchasing power from one nation to another. The strongest foreign currencies are convertible currencies; they are also called “key currencies”. Examples are US dollar, British pound sterling, German mark, Japanese yen, Italian lire, and the Swiss, French and Belgium franc. These currencies are bought and sold for other currencies internationally, and they are generally accepted as means of payment in most capitals of the world.
The foreign exchange market is a place of organizational framework within which foreign exchange or foreign currencies are bought and sold. The foreign exchange market locations include all places in a country where a currency is bought and sold for other currencies. It includes all networks of communication between banks and traders.
Other functions of foreign exchange market include the provision of short term credit finance, usually three months, within which the importer disposes his goods and makes payment to the seller. It also provides facilities for hedging risks arising from changing exchange rates. “Hedging” means an agreement today to pay or buy foreign exchange at a fixed rate for a specified period, usually for three months, irrespective of fluctuation in the rate at which foreign currencies changes values.

FOREIGN EXCHANGE RATE
In Nigeria domestic trade, payments are made and received in the national currency, the naira. In international trade, on the other hand, payments involve the exchange of the naira for other countries’ currencies and the exchange of other countries’ currencies for naira. This means that a Nigeria importer pays a British manufacturer in pound sterling (£), which is the legal tender in Britain. He buys this foreign exchange (the pound sterling) from the Central Bank of Nigeria. The Central Bank is a foreign exchange market location. Therefore, like all traded commodities, a price relationship exists between the naira used in buying the pound sterling. That price is the foreign exchange rate.
The foreign exchange rate is defined as the price of one unit of a foreign currency in terms of a unit of the domestic currency. The exchange rate between the Nigeria naira and the British pound sterling is the number of naira required to buy one pound sterling. Today, the foreign exchange rate of the naira in terms of pound sterling is about 230.29:1 (source CBN April 4, 2008). This means that to pay for good that costs one pound in Britain, a Nigeria importer will be required to buy one pound at the Nigerian Central Bank with N230.29.
When exchange rate rises, the domestic currency depreciates or falls in value in terms of foreign currency. Likewise, when the domestic currency appreciates or increases in value.

DETERMINATION OF FOREIGN EXCHANGE
When Nigeria residents buy British pound sterling (£) with the naira, the pound rises. The units of pound sterling bought by Nigerians are supplied by individuals, firms or the government of Britain. Therefore, there exist the demand for and supply of foreign exchange.
The demand for foreign currencies rises when goods and services are imported from abroad. The supply also rises in the cause of the export of goods and services. In general, the foreign exchange rate is determined by the forces of demand and supply of foreign exchange. The intersection of the demand and supply curve and the supply curve of foreign exchange determines the price of exchange. The higher the price or rate of obtaining the pound sterling in Nigeria, the less of it demanded. The lower the price, the greater the number of pound sterling will be bought.
A demand schedule for foreign exchange normally slopes downwards from left to right showing the rate and quantity relationship. On the other hand, the British supplier makes available more pounds in exchange when the rate is favourable to him; that is, when the rate of conversion gives him more naira for the same amount of pound sterling exchanged. Therefore, the supply schedule slopes upward from left to right. See fig. 1.1 below.
From fig. 1.1, we see that the intersection of demand and supply of the pound determines the exchange rate for the pound, which is N230.29 = £1. When the exchange rate increases from N230.29 to N232.29 for one pound sterling, the naira has depreciated by

(N232.29 - N230.29)
___________________

(N230.29)

= 0.86 %


On the other hand, if the rate falls from N230.29 to N225.29 for one pound sterling, the naira has appreciated by

(N230.29 - N225.29)
___________________

(N230.29)

= 2.2 %

When the naira appreciates in terms of the pound sterling (£), we need less naira to buy one pound sterling than was the case before. For example, instead of N230.29: £1, we now pay N225.29: £1, which is a gain of N5. When the naira depreciates in value with the respect to £1, we require more naira to buy one pound sterling. Instead of N230.29: £1, we may need to pay N232.29: £1.
However, what applies to Nigeria – British trade relationship also applies to all countries with which Nigeria has trade relationship.

