Like an ill-fated flight, the Central Bank of Nigeria’s plan to re-denominate the naira ran into stormy weather. It was aborted suddenly on presidential orders soon after take-off. Critics of CBN Governor Chukwuma Soludo say this was the inevitable end of a needless journey. But the question remains: what is the next move for the naira?

 

Barely three years after he launched a round of banking consolidation that stunned Nigerians by its success, Soludo embarked on yet another ambitious venture. On August 14 he announced an ambitious plan to give Nigeria a new currency, liberalize the foreign exchange market and link Nigeria's interest rate policy to a specific inflation target.

 

The most controversial point of his Strategic Agenda for the Naira, was a plan to knock two zeroes off the value of the currency by August 2008. One new Naira would have been worth 100 the Naira we use today. For those who love to express it in terms of motion, this would have meant moving the decimal point (yes, the naira is a decimal currency) two places to the left. 

 

Today there are about 126 Naira to every US dollar. Assuming the exchange rate remained constant, the new Naira would have started trading at 1.26 Naira per dollar in a year’s time.

 

But this is not to be – at least for now. President Umaru Yar’Adua stopped the professor of economics in his tracks, claiming ignorance of the move to issue a new currency before it was announced. He also doubted the real benefits of the policy, if implemented.

 

“In the present circumstance, the president is not convinced of the merits of the naira re-denomination plan put forward by the CBN without appropriate regard for the present Administration’s insistence on due process and the rule of law,” the president’s official spokesman said in a statement.

 

The central bank quickly bowed to the president’s orders. “The Board of the Central Bank of Nigeria (CBN) recognizes and reaffirms Mr. President’s approving authority in matters relating to the denomination, forms and design of our national currency, as enshrined in Section 19 of the CBN Act 2007,” the CBN said in a statement 24 hours later, announcing the suspension of its plans to issue a new beefed up Naira..

 

Soludo had planned to underpin the long-term strength of the new Naira with two key policies: the abolition of all restrictions on converting the Naira into foreign currencies and transferring money abroad and an interest rate policy aimed specifically at keeping inflation in check.

 

These two pillars of his currency reform remain in place for the time being, but they too are also starting to come under critical scrutiny.

 

New Zealand became the first country in the world to instruct its central bank to set interest rates in a way that would enable keep inflation within specific limits in 1989.

 

Since then, inflation targeting has been adopted as a strategy by several of the world's leading economies. It is now used by the European Central Bank, which manages the euro, the common currency of 13 European countries, the Bank of England, Brazil, Canada and South Africa, among others.

 

In Britain, for example, the Bank of England has been ordered by the government to target an average inflation rate of 2.0 percent. Its monetary policy committee meets every month to decide whether the minimum rate at which the Bank of England lends money to commercial banks should be raised or lowered in order to meet this target. It even publishes details of its votes so the markets can guage whether or not there is a division of opinion on how to proceed. At their August meeting, the nine members of the committee decided unanimously to keep the Bank Rate steady at 5.75 percent.

 

The Central Bank of Nigeria's minimum lending rate, which until now has been reviewed every three months, is currently set at 8.0 percent.

 

Mike Obadan, a professor of economics at the University of Benin City, in mid-western Nigeria, says inflation targeting has its merits as a tool for keeping a lid on inflation. But he argues that it has nothing to do with the issue of a new currency. “On its own, there’s nothing wrong with (inflation targeting). But currency redenomination has nothing to do with it,” he said.

 

There are two key aspects to inflation targeting. First, the authorities must decide on a policy framework that allows the central bank to use a short-term interest rate that underpins its lending to commercial banks to keep inflation rate within an agreed range. Typically, the inflation target set is in the rage of  1%-3%. That compares with an average inflation rate of between four and seven percent in Nigeria in recent months.

 

 The other key component of inflation targeting is a communications strategy through which the central bank keeps the public informed of its actions to help direct inflation expectations in the economy.

 

The Bank of England, for example, publishes the minutes of the meetings of its monetary policy committee which explain its thinking. It also publishes a Quarterly Inflation Report four times a year in which it analyses how the economy has performed and how prices are likely to evolve in the months ahead.

