Currency shocks in the real world

The oil shock of 2014 wreaked havoc on the Nigerian economy, especially through its effect on the Naira. We all remember how the story went. Crude oil made up a significant portion of Nigeria’s exports. The crude oil price crashed, which meant Nigeria’s export revenue crashed, which put the currency under immense pressure.

The policy debate that followed was very lively. Should we devalue, or should we not devalue? Should we restrict some imports and ban others? Should we allow markets to adjust and accept whatever happens after the adjustments? In the end, we opted for a series of sharp adjustments after a set of false starts which exacerbated the problem of pressure on the currency, allied with a combination of de facto import restrictions. The result was that between January of 2014 and now, the currency depreciated by about 120 percent, worse than any currency bar that of Venezuela.

In theory, the effects of sharp currency adjustments are clear. The economy suffers, something we experienced in practical terms, with the first major economic contraction in at least 25 years. The overall contraction however, hides what are really a varied set of reactions by different industries to the currency shock and the consequent policy changes. From this context, this report by the Foundation for Partnership Initiatives in the Niger Delta (PIND) tries to uncover some of the responses in particular industries, specifically focusing on aquaculture, cassava, palm oil, and poultry.

Sharp currency devaluations typically affect industries through prices. Prices of imported raw materials and other components go up, and prices of imported competitor products go up as well. Depending on the interactions between these various prices, domestic firms either expand and may or may not become more productive. These interactions are uncovered very clearly in the report. In all the sectors examined, input costs went up. Energy prices went up, cost of credit went up, fertilizer costs went up, and other specific input costs went up as well. Interestingly, input costs were up even for locally manufactured inputs, such as fish feed for aquaculture. Although, in some sense, it is not really surprising given that those local input suppliers also have input costs that have been affected by the currency movement.

The increase in input costs naturally implies that market prices for those goods have risen as well. However, the effect of this is expected to be mixed. Increasing market prices should lead to falling domestic demand, with customers opting to buy less or switch to cheaper alternatives. However, at the same time, locally produced goods should become more attractive to international markets, as they should be significantly cheaper than before, depending on the size of the currency movement. The report does show this diversity of response to increasing prices. In the aquaculture industry for instance, it suggests that demand for catfish went up, because prices for imported substitutes had gone up even higher. The same scenario is seen in the cassava industry where demand is up despite higher prices. This, according to the report, is due to even higher increases in the price of rice, a major substitute for cassava. On the flip side some instances show a switch away from the commodities to alternatives.

The most interesting bit however, is the happenings in the palm oil sector. The palm oil industry was one that benefited from de facto protectionist measures implemented by the central bank via their 41-item banned list. Prior to the ban, Nigeria imported a significant amount of palm oil, mostly as a raw material for industry. As expected, the restriction on imports has led to a relatively large increase in demand for domestic palm oil. The increase in demand has led to an increase in prices, with palm oil prices more than doubling since 2015 and palm oil firms becoming more profitable. However, the domestic palm oil industry has not been able to grow fast enough to meet the increased demand. Whereas the palm oil industry has become very profitable, the industries that depend on palm oil have borne the cost of that profitability. It is also not clear if productivity has increased in the palm oil industry. Theory tells us that is unlikely given the higher mark ups.

The most worrying thing about all the industries observed is the almost complete lack of growth in exports. Recall that a big part of the benefits to currency devaluations is the productivity growth that arises from new export opportunities. That however appears to be absent for the commodities examined and points to underlying problems in the Nigeria economy, which reforms have not addressed. That being said, the report demonstrates what most economists have suspected about Nigerian industry, which is that it is very normal. Firms and consumers respond to price movements in the way theory suggests they should respond. Hopefully this implies that conventional policy to improve productivity and kick-start exports, which is where the wealth creation really is, should be good enough if implemented.

The full report can be downloaded here.

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