FLEXIBLE AND FIXED EXCHANGE RATES
What I have described above applies to flexible exchange rate, which is determined by the interplay of the forces of demand and supply of foreign exchange. Under the gold standard system, the exchange rate was fixed by monetary authorities that link their currencies to a defined weight of gold. For example, if Nigeria fixed the price of one ounce of gold to N200 and Britain fixed one ounce of gold to £50, the exchange rate in terms of the naira in terms of pound will be N200: £50, or 4: 1 ratio. This means that N4 will buy £1, that is, N4: £1.
Using one ounce of gold to determine the relationship between naira and pound sterling has established a fixed rate of exchange, which is called the “mint parity”. Suppose it costs 10% to ship N4 worth of gold to Britain, that is, it cost 40k to transport N4 to Britain, this means that the exchange rate for the importer of goods has risen to N4 .40. The transport cost has raised the exchange rate to its upper limit of N4.40 in terms of pound. Similarly, the gold import point is N4 – 40k, or N3.60. This is the lower limit of the exchange rate of naira in terms of the pound.
The exchange rate under gold standard (fixed exchange rate) would try to settle within the upper and lower range. This small range variations arises because of shipping cost of gold (transportation cost include handling charges, insurance and interest).

THE BALANCE OF PAYMENTS
The balance of payments of any country is a record of all economic transactions involving payments and receipts between the resident one country and the residents of other countries of the world in any given period, usually in one calendar year. Like the balance sheet of income and expenditure of firms or individuals, the balance of international accounts shows credit (+) for payments received by the country and debit (-) for payments made to other countries. The overall balance enables the government of the nation to see its international economic position. It will then take measures to correct, improve or adjust its economic position.

COMPOSITION OF THE BALANCE OF PAYMENT
There are three main accounts of the balance of payments into which all economic transactions between a nation and the rest of the world are classified. These are:
(a) The current account,
(b) The capital account, and
(c) The official settlement account.
THE CURRENT ACCOUNT
The current account shows the flow of payments and receipts for goods (merchandise trade), services and transfer payments (see Table 1.2). It is made up of two parts, namely:
(i) Imports and export, and
(ii) Services and other indivisible items.

Imports and Exports
The balance of imports and exports is known as the balance of trade. (By definition, the term “balance of trade” means the relation between the exports and imports of visible commodities). The term “visible” denotes that the import and export items can be seen or felt. Visible commodities include foodstuffs, raw materials, petroleum, machinery, etc. A country is said to have a favourable balance of trade only when the value of the exports exceeds that of the imports. If reverse is the case that is to say, if the value of imports exceeds the value of exports, we say that the country has unfavourable balance of payment.

Invisible Items
These are payments for services that are not visible. These services that come under invisible items are as follows:
(i) traveling and transportation,
(ii) income from investments,
(iii) financial services,
(iv) transfer payments (private and government), and others

THE CAPITAL ACCOUNT
This part of the balance of payments account refers to capital movements in the form of investment funds and loans. The flow of international investments and loans is of both long and short term varieties. “Long term capital transfer” refers to investment with a maturity of one year or more, while the “short term” transfer means one maturing in a period of less than one year. Long term capital may be direct investment on factories, machinery or bridges. It can also be in form of portfolio investment, for example, purchase of foreign stocks, shares or bonds. Loans of one year or more are considered “long term”, while loans maturing in less than one year are called “short term”.
When the current account and capital account have been taken into account, we have balance of payments.

