So I logged onto Nigerian Twitter yesterday
afternoon and found people abusing economists and
financial analysts for speaking in jargons about the
CBN’s actions. So for those who’re still confused
about what’s going on with Nigeria’s economy and
are trying to understand the implications, here’s a
simplified version. No bricklayers were insulted in
the writing of this post…at least, not explicitly.

So How Did This All Start?

First thing first, oil price fell. Why? Everyone’s
increased their production of oil and no one plans on
cutting back. In the US, shale oil’s getting cheaper,
so there’s more oil out there…and we all know what
happens when you have a lot more of a product —
price falls. When price falls, consumers are happy
and producers are unhappy. Consequently, nations
that are consumers of oil have a lovely time, and oil
producer countries …a not so lovely time.

So? What Does This Have to Do With the Naira?

Before we go on, a little info on currency and
exchange markets. It’s important to note that our
currency doesn’t exist in a vacuum. Essentially, a
unit of our currency is exchanged for a unit of
another currency. Hence the term, Foreign
Exchange or Forex or FX, for short. When we buy
products from outside Nigeria, we have to exchange
our Naira for Dollars. Your Naira is useless outside
of Nigeria. It’s why you convert your Naira to Dollars
before you travel. You want to test it? Travel to
Dubai with only Naira.
Back to the question you raised. Nigeria is fortunate
(?) to be an oil producing nation…when oil prices are
high. Presently, oil prices are not high and that’s
bad for us. Nigeria’s economy is dependent on oil
revenue: about 75% of Government revenue comes
from our crude oil sales. So when oil prices fall,
oil revenue falls too, and that’s bad for the
economy.
In the currency market, exchange rates are often
centered on the health of a country’s economy.
When the economy of a country is strong, its
currency is also strong in the foreign exchange
market. When the economy appears to be weak, its
currency loses value in the currency exchange rate.
Nigeria’s dependent on oil, so when oil prices are
weak, so our currency loses value in the foreign
exchange market. This loss of value of Naira is
called a ‘depreciation’ in currency value.
Here’s a simple example. If we began with a dollar
exchange for a Naira, both are in a sense equal.
However, once I have to give out 2 of my Naira for
just 1 of your dollar then the value of Naira has
fallen. In the past months, the exchange rate was $1
dollar to roughly N150. Thanks to depreciation and
eventually devaluation (we’ll get to that later), it’s
now $1 to N168.

Alright. I Get the Currency Part, But What Does
Our External Reserves Have to Do with our
Naira Value?

To explain this, we’ll have to look into what the
External Reserves is and why it exists. Think of your
External Reserves as a Savings account where you
put some portion of your salary every month. That
money gets saved for something later: paying your
children’s university fees, buying a house, or
importantly, in case things get bad in the future
(perhaps you lose your job).
Likewise, countries keep these reserves, but mainly
to safeguard the value of their domestic currency,
boost their credit worthiness, protect against
external shocks and provide a cushion for a rainy
day when national revenue plummets. When Nigeria
earns revenue from oil, it gets paid in dollars, so we
simply stash a portion of the money in our reserves.
Moreover, the reserves of oil producing countries
like Nigeria tend to benefit economically from higher
oil prices. The higher the price of oil, the more
money oil producing countries like Nigeria get to
earn and save.

So if We Have an External Reserve, Why’re We
Worried?
Well, having a bank account doesn’t mean you have
money. We have a reserve, but our money no
plenty. Nigeria has been dancing shoki with its
reserves. When oil price was high, we apparently
weren’t saving that much into our reserves. In fact,
our reserves have been on a downward trend for
years. We’ve been using our External Reserves to
keep the value of Naira stable for months. When our
currency appears to be falling, we take out some
dollars from our external reserves and purchase
Naira. Increased demand for Naira leads to
increased value of Naira, and that’s how we stabilize
our currency.
However, we sacrifice a portion of our External
Reserves to pull this off. For instance, “while the
central bank stepped in Nov. 7 to send the Naira to
its biggest one-day gain in three years, intervening
in the market has reduced foreign reserves to a
four-month low of $37.8 billion.” In the last few
months, even Russia with their large reserves had to
devalue their currency by 23%.

So is This why Everyone Was Making Noise
About CBN Devaluing the Naira?

Yes. Now there’s only so much spending from the
reserves that the CBN can do, especially given that
we’ve really sucked at growing our reserves when
oil price was in the $100 range. It’s like when your
office was paying you N100k, you were clubbing
every weekend rather than saving some money.
Then the minute your office decided to increase
your income tax, that’s when your jobless relative
comes to live with you too. So now, your salary is
not only less, it’s burning faster cause there’s an
extra mouth to feed.
The drop in oil price does not only send our currency
downwards, it also makes it difficult for the CBN to
defend our currency. It’s a double whammy.
Essentially, if the CBN keeps trying to defend the
rate at N150, it’ll burn through the reserves pretty
fast and then we’ll be screwed. So relaxing this
currency threshold to N168 means they can relax a
bit. They don’t have to keep using as much of the
reserves to prop up the Naira. If you’re still curious
on how it all works, Feyi goes into the intricacies of
devaluation in his fantastic post here.

