Of GDP Growth, Currency Valuation and Policy Choices by David Adeoye (@Fritova)

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It is not in question that the Nigerian economy has seen better times and will (hopefully) in the near future still see even better times. What is indeed troubling is the apparent misunderstanding, and sometimes, of basic economic concepts and issues even by those who should know including frontline media houses and persons in government. In the past few days, for example, Channels TV, Thisday and The Cable all reported that Nigeria’s GDP is at a 25-year low. A few weeks earlier, a minister had said, “We do not have a command-and-control economy, what we are trying to have is a planned economy.” Yes, the reader can judge the logic and validity of these statements but the fact is that when the media and public figures speak, beyond informing or ‘mis-informing’ people, there is also an educative component of public speak. In this piece, I attempt a succinct discussion of GDP growth, currency valuation, and policy choices to set each of these on a desirable course.

In national income accounting there are two primary measures of a country’s economic production activity. The Gross National Product (GNP) measures the aggregate of all production activities engaged in by citizens of a country regardless of their location or residence, while the Gross Domestic Product (GDP) is a measure of production activities conducted within the geographical boundaries of a country. The difference between the two is called ‘net income from abroad’ and could be negative or positive. In recent decades as a result of increased globalization of production, the GDP has become the preferred measure as it more accurately captures the effects and effectiveness of both fiscal and monetary policies.

The GDP is the aggregate value of all final goods and services produced in an economy within a specified period usually a year or a quarter. It captures the expenditures by households (C for consumption), firms (I for investment) and government (G for government expenditure). It also makes an adjustment for the component of that aggregate that is either produced or consumed in other countries. This is captured as ‘net exports’ and calculated as ‘exports-minus-imports’ or total value of exports less total value of imports. Imports in this sense is unit price multiplied by quantity which means significant drops in the price or production volume of major export products could result in a drop in the economy’s aggregate production.

The measurement of GDP focuses more on quantum of production while attempting to hold domestic prices constant. This is to adjust for the effects of short-term inflation and allow both cross-country and time series comparison of actual changes in production. Usually GDP over a period of time is measured using what is known as constant prices or the price level for a reference year (called the base year). In the case of Nigeria, 1984 was the base year for some time into the late 1990s. This was later changed to 1990 and remained so until 2014 when the base year was changed to 2010. Official changes of the base year to account for longer-term price movement is what is called re-basing of the GDP.

When GDP is measured at constant prices, th resulting aggregate value is called ‘real GDP’ and when it is measured at current prices (not adjusted for short-term inflation),the resulting measure is called nominal GDP. Economic growth is therefore defined as “the percentage change in real GDP”. Now when the national bureau of statistics, NBS, announced on Friday, May 20 that the Nigerian economy recorded a growth of -0.36% during the first quarter of 2016, it meant just that. Suggesting that our GDP has reached a 25-year low is patently misleading. What reached a 25-year low is the GDP growth rate!

To the heart of the matter, that Nigeria’s GDP shrank is ral cause for worry. Beyond the drop in both crude oil prices, the matter speaks volume of the quality of economic choices (or non-choices) by both the fiscal and monetary authorities in the country. GDP growth is usually decomposed into three main components: growth in labour force + growth in the stock of capital + growth in the productivity of both capital and labour. In a country where the population is estimated to grow at 2.75% per annum (0.685 per quarter), there is clearly growth in availability of labour. Hence, we can say with all confidence that this negative growth comes from shrinkage of available capital (both financial and physical) and the declining level of productivity in Nigeria’s major cities.

An aspect of capital shortage we cannot ignore is the lack of sufficient foreign currency. Yes, the government can print naira notes but can it do the same of any other currency? No. When it comes to foreign currency, we can only earn or buy. If we borrow, we’ll have to repay some day, and maybe soon depending on the tenor of the debt. With the current artificially high value of the naira (N197 to a dollar), both investors and speculators know that the naira is significantly over valued which means they will rather hold US dollars rather than convert same into a vulnerable and ‘soon-to-be devalued’ currency as the naira. If you’re in their shoes, would you sell $1 million dollar for N197 million when you know that simply by waiting for few months or a year, you can sell the same $1 million for between N260-285 million?

Formally, currency values are estimated using valuation models and based on hard facts: a country’s earnings of foreign exchange and its import demand. When a currency is determined to be overvalued or undervalued, investors and speculators expect that over time, it will find its true level. They however pay some attention to the country’s ability to defend its currency. The strongest indicator of this ability is the size of the country’s reserves of foreign currency (popularly called ‘foreign reserves) relative to its monthly import bill. A country with reserves large enough to support over 12 months of import has a larger capacity to defend it’s currency than one whose reserves can barely support 4 months of import demand. Hence when foreign currency earnings are low, and the foreign reserves are small, investors know that it’s only a matter of time for a depreciated currency to be formally devalued! All the tough talk and grandstanding notwithstanding.

During the intervening period, foreign investors will ‘technically starve’ such a country of foreign funding and would you blame them? When you invest in a country, you’re taking on both currency risk and market risk. So if the market goes up 15% in 6 months you’ve done well but not if the currency goes down 30% or even more over the same period. So if you’re the investor, what would you do? The consequence of all this is that Nigerian producers have very limited access to foreign currency to import vital equipments and production inputs. And the result is scaled down operations and shut-down of factories and loss of jobs. There is also the added impact of investors who were already here but who have decided to take their funds out (again in dollars). If I must mention, the Yuan deal with China will make no lasting difference unless we have items to export to China on a sustainable basis. Why? The problem is not with the dollar, it is with the naira. So yuan is no cure. And by the way, Nigeria is not short of dollars so to speak. We are short of foreign currency in whatever name it is called.

In addition to the capital matter are inefficiencies in most of our cities: the endless fuel queues (intermittent for nearly 9 months), the lack of sufficient grid energy (we reached zero megawatts transmission at least 5 times in the past 90 days), the absence of efficient mass transit in the face of urban congestion with hundreds of thousands of man hours expended on commuting or driving within our cities. And then there is the issue of renewed militancy in the Niger Delta. Hmm! We couldn’t have expected that all this would not one day catch up with our productivity and growth. Surely it would. And really, it has. There are only about 39 days to the end of another quarter and there is not much to suggest that it would not be another quarter of negative growth by which time the economy would officially be in a recession- the first to be witnessed by most Nigerians younger than 30.

I do hear policy makers continue to say the economy’s fundamentals remain strong. True that is not in doubt. Yet to keep bragging on a bright future without making the hard choices and the sacrifices to realize the promise will only keep that potential where it rightly belongs- in the distant future.

Thank you and have a pleasant week.
@fritova.

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