THE OFFICIAL SETTLEMENT ACCOUNT
A country’s official settlement account shows the charge in its liquid (cash) or non-liquid liabilities to foreign official holders and change in its official reserve assets during the year. In Nigeria Central Bank Report, this is known as “Monetary Movement”.
In international transactions involving payments, a balance must be achieved annually. This is because every export by one country is an import into the country that receives the commodity. All payments involve crediting or debiting in a country’s account, a credit balance (+) in the current and capital accounts shows a favourable balance and a debit balance (-) shows unfavourable balance. A favourable (credit) or unfavourable (debit) balance must be covered in some ways. The official settlement account (or monetary movement) shows how a country balances its current and capital accounts.

HOW A COUNTRY SETTLE ITS ACCOUNT
A settlement accounts means a change in the nation’s reserve assets, and a country’s reserve assets, and are made up of the following.
(1)The Central Bank and other monetary authorities hold stocks gold.
(2) The country also holds convertible currencies which are internationally acceptable currencies, often called the “key currencies”, for example US dollar, British sterling, German mark, Italian lire, Japanese yen, Swiss, France, and Belgium franc. (During oil boom in Nigeria, the NAIRA was almost a convertible currency. It was easily acceptable internationally for settlement of international obligation). The most important of all key currencies is the US dollar, which forms a major portion of nation’s reserves.
(3) The IMF Special Drawing Right (SDR); which refers to special accounting entries of the IMF, provide members additional supplementary reserves on which members could draw on the fund depends on the quota allotted to members. A nation can balance it accounts by using its Special Drawing Right (SDR) reserve.
(4) When a nation is a member of IMF, it is require to deposit with IMF a specified amount of its total deposits in gold or convertible currency. This is called the gold trenche position and is available to the country on demand in the event of balance of payments difficulties. Since “no strings are attached” in the use of this account to balance their international indebtedness.
(5) Other ways in which countries can balance their accounts are through borrowing from other countries or from other bodies such as the IMF.
(6) Countries can also purchase goods on credit as a means of balancing their accounts.
(7) A country can also sell foreign investments to balance a debit balance.
(8) When a country has a favourable balance of payments, that is, credit balance on current account, the country can receive gold and convertible currencies. It may also increase its investments abroad, as a means of balancing its account.

BALANCE OF PAYMENTS DISEQUILIBRIUM
A state of disequilibrium occurs in the balance of payments when an adverse or unfavourable balance results in movements in short-term capital and/or adjustments to reserves. Disequilibrium has two aspects: surpluses and deficits. A country is said to have a surpluses and deficits. A country is said to have a surplus in the balance of payments if its income flow exceeds its expenditure flow. On the other hand, a deficit or debit in the balance of payments means that the country’s expenditure flow exceeds its income flow. A deficit or debit balance is of two kinds: temporary and fundamental. A deficit is temporary if it can be corrected or adjusted within a short time. It is persistent if it is of long duration. If it is not corrected, reserves will run out and other countries will lose confidence in the country; as a result, such a country will find it difficult in raising external loans for the development of its economy

CAUSES OF PAYMENTS DISEQUILIBRIUM IN THE BALANCE OF PAYMENTS
The following are the main causes of disequilibrium in the balance of payments:
(1) Excessive importation of goods and services,
(2) Deficiency in domestic output,
(3) Inadequate patronage of home-made goods which are regarded as inferior goods, and
(4) High level of importation of technical know how in developing countries.

