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Major setback for CBN currency plans: the proposal by the governor of the Central Bank of Nigeria that the currency would be redenominated next year was seen as a logical outcome of the country's strong financial position; it therefore came as a shock when Abuja announced its suspension. What lay behind the move? Neil Ford and Anver Versi report.

Following on from Nigeria's deep-seated banking reforms and landmark debt repayment deal in 2006, the Central Bank of Nigeria (CBN) announced in August that it would make the Naira fully convertible from 1 January 2009.

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The decision should have provided more reassurance that the country's economic recovery is well on track. However, the revelation was overshadowed by Abuja's decision, which came out of the blue, to block a plan to re-denominate the Naira by August 2008.

At present, the value of the Naira is heavily regulated by the CBN, which sets a fixed exchange rate and limits exchanges with foreign currencies. Many African currencies are subject to the same controls and regulations in order to protect what are perceived to be vulnerable economies.

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In many ways, such regulation mirrors the same tight controls that many African governments impose on fuel prices: it is easy to see why it is done but tight control is a sign of economic weakness rather than strength.

The CBN currently sells foreign currency by auction and Nigerian businesses are required to apply for dollars for a trade transaction, lengthening the process and adding unnecessary red tape. As a result, making the Naira fully convertible could enable much greater and more flexible flows of money in and out of the country.

The foreign exchange market was partly deregulated in February 2006, giving Nigerian citizens and banks improved access to hard currency, and the move has been widely regarded as a success.

Abuja and the CBN are obviously confident that the Nigerian economy is now sufficiently robust that foreign currency will flow into rather than out of the country under a more flexible regime.

The change would encourage investment in Nigeria and boost liquidity in the banking sector, which in turn should improve access to credit for Nigerian businesses.

The change had been expected by analysts, as Nigeria had agreed to sign up to the IMF's Article VIII, which demands that no member state restrict transfers for current international transactions.

Currencies will now be traded by the more internationally usual practice of interbank dealing. The CBN governor, Prof Chukwuma Soludo CFR, told journalists: "As the market deepens, the Central Bank will gradually withdraw from the weekly Dutch auction system and only intervene in the market as may be required to achieve defined policy objectives."

The CBN will pass oil revenues to the federal and state governments from now on in order to deepen the foreign exchange market.

This could pose some problems for state governments, which may have little or no experience in handling foreign currencies. The governor recognises that "undue appreciation" of the Naira would be undesirable and indicated that the CBN will intervene as required, although he did not reveal whether it would introduce a specific target value against either the US dollar or euro.

In announcing the plan, Soludo also revealed that he planned to redenominate the Naira from August 2008, so that 100 old Naira would become one new Naira. The value of the Nigerian national currency has declined from about N2 to the US dollar in the 1980s to around N125 to the US dollar today.

However, it has appreciated over the past two years because of the country's growing oil revenues, the rising stock market and higher Nigerian reserves of foreign currency.

The CBN believed that exchanging the Naira with other currencies would be much easier with a higher value Naira, while it also argued that Nigerians would not have to carry so many notes with them to make even relatively small payments.

The reform would enable the CBN to issue more coin denominations, leaving the N20 note as the largest denomination. At the current exchange rate, this would result in N1.25 to the US dollar.

The CBN argued that the costs of printing new bank notes would be balanced out by the need to issue fewer bank notes in the longer term.

Redenomination has already taken place in the neighbouring country of Ghana, where there does not appear to have been any great impact on prices. Many had feared that it would result in much higher inflation, as vendors took the opportunity to increase prices before consumers could adjust to the new rates.

Clash with Abuja

However, Nigeria's minister of justice, Michael Aondoakaa, quickly responded by announcing that he was freezing the redenomination process because President Yar'Adua had not yet given his written permission for the move.

It seems odd in the extreme that Abuja would seek to block the plans, given that the CBN revealed that it had discussed the plans with the federal government prior to its announcement and that a former CBN insider, Soludo's ex-deputy governor at the CBN, Dr Shamsudeen Usman is now finance minister.

