Forex Availability and Exchange Rate Depreciation - A Manufacturer's Nightmare

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Friday, April 30, 2021, 02:33 PM / by FDC / Header Image Credit: BBC

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Nigeria's exchange rate policy has been a subject of controversy. The price of forex is the major problem followed by the availability of adequate forex supply, which leads to a blended rate for forex transactions. In addition, there are limited hedging opportunities, e.g. the 12-month NDF market rate is trading at N456.96/$ indicating that the market expects the naira to depreciate.


In the last three years, the currency depreciated by 33.61% to N485/$ at the parallel market. This was also the case at the I& E window, where the naira weakened by over 14.35% to currently trade at N412/$ from N360.3/$ at the end of 2017. The window was introduced in 2017 after the oil price crash (2016) to facilitate transactions for individuals and businesses that need dollars to repay loans, dividends, settle trade transactions and repatriate capital. In all, currency volatility in recent times is a deja vu of the oil price crash in 2016. However, this time around its impact was worsened by the economic fall out of the covid-19 pandemic. In Q2'20, which was the peak of the pandemic, oil prices fell to as low as $18pb before recovering to a range of $60-69pb in Q1'21.


The strong link between exchange rate pressures and the manufacturing sector cannot be overstated at this time, because most manufacturers rely heavily on imported raw materials. The result of a weaker currency has been a surge in import costs with imported inflation climbing as high as 16.86% in Mar'21. A market-determined exchange rate is important to boost output growth and drive industrialization especially with the commencement of the African Continental Free Trade Agreement (AfCFTA).


Multiple Rates and the IMF

The IMF through its article IV review has strongly advocated for a market-driven and unified exchange rate system in Nigeria, because it encourages transparency in exchange rate determination for investors (domestic and international) and manufacturers. The multilateral lender stated that multiple rates, limited flexibility and forex shortages are economic challenges and disincentives to investors. The IMF further recommended a gradual and multi-step approach to establishing a clear and unified exchange rate regime. The near-term focus should be on allowing greater flexibility and removing the payments backlog. We have recently seen the convergence around the IEFX rate and the CBN has resumed clearing of the $2bn dollar demand backlog to Foreign Portfolio Investors (FPIs). Nigeria currently operates at least seven exchange rates for various transactions including government, banks and manufacturers.


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Manufacturing Sector Operations & Exchange Rate - Current State 

The FBN purchasing mangers' index reading for March eased by 3.02% to 51.4 points from 53 points recorded in February. This was mainly because of the difficulty manufacturers faced while sourcing for forex to acquire raw materials. To address the issue of dollar scarcity, the CBN has embarked on several initiatives including encouraging exporters to repatriate proceeds, licensing of 10 additional IMTOs and the naira4dollar promo. However, exchange rate policy ambiguities and forex market shortages continue to linger, worsening the business environment for manufacturers. Even though, the CBN has made moves toward naira convergence at the I&E window,


forex rationing has continued. So far in April, the average daily turnover fell by 13.4% to $57.7mn from $66.63mn in March. Furthermore, dollar sales by the CBN with a 60-day delivery means the effective cost is higher as most manufacturers are forced to source for forex from the parallel market, leading to a more expensive and blended rate around N460/$. About 10% of their forex is gotten from official sources, while 90% from the parallel market.



  • Sector growth: There is a high probability that forex rationing will increase the exchange rate pressures at the autonomous market, which could impede growth in the manufacturing sector. The sector contracted by 1.51% in Q4'20 and if the situation spirals out of control, the sector could move deeper into the negative territory. Because as it is, output levels would be limited by challenges in raw materials procurement. This constrains expansion plans particularly in the face of regional competition resulting from the African Continental free trade agreement (AfCFTA). It would also frustrate and force small businesses to shut down.
  • Capital flight: More companies are likely to move their operations to neighboring countries if these problems persist, especially with the commencement of the AfCFTA. Other African countries like Ghana and South Africa would be more enticing for business operations. This would worsen the country's already abysmal state of forex inflows. The immediate impact, is a further depreciation of the naira at both the parallel market (N490/$ - N500/$) and I & E window (N412/$ - N415/$).
  • Higher import costs to push up imported inflation: Currency volatility would heighten import costs and increase imported inflation. The impact on economic agents is largely dependent on who bears the final burden of higher costs. If manufacturers decide to absorb the costs, corporate margins will likely remain squeezed. However, if they decide to pass the burden to the already embattled Nigerian consumer, disposable income will be negatively affected.



In summary, it is difficult to forecast the exchange rate but some institutions have made various calls.

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A tough business environment will continue to encourage capital flight and loss of the much-needed investment inflows. The manufacturing sector is a huge player in the government's plan to diversify its revenue base and fasten the pace of industrialization. The world is fast transitioning away from oil, so this should be a wakeup call for the government to hasten its steps towards boosting the activities of other sectors that have the potential to drive economic growth. More noteworthy is that if these forex challenges persist, alongside the rising insecurity levels and already weak macroeconomic environment, Nigeria could lose its chance of being a hub as the AfCFTA progresses.

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