There seems to be a lot of confusion on the difference between the ECA and the CBN’s external reserves and what constitutes good and bad policy regarding both accounts so I am going to try to clear it up with this post.
First we have the Excess Crude Account (or the new Sovereign Wealth Fund). The point of this account is to guarantee revenues for the Government if there is a significant drop in its regular revenues. Such a drop could come from an economic downturn that reduces tax revenues to levels below expectations or more specific to Nigeria’s case a crash in oil prices. Something which happens very frequently. Good fiscal policy would be to set the budget based on a logical revenue benchmark and save all the unexpected extra revenue. Hence the ECA should be increasing during “good times” and decreasing during “bad times”. This guarantees, in our specific case, that government policy is not affected by fluctuations in oil prices. The ECA is usually domiciled outside the domestic economy to protect from domestic downturns. Basically the ECA is a glorified government savings account. At this pont it is important to note that the government does NOT mean the CBN. The government here is just the federal, state and local governments.
Secondly we have the CBN’s external reserves which is really just the physical ( or readily available) amount of foreign currency the central bank has at its disposal. Foreign exchange markets are usually very volatile and one of the primary objectives of the CBN is to ensure price and monetary stability, conditions which are ideal for economic growth. Exchange rates are ALWAYS determined by the demand and supply of any particular foreign currency and the central bank acts to stabilize these rates by either selling some of its stock of reserves to increase supply hence reducing rates or buying up some foreign currency from the market to raise rates. The point of maintaining reserves is for the CBN to have the ability to stabilize the rates. Remember the CBN cannot print foreign currency so it needs to have physical ( or readily available ) stock of foreign currency to be able to act to stabilize exchange markets. Note that the CBN cannot use the reserves for anything else. For instance the CBN cannot use the reserves to build a highway. That would simply count as the CBN selling reserves to the market and reducing exchange rates or devaluing the local currency. So from the CBN’s point of view good management of excess reserves would be a case where it has enough reserves to stabilize the markets for the near future.
Getting back to the point of the post, the CBN defending the naira (or preventing the naira from appreciating) is completely different from the FG running down the excess crude account. The central bank intervening in the exchange market is really very normal especially in countries like Nigeria where the bulk of foreign exchange comes from a single source. Also considering that the actual amount of excess reserves has been relatively stable since the beginning of the year then defending the naira is really a non-issue. The FG running down the ECA during a period when the oil price is way above the budgeted benchmark is what we should be protesting against.
Update: A reader asked if there was a relationship between the ECA and the CBN’s external reserves. There is a link. Withdrawals from the ECA should actually boost the CBN’s external reserves. A $2bn withdrawal for example is equivalent to a random foreign company x spending $2bn in Nigeria which implies more dollars entering the local exchange market further implying that the CBN, if it was trying to stabilize the currency, will have to buy some dollars from the market or on the flip side not sell as much dollars on the market as it would have. Since the FG is the party spending in this case the dollars probably just go directly to the external reserves stash with the FG spending the Naira equivalent. In practice however the effect is not that severe. The ECA has dropped from a reported $4bn in april 2010 to $500mn in aug 2010 and has reportedly risen to $6.9bn in July 2011 ( although I don’t believe it). The external reserves has however hovered around $33bn during the period. I doubt the ECA has that much of an impact on the reserves.