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Sunday, December 10, 2023

Navigating Nigeria’s currency conundrum: Revisiting the Naira’s float

Rationally assessing the decision to float the naira requires a critical examination of the economic realities and global currency markets

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By Abdulrauf Aliyu

As the new Central Bank team assumes its pivotal role in steering the nation’s monetary policy, they face a crucial decision that warrants a second look: the floating of the naira. This policy decision has been the subject of intense debate and scrutiny. Many, including myself, believe that it was based on flawed judgments, as Nobel Prize-winning economist Daniel Kahneman would put it.

In his seminal works “Thinking, Fast, and Slow” and “Noise: Flaws in Human Judgment,” Kahneman dissects the intricacies of human decision-making, revealing various cognitive biases that can lead to suboptimal choices. In this op-ed, we will explore how these cognitive biases might have influenced the decision to float the naira and why it’s imperative for the new CBN team to reconsider this approach.
Kahneman identifies two key components of flawed judgments that are pertinent to the naira’s float: overconfidence and anchoring.

Overconfidence refers to our tendency to believe we know more than we do or that our predictions are more accurate than they actually are. When considering the decision to float the naira, the former CBN governor and his team might have been overconfident in their ability to manage the consequences of such a move. They might have overestimated their grasp of the complex economic dynamics at play as well as the extent to which the market would respond. Overconfidence can lead to risky decisions, and in this case, floating the naira could be seen as a high-stakes gamble that Nigeria might not have been prepared for.

Anchoring, another cognitive bias highlighted by Kahneman, involves fixating on specific information when making judgments. In the context of the Naira’s float, the former CBN team might have been anchored to the idea that currency flexibility would solve Nigeria’s economic woes. This fixation on a single solution could have blinded them to the potential pitfalls and risks associated with such a move. Instead of considering the unique challenges faced by Nigeria, they might have been influenced by success stories in other countries with more stable economies, which could have created a false sense of security.

Rationally assessing the decision to float the naira requires a critical examination of the economic realities and global currency markets. When it comes to currency exchange, few currencies are truly on a free float in the world. The most widely traded and accepted currencies, like the US Dollar, Euro, and Japanese Yen, may enjoy relative flexibility, but they are also supported by strong economies and vast reserves. In contrast, the Chinese Yuan is managed by the Chinese government to maintain a stable value, reflecting the importance of a controlled exchange rate in the global context.

So why did the former CBN governor and his deputies decide to float the naira despite the glaring challenges Nigeria faces? One possible explanation could be a misjudgement of Nigeria’s economic position. Floating a currency is most effective when a country has ample foreign reserves, a balanced trade account, and a stable economic base. Nigeria, unfortunately, does not meet these criteria. With low foreign reserves and a trade deficit, the decision to float the naira may have been based on overconfidence in its potential to solve these underlying issues. This decision, however, might have inadvertently exacerbated Nigeria’s economic problems.

As a strategic measure, the new Central Bank team must urgently address the backlog in the foreign exchange market. The unresolved commitments in the market have eroded confidence and weakened the naira. Market participants operate in a fog of uncertainty, not knowing when or if their commitments will be met. This lack of clarity amplifies the cognitive biases discussed earlier, making rational decision-making nearly impossible.

The new team must take decisive action to restore confidence and strengthen the naira’s value. Clearing the backlog of approximately $6.8 billion of swap deals, forward contracts, and commitments by airlines is crucial. Delayed or defaulted commitments not only harm the credibility of the market but also undermine faith in Nigeria’s financial systems.

Furthermore, the Central Bank should halt the constant issuance of circulars and bans on various financial products. These knee-jerk reactions only fuel market uncertainty and discourage investments. The continuous regulatory changes create an unstable environment where market participants find it challenging to make informed, rational decisions.
In the absence of clear market dynamics, participants operate on speculative grounds, further distorting the exchange rate. This speculative behavior not only jeopardizes the value of the naira but also deters foreign investors from entering the market. Restoring confidence and rationality in the market is the central challenge for the new Central Bank team. To achieve this, they must ensure that market dynamics are transparent and that commitments are met promptly and fairly.

It is important to acknowledge that the decision to float the naira was not taken lightly and was influenced by a complex web of factors. The hope was that a flexible exchange rate would attract foreign investments and help rebalance the trade account. However, these aspirations have not materialized, and Nigeria’s economic challenges persist.

In hindsight, the decision might have been too hasty, driven by overconfidence, and anchored to the belief that a flexible Naira would resolve all issues. The new Central Bank team must now chart a more prudent course, address the backlog of unmet commitments, and restore market confidence.

On a final note, revisiting the decision to float the naira is essential for Nigeria’s economic stability and growth. The new Central Bank team must confront the backlog in the foreign exchange market, restore market dynamics and participant confidence, and put an end to the erratic issuance of circulars and product bans. By doing so, they can lay the groundwork for a more rational and stable currency market, enhancing Nigeria’s economic prospects in the process.

The lessons learned from cognitive biases and the flaws in human judgment, as illuminated by Daniel Kahneman, underscore the importance of revisiting this significant policy decision. It’s time for Nigeria to steer its economic ship with a steady hand and clear judgment.

Abdulrauf Aliyu
An economist and Policy Analyst writes from
45 Ashiru Road, U/Dosa New Extension

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