Download exchange raate management in the face of global crisis

BY
FESTUS O. ODOKO
DIRECTOR OF RESEARCH AND OPERATIONS
WEST AFRICAN MONETARY AGENCY
FREETOWN, SIERRA LEONE
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Introduction
Exchange rate management: conceptual
issues
The global economic crisis and implications
for developing countries
Nigeria’s recent experience with exchange
rate management
The way forward
Concluding remarks
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The global economic crisis constitute serious
challenge to economic management
One major impact has been on the
development of exchange rates
Outcomes not limited to industrial countries
Several developing countries suffered
repercussions
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Exchange rate is the price of one currency in
terms of another.
Nominal versus real exchange rates
Appreciation versus depreciation
Two types of exchange rate regimes:
 Fixed exchange rate regime
 Flexible exchange rate regime
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Factors that affect exchange rates:
 economic fundamentals
▪ money supply, interest rates, inflation, degree of financial
development & mobility
▪ trade balances
▪ the type of exchange rate regime
▪ complementary measures e.g. Counter
▪ cyclical fiscal policy, prudential regulation, and capital
controls
 non-economic factors market expectations, rumours,
panics etc.
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The recent economic crisis initially started as
a financial crisis arising from low interest
rates and high world economic growth.
low interest rates prompted investors around
the world to search for yield further down the
credit quality curve, and high growth/low
volatility led them to overoptimistic
assessments about the risks ahead.
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The financial system developed new structures
and created new instruments that seemed to
offer higher risk-adjusted yields, but were in
fact more risky than they appeared.
market discipline failed as optimism prevailed,
due diligence was outsourced to credit rating
agencies, and a financial sector compensation
system based on short-term profits reinforced
the momentum for risk taking.
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The immediate cause was the housing bubble
in the US and expectations of increasing
values in the housing market and especially
the difficulties experienced with repaying
sub-prime mortgages in the United States of
America.
INDICATOR
GDP DROWTH
INFLATION (Y-Y)
FOREIGN RESERVES (Billion)
2003
2004
2005
2006
2007
2008
9.6
6.6
6.4
6.0
6.2
6.1
23.8
10.0
11.6
8.5
6.6
15.1
7.5
17.0
28.3
42.3
51.3
53.0
3.5
3.6
3.7
50.64
60.12
82.00
82.00
133.50 132.15
128.65
125.83
118.53
5.1
13.3
9.5
EXTERNAL DEBT (US$’ B)
OIL PRICE (US$) (Annual Av.)
EXCHANGE RATE (US$)
(Annual Av.)
STOCK MKT CAPITALIZATION
(Trillion)
28.1
129.36
1.4
36.5
2.1
2.9
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Before the crisis:
 The growth of output represented by GDP averaged
7.0 per cent over the period 2003 to 2007.
 Inflation during this period dropped sharply to 6.6 per
cent in 2007 from 30.6 per cent in 2001.
 External debt came down to less than 2 per cent of
GDP in 2007 from about 50 per cent in 2004 while
debt service to export ratio fell to 0.7 per cent.
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With onset of the crisis
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MANAGEMENT OPTIONS:
 use reserves to defend the naira
 gradual depreciation
 shock therapy i.e. rapid depreciation
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SUPPLEMENTARY MEASURES
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Reversion to RDAS
Suspension of inter-bank forex mkt
Introduction of band of +/_ 3%
Revision/ enlargement of eligible transactions under
RDAS
Under a flexible exchange rate regime there are
several options available:
-Short run response
- Medium to long-term response
In the short term exchange rate could be affected
by prudent fiscal management and market
expectations
In the medium term there is need to affect the
factors that underlie demand for and the supply
of forex
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Increase available forex by increasing
production and export – agric products,
manufactures and services including
transportation, insurance and educational
services
Reduce the demand for forex by patronizing
made in Nigeria products, by utilizing local
health care institutions, revamping
educational institutions and using local
insurance companies
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Lessons that can be drawn from the crisis
include:
-anticipate economic developments and put
in place contingency plans to mitigate adverse
ones
-collaboration needed at both regional and
international levels to tackle crisis
-need for responsible reporting
-change of mindset on the part of all
stakeholders
Final Word: we need Nigeria more than Nigeria
needs us