CBN’s Exchange Rate Policy: Possibility of Unification?

Proshare - Facebook Proshare - Twitter Proshare - Linked In Proshare - WhatsApp

Tuesday, June 18, 2018 09:50 AM / By FDC  Ltd


The exchange rate has been a subject of political and market acrimony in Nigeria. For an oil-dependent economy with a high marginal propensity to import (approximately 70%) and where smuggling is still paramount, exchange rate management remains a sensitive issue. Nigeria’s excessive dependence on oil revenue as a major source of foreign exchange has made the country vulnerable to external shocks. The exchange rate is determined by both subjective and objective factors including – the level of external reserves, balance of trade, terms of trade among others.  

The structure of the Nigerian forex market is that of a price discriminating monopoly, wherein there are different prices for the same product (currency) and the CBN is the main supplier. This has created room for speculative trading, arbitrage and abuse, resulting in either transaction gains or losses for companies that are dollar dependent. Currently, there are approximately seven different exchange rates in Nigeria. 


Proshare Nigeria Pvt. Ltd.


Recently, the CBN revised the official rate on its website to ‘market determined’ and adjusted the customs duty rate to N326/$ from N306/$. This led to speculations by some analysts that the CBN is making a move towards achieving a unified exchange rate. Contrary to this, the official rate was reversed to its original value (N306/$) and the apex bank reaffirmed that there are no changes to the country’s exchange rate structure. Nonetheless, the initial revision of the rate coupled with the adjustment in the custom duty rate, is a pointer to a possible unification in the near term. The CBN is probably testing the markets for a reaction. 


The optimal solution

The exchange rate is the price that brings about equilibrium between aggregate demand and supply for the currency. Typically, the pricing of a product is determined by its market structure. For instance, in a perfectly competitive market, the price of a commodity is determined by the intersection of the demand and supply curve. In the exchange rate market, there is the fixed or flexible exchange rate system. The flexible exchange rate is a dynamic equilibrium rate which allows for adjustments based on market fundamentals. Currently, Nigeria’s exchange rate mechanism is a managed fixed system with multiple rates- this is rigid with limited volatility. 

In addressing Nigeria’s forex market challenges, it is important to concentrate on changing the structure of the market rather than focusing on the rates. This is because rates are determined by the market structure. More importantly, the exchange rate needs to be aligned with economic fundamentals. Thus, the optimal solution to Nigeria’s exchange rate conundrum is a dynamic equilibrium (unified) exchange rate. Here, there will be a unified rate that would change in line with market realities.


Equilibrium Exchange Rate with no Gaps

Proshare Nigeria Pvt. Ltd.


The unification of the exchange rate would play a crucial role in eliminating arbitrages and increasing efficiencies in the forex market. However, we cannot ignore policy making concern of its pass through effect on prices, especially with the adjustments in the custom duty rate. A higher exchange rate makes imports more expensive, thus increasing import bill of manufacturers. They could pass on the costs to the consumers, share the pass through effect or bear the brunt of it all. On a positive note, government revenue will increase and imports could be discouraged. 

Proshare Nigeria Pvt. Ltd.

Related News

1.       Continuity Of FX Policy, Hot Air Notwithstanding

2.      Nigeria Central Bank Quashes Talk of Exchange-Rate Policy Change

3.      CBN Injects $210m Into Forex Market

4.      Currency Volatility and Stock Markets: A Lesson in the Domino Effect

5.      Travelling Abroad? PTA and BTA in USD, EUR and GBP Now Available In All Zenith Bank Branches

6.      Gross Official Reserves Increased By US$330m in May 2019 to US$45.12bn

7.      CBN Injects $294.7m, CNY 31.43m into Retail SMIS

8.     CBN Injects $205m into Forex Market

9.      Gross Official Reserves Increased By US$360m in April 2019 to US$44.79bn

10.  CBN Injects $205m Into Forex Market

11.   How to Combine a Job with Forex Trading?

12.  The Many FX Interventions Of The CBN

13.  CBN Intervenes With $271.83m, CNY41.14m In Retail SMIS

Proshare Nigeria Pvt. Ltd.

Proshare Nigeria Pvt. Ltd.

Related News