 

However, any decision to give the central bank greater autonomy to set interest rates must always come from the government.

 

US President George W Bush has been reluctant to take such a step. This explains why the Federal Reserve Bank of America has yet to begin an explicit policy of inflation targeting, despite the outstanding anti-inflation work of former chairmen such as Paul Volcker and Alan Greenspan and the enthusiasm for inflation targeting of the Fed’s  current chairman, Ben Bernanke.

 

What was curious about Soludo’s announcement that Nigeria would soon join the growing band of countries using a specific inflation target as a guide for setting interest rates was that neither President, nor the Finance Minister had made any announcement in advance, authorizing the CBN to embark on this radical new policy.

 

Some governments fear that locking interest rates into an inflation target is too rigid a strategy. They fear it could compromise other aims of the economic policy such as stimulating growth and reducing unemployment.

 

But Bernanke disagrees. “I am not aware of any real-world central bank …that does not treat the stabilization of employment and output as an important policy objective,” he said in a paper in 2003, long before he became the Fed chairman.

 

This political dimension of monetary policy was evident in the naira redenomination debacle. Although Yar’Adua said through his spokesman that he did not know about the plan before hand, he came under mounting political pressure to veto the move. It was even disowned by his predecessor, Olusegun Obasanjo, who had authorized so many other last minute controversial decisions before bowing out at the end of May.

 

Soludo said he was acting on the basis of the new CBN Act, especially Section 2, which provides, in part, that the functions of the CBN shall be to “ensure monetary and price stability, (and) to issue legal tender in Nigeria.”

 

But Yar’Adua’s official spokesman,  Segun Adeniyi , pointed out that this Act was one of those signed into law by Obasanjo in the twilight of his administration. And such laws, he  explained, were being reviewed by the minister of justice, on the orders of the new president.  

 

Some of those last-minute actions of Obasanjo’s administration, such as the sale of two oil refineries to a close associate of the former president and an increase in value added tax (VAT), have already been revoked.

 

It is thus plausible, some observers say, that the decision to halt Soludo was not only because he failed to get the president’s go-ahead, but also because of the government’s determination not to be seen to be toeing the line of the previous administration.

 

Soludo said that the redenomination of the Naira  was part of a much broader reform programme that has already led to a major restructuring in the banking sector..

 

“The thrust of the agenda focuses on the Naira as our national currency---- to realign its denominations, ensure its stability and global integration. These will help to deepen the reforms of the financial system and national economy, and make the Naira the currency of reference in Africa thereby facilitating our quest for international financial status,” the governor said.

 

Soludo said his proposed currency reforms would make Nigeria fully compliant with Article VIII of the International Monetary Fund's (IMF). This requires that: “no member shall, without the approval of the Fund, impose restrictions on the making of payments and transfers for current international transactions.”

 

However, some economists said it was unnecessary to lift all restrictions on the Naira's convertibility, given the progress already made in easing restrictions on financial transfers related to external trade.

 

“I think we have done much in this area and also in the area of capital account,” said Obadan. He noted that the Nigerian foreign exchange market is already liberalized: anyone can go to the market and buy foreign exchange and take away from the country.

 

Once it was a crime to take out or bring in any amount of foreign currency into the country without formally declaring it. These rules have been greatly relaxed, although travellers entering and leaving Nigeria are still supposed to declare if they are carrying more than US$5,000 in foreign currency.

 

Obadan says perhaps the central bank simply aims to remove whatever residual restrictions remain, but he warns of the danger in doing this because it could pave the way for a panic run on the Naira in the event of a crisis of investor confidence.

 

“If we remove completely current account and capital account restrictions, we may put pressure on the foreign reserves,” he said.

 

Soludo also hoped to reduce the Central Bank of Nigeria's dominant role in the foreign exchange market by sharing out part of Nigeria's oil revenues to the Federal and state governments in US Dollars rather than Naira. This policy, which was due to take effect from September 2007, would have made the Federal Government and the 36 state governments independent players in Nigeria's foreign exchange market, alongside the CBN and commercial banks.