Okayyy! I Think I Understand Now, But How
Does This Affect Me?
Like many other economic events, devalution
creates winners and losers. Let’s start with the
losers. If you generate revenue in Naira and incur
costs in dollars, this is a bad time for you. Any
activity that has you converting Naira for Dollars will
hurt you way more than a few months ago.
Let’s have a moment of silence for our Igbo brother
who will be ‘importing containers’ this christmas.
Life just got harder for them. Given that importers
have to pay for their imported goods in dollars…and
dollars just got more expensive, the cost of their
goods have increased overnight.
Same thing happens to those Behind parents who’ve
got their kids in Nigerian schools that only accept
their fees in dollars or Nigerians that have children
schooling abroad. If you like flying, shopping or
doing anything abroad, your cost of doing so has
risen. On the contrary, if you earn in dollars and pay
in Naira, life is looking pretty good at the moment.
Exporters also benefit. The fall in value of Naira
means more exports because our exports have
gotten cheaper. But ermm…what exactly are we
exporting?

Phew. So It Doesn’t Affect Me Like That
Don’t be so sure. Nigeria’s an import-dependent
nation, which means that most of what you purchase
is produced abroad. I heard we import our toothpick
too. If the prices of imports have risen, trust your
Nigerian brothers and sisters to increase their prices
too…leading to what’s popularly known as inflation.
I Was Hearing All These Oversabies Saying
CRR, MPR. What Does This Mean?
CRR stands for Cash Reserve Ratio. It’s the
proportion of what a bank can lend, to what it has in
its coffers. So if the bank has N1000 and its ratio is
50%, can only use 50% of that money (N500) for
business. Given that awon banks do not mess
around with profit making, they will make sure that
N500 brings back maximum profit. Banks are like
the servant in Jesus’ parable that got 10 talents from
his master, not the lazy one that got 1 talent. So to
make max profit off the N500, they will raise interest
rate if you want to borrow their money.
MPR stands for Monetary Policy Rate. The Central
Bank uses the MPR to control base interest rate. The
higher the rate, the less money in circulation. How?
If interest rate is higher, will you borrow money from
the bank knowing that you’ll pay much more later
on? Nope. Instead, you’ll take your money from your
pocket and give it to the bank, so they’ll make you
more money.
Remember that thanks to devaluation, awon boys
will be increasing prices left and right. General price
increase in a given period leads to inflation. To
tackle this, CBN increases CRR and MPR to reduce
demand for money. This way, they prevent
inflationary rise.

Okayy. I think I Understand That Part, So
What’s This Austerity Thing Aunt Ngozi was
Talking About?

That one is another long story. So, we’ve all been in
situations when we’re broke. Ok, maybe just some
of us. We adjust our lifestyle around the middle of
the month when our salary hasn’t been paid. You go
from eating jollof rice to drinking garri. When friends
tell you to come out and party, you form ‘I’m very
busy’.
Nigeria’s proposed austerity measures are similar…
except on a grander scale. To cushion the effect of
the falling crude oil prices, we have to cut back on
spending and quite literally tighten our belts. The
Government is cutting back on wastage (less
government traveling and all that sort). The
Government’s also raising taxes on luxury goods
such as private jets, yachts and champagne.
Somewhere in this luxury tax is the amusing
observation that the revenue from taxes on the rich
will still go back to the rich.
For the proletariat, the sweet subsidy you enjoy
when you fuel your car will also get cut. Prepare to
pay more for fuel. This is a good thing. Subsidy has
to go anyways.

Wow. That was Long. So, Any Lesson to Learn
from All This?
Yes. First lesson: Nigeria is the most reactive and
least proactive nation you could’ve been born into.
This isn’t the first time oil prices have fallen.
Government should’ve gotten used to fluctuating oil
price and prepared accordingly. And, since oil is the
figurative oil in Nigeria’s economic engine, judicious
and prudent management of oil revenue should’ve
been practiced. However, we largely mismanaged
our wealth during the time of booms and we’re now
trying to behave ourselves in the time of slump.
Let’s see how that goes.
The second lesson to be learnt is that we should’ve
diversified our economic sources of revenue a long
time ago to prevent price shock of primary products
from affecting us drastically. Also, State
Governments should’ve been pressured to increase
their internally generated revenue much sooner. We
can’t keep reacting to every economic shock that
hits us.

Anyways, this is getting too long and no one
probably got to the end, so no need for a witty or
wise ending. But, if you reached this point, congrats!
After spending all that time reading this, make sure
you show off your new macroeconomic knowledge
to your friends. And please, stop abusing econ-
nerds. We have feelings too. Selah.

naijanomics.me/2014/11/26/the-bricklayers-explanation-to-oil-price-fall-naira-devaluation-everything-else/

I'm not bothered, back to exportation of agricultural produce. Oh! Who remembers the groundnut pyramids

I understand better now

Thanks OP. Great explanation in simplicity. Lovely.