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Friday, Aug 06, 2021 / 8:50 a.m. / By FDC Ltd / Header image credit: Nasdaq
Exchange rate stability is a major macroeconomic indicator used to measure the performance of an economy. The Nigerian forex market has undergone significant changes over the years. The foreign exchange market went from a fixed regime in the 1960s to a pegged regime between the 1970s and the mid-1980s, and to various types of floating systems managed since 1986 (the period of the structural adjustment program) .
The country currently has multiple exchange rates (parallel, bureau de change, IATA, investor and exporter counter, but to name a few) and is currently adopting the managed floating exchange rate system. On May 24, 2021, the CBN officially replaced the official exchange rate with the more flexible Nigerian Autonomous Exchange Fixation Rate (NAFEX) in an effort to unify the country’s multiple exchange rates. This replacement means a technical devaluation of the naira of 7.56% at the NAFEX rate (410 N / $) compared to the previous official rate of 379 N / $.
However, the exchange rate remained volatile in the parallel market, driven by speculative activity and panic buying. Uncertainty over the CBN’s foreign exchange policy not only prompted profiteers to act, but also kept investors at bay, stopping REIT inflows.
Exchange rate volatility and its impact
Two sectors very vulnerable to exchange rate volatility are trade and manufacturing and both have a combined contribution to GDP of 25.54% .5 Nigeria is an import dependent country, which makes it highly vulnerable to volatility of exchange rates. In the first quarter of 2021, Nigeria’s total import bill was 6.85 billion naira compared to 2.91 billion naira in export earnings. Rising world prices coupled with the depreciation of the naira made imported goods more expensive, resulting in a higher import bill for the government. It has also led to an increase in the cost of domestically produced products, as manufacturers pass the cost burden on to consumers in the form of higher prices. CBN’s forex rationing has prompted many manufacturers to adopt a blended exchange rate to meet their currency needs. Also due to foreign exchange shortages and the high cost of imported items, the trade sector has been affected as retail and wholesale traders find it difficult to stock up according to their inventory levels. As a result, many imported items are either scarce or very expensive when available.
Go forward
There are two options that the CBN could adopt in its forex reform path. One is full convertibility of the naira and the other is the adoption of a sliding parity and gradual convergence of multiple exchange rates.
Both options have their pros and cons. While full convertibility of the naira will have a positive impact on the country’s trade balance, which is in deficit of 3.94 trn7, Nigeria’s capacity utilization remains low. Countries that benefit from a fully convertible exchange rate have a high export base and can increase their exports to take advantage of the weaker currency. Nigeria’s main export (or only if we are straightforward) is petroleum. The unintended consequence of a fully convertible currency is the sharp increase in the costs of servicing the external debt due to the weakness of the currency. This situation would be exacerbated when global interest rates started to rise. The other option of a peg crawling reduces the impact of a sharp rise in prices. However, this will encourage speculative activity and panic buying in autonomous markets.
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