 

Obadan says this move, like the complete liberalization of currency movements, would only cause trouble in a country where corruption is rife. “More participants sharing in the foreign exchange market may be problematic in our circumstance. It will work well where there is good governance, but this is not the case in Nigeria.”

 

Early in Obasanjo’s administration, Nenadi Usman,who was then Minister of State for Finance and later became Finance Minister, alleged that state governors were remitting their monthly budget allocations abroad into private accounts.

 

Usman substantiated her claim with a correlation between movements in the exchange rate of the naira in the black market, and the time of the release of the allocations to state governments. According to her, the value of the dollar always rose on the black market immediately after the state governments received their money, as the governors, through their cronies, flooded market with naira to buy foreign currency.

 

Anyone who doubted the veracity of Usman’s claims then must have been stunned by the number of former governors who have since been accused by the Economic and Financial Crimes Commission of illegally transferring funds abroad and acquiring expensive properties overseas. Some of these assets have been seized.

 

Soludo said phase one” of the reform programme was part of a larger design to create prosperity for Nigerians and make the country the hub of Africa’s financial system by year 2020. During this first phase of his plan, the Nigerian economy has made significant progress.

 

CBN’s statistics reeled out by Soludo indicate that deposits and credits in the banking system have more than doubled since the banking consolidation exercise began three years ago.

 

Non-performing loans have fallen from 23% of all bank loans to about 7% over the same period.

 

Since Nigeria’s banks were forced into a series mergers last year to increase their capital base, they have also acquired more muscle in financial markets. Nigeria's leading banks now finance big projects valued at hundreds of millions of dollars and also operate in the oil and gas sector --- a feat they never could have managed previously, Soludo noted.

 

The second phase of banking reform, announced in August, was due to make Nigeria’s financial system even more robust and powerful, he said. “Our specific objective in Phase Two of the reforms is to make the Naira the currency of reference in Africa, and thus a strategic catalyst for achieving the goal of an international financial centre as well as promoting Nigeria’s rapid economic development,” he explained.

 

Again, Soludo's critics faulted the move.

 

Ayo Teriba, a consulting economist, said it amounted to railroading Nigeria into the planned West African regional currency, to be called the Eco (although there had been reports that the currency could actually be named Naira). To him, the decision was not for the central bank to take.

 “Nigerians will decide what they want, and it’s the president and the National Assembly that will decide what Nigerians want,” said Teriba, who consults for private and international organisations.

 

Pointing to other countries that have ditched their own currency in order to adopt a regional currency such as the euro or the CFA franc, Teriba stressed that the decision in each case had been taken by the government at the highest level, not the central bank

 

“He (the central bank governor) is like a pilot. It’s where you want to go that he takes you to. He cannot determine your destination.”

 

Obadan says CBN’s plan to make the Naira a reference currency in Africa implies making it a strong currency, but argues that the conditions for that are absent in the Nigerian economy.

 

“If you want to make a currency a reference, it has to be strong.” That strength, he pointed out, derives from the underlying strength of the economy: how productive is the economy? It also depends on the competitiveness of the productive process, he argued.

 

These factors, Obadan said, will influence the decision by foreigners to buy Nigeria’s goods. He said Nigeria cannot compel outsiders to demand for the naira (which they need to buy the country’s goods) when they do not think that the conditions in the country warrant their buying our products.

 

 “It’s only when outsiders want to buy our goods that they will demand our naira. It’s not by fiat,” he said.

 

Dr Ndubuisi Nwokoma, a Senior Lecturer in the Department of Economics, University of Lagos, says that the Nigerian economy currently faces structural difficulties that impede productivity. These are the issues that should be addressed meaningfully by the government. He pointed out the dilapidated state of Nigeria's roads and railways and the pathetic state of its electricity and water supply systems.

 

“Once you address the problem of the real sector, exchange rate and interest rates will adjust automatically,” said Nwokoma.

 

While Soludo is clear about what he wants to achieve for Nigerians, he knows that not all of his compatriots may understand, lot alone appreciate what he is doing.

 

Speaking about his plans for financial reform with this writer, the central bank governor once said: "Sometime in the future, this era will be seen as the time when Nigerians turned the bend. We are not expecting any applause, and probably, none will come."