BALANCE OF PAYMENTS ADJUSTMENTS
One or more of the following methods can correct a deficit in balance of payments.
1. Restriction of Debit Items and Encouragement of Credit Item
The restriction of imports and other debit items can be achieved by the use of import duties and quotas. The encouragement of exports and other credits can be promoted through subsidies and concessions as well as by an increase in interest rates.
2. Borrowing
A country with a deficit or debit balance can borrow to correct the deficit. This is an economical acceptable practice, provided the loan is able to generate and accelerate economic development of the country and, thus, provides a means of paying back the loan.
3. Selling Investments Abroad
This will enable the country to acquire the foreign exchange it needs to pay for its imports.
4. Transfer of Gold
Countries maintain reserved gold to enable them to cover deficits, which are likely to occur from time to time in their balance of payments.
5. Adjustment through Exchange Control
A country, which has a balance of payments problem, may restrict the supply of foreign exchange. For example, exchange control measures in Nigeria in 1984 required that all imports, except prohibited goods, be subject to specific import licenses.
In addition to foreign exchange restriction, a country can intervene in the foreign exchange market by fixing its own rate.
6. Adjustment through Devaluation
Devaluation means a fall in the exchange value of a country’s currency in relation to the currencies of other countries. Devaluation can be commended only if export and import elasticity are greater than one to be favourable and less than one to be unfavourable.
Devaluation cheapens exports and makes imports dearer, thus improving the balance of payments. For devaluation to be effective, the demand for the devalued exports should be elastic. Devaluation is always resorted to when a country is faced with persistent or continuous deficit in its balance of payments.
In depreciation, the currency under pressure is allowed to slide gradually; while devaluation is a sharp, definitive downward revision of the value of a country’s currency. For example, a country devaluing its currency by 20% announces to the world that its currency is only 80% of former value. The exchange rate then automatically changes by the same percentage.
7. Depreciation of Foreign Currency
Depreciation of currency is applied when exchange rate is flexible. It is a downward adjustment of the value of the currency in terms of other currencies. Depreciation makes imports more costly and lowers the value of exports since foreign currencies will be more expensive to buy and domestic currency cheaper for foreigners. For example, in September 1981, the Nigerian naira exchanged for 0.8058 British pound sterling. In 1987, after the naira was allowed to slide against foreign currencies in the wake of disequilibrium, the Nigeria naira in the second-tire Foreign Exchange Market was exchanged for 7.1112 British pound sterling. The value of naira in terms of British pound sterling had fallen by 783%.
This means that in 1987, you required about N8 to buy what could have been bought with N1 in Britain in 1981. This was the effect of depreciation of currency. As a result, not many Nigeria could afford to import from Britain or from other countries since the Nigerian naira was low in value in terms of other currencies. Foreign Exchange had become very dear to obtain.
The depreciation of the naira on the Foreign Exchange Market was one of the measures of the Structural Adjustment Programme (SAP), adopted by Nigeria to solve its balance of payments disequilibrium.
8. Errors and Omissions
All international economic transactions are recorded as credit and debit in the balance of payments. Theoretically, in double-entry bookkeeping, total credit should equal total debits. Therefore, in the balance of payments accounting, the entries in the three accounts should be equal. In practice, because of recording errors and omissions, the equality in credit and debit entries is hardly attained. As a result, “Errors and Omissions” entries are recorded to balance the overall account.
In Nigeria’s 1975 balance of payments, a balancing item of (-26.2) million naira was recorded to balance the overall account. This is officially known as “Errors and Omissions”.

