Naira Struggles Part 4: Blast from the Past

The year was 1979. Nigeria had just witnessed its first transfer of power from a military regime to a democracy. The dictator Obasanjo had peacefully handed over power to the democrat Shagari. There was optimism in the air. There was democracy. Oil prices were rising moving from about $3 a barrel in 1970 to about $25 a barrel in 1979 when Shagari took charge. Prices would go on to hit lofty highs of about $38 a barrel. Oil output was rising also. Nigeria had gone from a war time low of about 140,000 barrels per day of oil exports to about 1.2m barrels per day in 1983. Oil had grown to be our number one export accounting for 96% of government revenue. The government was flush with cash. In the famous words of Gen. Yakubu Gowon; “our problem was not money, but how to spend it”.

From a central banking perspective things were kept very open. Between 1970 and 1979 the Naira strengthened due to the inflow of oil dollars. The Naira (technically the Nigerian pound until 1973. Thanks Jide) exchanged at N0.71 to $1 in 1970 strengthening to a peak of N0.55 to a dollar in 1980. As expected imports expanded. Interest rates were kept low to “boost local industry”. In fact between 1972 and 1980 the real interest rate was negative. Inflation was still unstable but had dropped from a high of 34% in 1975 to 9.9% in 1980. There were technically some capital controls but they were not really enforced.

From my last post you can get a sense of what was happening. The government allowed the currency to strengthen, stuck with a low interest rate and at the same time reduced inflation. This was only feasible because there were lots of capital inflows from oil sales.

Unfortunately the unthinkable happened. The oil glut of 1980s led to a fall in oil prices. This of course meant the capital inflows that supported the “stable” monetary regime starting disappearing. A lot is known about the eventual demise of the Shagari government and the economic policies of the incoming dictator, Gen. Buhari. But not much is known about the actions the central bank took at the time to manage the situation. With respect to the Naira the central bank had kept a pseudo-floating regime before the drop, allowing the Naira to strengthen. When the crisis hit though the central bank switched to a fixed regime, refusing the devaluation of the Naira and instead implementing capital controls.

According to Pinto (1987), “the major and almost exclusive policy response until 1984 was to intensify rationing of foreign exchange. Rather than let the Naira depreciate in an attempt to restore equilibrium, it was decided to amend an import licensing system. In 1982, a foreign exchange budget constraint and a priority allocation formula were imposed on the issuance of licenses. In 1984 the licensing system was completely revised with the scrapping of the open general license (OGL) system. Prior to 1981, OGL had allowed for unrestricted importation of nonprohibited items and goods not subject to individual licensing. Further, advance import deposits, which had been imposed on goods in 1970 (lifted in 1980) were reintroduced in 1982 for all goods. For the first time, in 1982 and 1983, Nigeria accumulated trade arrears, evidence of the excess demand for foreign exchange at the official rate.

With private capital transactions and a large fraction of private commercial transactions rationed out of the official foreign exchange market, the premium on foreign exchange in the parallel (illegal) market started growing. … With an increasing fraction of legal commercial transactions rationed out of the official market, the foreign exchange market in Nigeria began increasingly to assume the appearance of a dual exchange system: an official market where the exchange rate is fixed….and an illegal parallel market where the Naira flows freely.

In the parallel market, there is a demand for foreign currency for imports to hold as an asset [aka speculators].”

All sounds very familiar doesn’t it? The consequences of this policy were that by the first quarter of 1980 the dollar sold for 77% higher than it did on the official market rising to a 400% premium in 1985 before SAP was implemented. As you would expect there was a gradual but consistent depletion in the foreign reserves. In 1980 reserves could cover 5.8 months of imports. By the fall of the Shagari regime it could cover only 1 month’s imports. (Mosley, 1992)

We know how this ended. General economic collapse. In 1981 GDP shrunk by 8.4%, in 1982 by 3.2% and in 1983 by 6.3%. The position of the regime became untenable. Then a coup, then dictator Buhari.

Unfortunately the Buhari regime stuck with the same monetary and exchange rate policies but added the military and guns to the equation. Unsurprisingly the economic contraction continued and the regime also fell. The economic contraction would not stop until the introduction of SAP and the subsequent devaluation of the Naira in 1986.
Of course you can’t blame the entire episode on the central bank. The reckless spending policies of the Gowon/Obasanjo/Shagari oil boom years played a part. So did the not so smart economic policies of Shagari and Buhari during the falling oil years. A big part of the equation though was the central banks refusal to adjust to the new reality of a weaker naira. Until it was forced to adjust overnight.

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