At the end of August, the Bank governor said: "The Board of the Central Bank of Nigeria recognises and reaffirms Mr. President's approving authority in matters relating to the denomination, forms and design of our national currency, as enshrined in Section 19 of the CBN Act 2007. The Bank therefore accepts Mr. President's decision to suspend the implementation of the redenomination aspect of the Strategic Agenda for the Naira."

President Yar'Adua quickly moved to reaffirm his confidence in Soludo. According to a presidential adviser, the president "retains his trust and confidence in the competence and ability of Professor Chukwuma Soludo to manage the CBN professionally, efficiently" and "recognises and will continue to respect the autonomous powers granted to the board and governor of the Central Bank of Nigeria by the CBN Act, 2007."

He added: "There is no confusion at all. There is really no big deal about what is going on. The point is that the Central Bank has autonomy over monetary policies but it is the responsibility of the federal government to manage its physical policies. But what happened over the redenomination is that the Central Bank went beyond its powers and the issue has been resolved."

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The most charitable explanation for the dispute is that the lines of communication between the Central Bank and the Presidency have not yet been fully developed following the elections.

In addition, there appears to be some doubt over the full extent of the CBN's authority following the introduction of the CBN Act, 2007. However, it remains to be seen whether the redenomination process will now be permanently abandoned or whether it has simply been suspended for a period to signal Abuja's early displeasure.

Heart of the process

Major steps have certainly been taken to overhaul the Nigerian banking sector and economy over the past four years. Prof Soludo has been at the heart of this process and his radical reforms have brought global credibility to Nigerian banks where some Nigerians feared, prior to his appointment as CBN governor by President Obasanjo, that the domestic banking sector was corrupt and ungovernable.

By suspending the redenomination policy on procedural alone, without serious consideration to the economic merits of the Strategic Agenda for the Naira, the government would appear to be making a big mistake, both domestically and internationally.

Following an unprecedented campaign by the CBN to showcase Nigeria's investment and banking reforms globally, Nigerian banks have just recently started to form global banking partnerships. Many of these have not yet been signed and sealed. In this context, any signal that the reforms might be running out of steam could undo all the good work that has gone before.

Nigeria's strategic goal of becoming a global economy by 2020, (See African Business, August/September 2007) will also be setback if Abuja is perceived to be trying to force the CBN governor from office. The pressured exit of former finance minister Dr Ngozi Okonjo-Iweala, who worked tirelessly for Nigeria's debt relief and who was widely respected internationally, was seen as a damaging own-goal by the Obasanjo administration.

Even this small gesture is already causing ripples in the international financial community. It is raising concerns that politics may once again be intruding on practical economic governance. More critically, it is also being perceived as a sign of weakness from the new administration of Yar'Adua--a perception that may halt or at least slow down the rate of investment now flowing into Nigeria.

RELATED ARTICLE: Currency

Redenomination and what it means

Over the past 47 years, several governments around the world have redenominated their currencies for a variety of reasons. In Africa, the latest to do so were Ghana and Zimbabwe--in the case of the latter it was a coping measure in the face of rapidly rising inflation.

In the case of Ghana and Nigeria, the aim was more practical. Countries seek to redenominate their currencies either because of rapidly rising inflation or because the purchasing power of a currency has gradually eroded over time so that to make the same purchase as one did, say 10 years ago, one would have to carry a stackful of currency notes. It this situation, the lower denominations often become meaningless since they can purchase nothing.

Redenomination in such cases is a mechanism to adjust the nominal value of the currency to reflect its real purchasing power. It also allows the standard unit of currency, say one Naira, to be effectively split into usable smaller denominations. An added benefit is that the redenominated currency would also achieve a parity of sorts with strong foreign currencies, making trade and exchange calculations much simpler.
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Title Annotation:AFRICA'S TOP 100 BANKS; Central Bank of Nigeria
Comment:Major setback for CBN currency plans: the proposal by the governor of the Central Bank of Nigeria that the currency would be redenominated next year was seen as a logical outcome of the country's strong financial position; it therefore came as a shock when Abuja announced its suspension.
Author:Ford, Neil; Versi, Anver
Publication:African Business
Geographic Code:6NIGR
Date:Oct 1, 2007
Words:1567
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