NAIRA SLIDE IN INTERNATIONAL MARKET
Nigeria’s economic crisis was due to structural imbalance in the economy, caused by the oil boom in the 1970s. The weakening of the international oil market, which began in mid-1981, worsened the problems caused by the structural imbalance. Nigeria declared a state of economic emergency in October 1985.
As the country had rejected the International Monetary Fund’s (IMF) offer of a loan, it decided to embark on a structural adjustment programme which it was convinced would produce effective and more lasting solutions to its basic economic problems. The Structural Adjustment Programme (SAP) was lunched in January 1986 by the government to revamp or help the economy to recover quickly.
The SAP had three main objectives to accomplish, namely:
(1)To restructure and diversify the productive base of the economy in order to reduce dependence on oil sector and imports.
(2)To achieve a fiscal and balance of payments viability over the medium and long term.
(3)To lay the basis for a sustainable non-inflationary growth over the medium and long term.
The programmes initiated included measures to find a more realistic value of the naira, reduce import dependence, make economy less dependent on a single product for Foreign Exchange earnings and promote greater reliance on local raw materials for better industrial development. The SAP was, therefore a more stringent version of the austerity measures instituted by the Nigeria Government in 1984. It thus, emerged a rationalization of import and excise tariffs, the recommendation to disband the Commodity Boards and the introduction of the Second-tier Foreign Exchange Market. Other policy measure included the rescheduling of the nation’s debt, programmes for improving internal revenue generation and the implementation of new but improved counter-trade arrangements.
The key element to the implementation of SAP is the Second-tire Exchange Market (SFEM). It commenced operation on 29 September 1986. Essentially, the intention of SFEM was allow the naira find its value in free competitive market in relation to the major international currencies. In order words, market forces of supply and demand in the open market should determine the value of naira. It was believe that the system would render various bureaucratic controls like import licensing unnecessary, and assist in a more rational allocation of the country’s financial resources. It was also believed that the SFEM would encourage those companies whose products had a high local content. It was expected, too, that exports of commodities and, to some extent, other local products, would expand and there would be a rapid expansion of agriculture generally.
The initiators of SFEM were of course aware of some of the advantage and disadvantages. The envisaged advantages are that it would reduce the nation’s dependence on imports of flour, fibre materials and consumer goods and, redirect production towards the use of domestic raw materials; and secondly, that it would readjust the gross imbalance in incomes and welfare between the urban and rural regions. In this respect, agricultural exports and domestic substitutes of imported food items, raise rural income and encourage more farmers to expand agricultural production would also make available to home industries local raw materials and reduce their dependence on imported substitutes. Thus, the expected greater inflow of foreign resources as exchange rate became more realistic, would be used to finance the importation of essential capital goods and complementary industrial inputs spare parts. This would enable industries to increase the utilization of their installed capacity and generate more employment, since employers would be able to recall retrenched workers.
Some unpleasant side effect (disadvantage) of introducing SFEM envisages include: there would be an initial rise in prices of imported goods. However, the expected increase in production would eventually stabilize prices to a reasonable level. Also, imported consumer goods would cost more, because the essence of SAP is to make consumers, especially the urban elite, adjust their consumption habits in favour of home-produced goods and services and also, generally, to concentrate on essentials rather than on luxuries.
However, in September 1987, just a year after the introduction of SFEM the prices of both domestic and foreign consumer and capital goods have risen out of proportion. In an effort to make naira to find its level or value in the open market, the naira has depreciated to N4 = US$1 or N6 = £1 approximately. Since the introduction of SFEM, the value of naira kept creeping and fluctuating; and increased year in year out, presently, the value of naira to US dollar is approximately N120 to US$1; also the value of naira to British pound sterling is about N230 to £1.

CHAPTER THREE

CONCLUSION AND RECOMMENDATION
In order to find a realistic value for naira, there is need to reduce rate of dependence of foreign goods that has a close substitute, make the economy less dependent on a single product for foreign exchange earnings and promote greater reliance on local raw materials for better industrial development. The dominance of petroleum in the Nigeria economy has led to instability in the economy, national development plans and budgets. There is need to restructure and diversify the productive base of the economy in order to reduce dependence on the oil sector and import. The development of the oil industry has led to the neglect of the agricultural sector. Efforts should be made to revive the agriculture since Nigeria has vast land for its agricultural base.

The development on infractural facilities including roads, railways, power (electricity), irrigation system etc will help the local industry to grow. If the country can be self sufficient, he will be able to generate foreign income from excess. This will strengthen the naira and give it a good place in international trade.

A TERM PAPER PRESENTED
(BY AGWANIHU EZINWANE FABIAN)
IN PARTIAL FULFILMENT OF THE REQUIREMENT FOR THE AWARD OF B.ED DEGREE IN ECONOMICS/EDUCATION IN DEPT. OF EDUCATION ALVAN IKOKU COLLEGE OF EDUCATION OWERRI, IMO-STATE.
(AUGUST, 2008)

published by Tope And Ezinne