In what could be another step in the gradual harmonization of exchange rates, the Central Bank of Nigeria (CBN) has removed the official rate of N379/$ from its website. This follows the announcement by the Finance Minister (in March), that the official rate had been scrapped and the Nigerian Government had adopted the NAFEX exchange rate as the official rate of conversion for FAAC allocations. With this move, the NAFEX rate is now regarded as the default rate for all official and legitimate transactions. This means that all government inflows will now be monetized at the NAFEX rate (currently at N410/$).
This is a major move towards convergence and a possible unification of exchange rates while also meeting some of the lenders' preconditions of the $3bn Eurobond issue. A change of foreign exchange policies is also a major conditionality for the World Bank to approve a $1.5bn loan to the Nigerian government. The NAFEX rate is the closest to a market-driven exchange rate and is referenced by both the private and public sector for official transactions.
While the NAFEX rate is already reflected in FAAC disbursements, external debt service obligations for state governments, which were previously calculated at the exchange rate of N379/$, will rise by 8-9%. We estimate that the landing cost of imported petroleum products will likely rise by the same magnitude, adding to the already crippling fuel subsidy bill of the federal government and further fuelling imported inflation.
The adoption of the NAFEX rate will have negligible impact on manufacturers who had previously sourced between 60-80% of their forex from the parallel market and the rest from the NAFEX window. In addition, the CBN will now sell forex to the BDC's at a devalued rate (official + N4/$) of N415/$.
Nigeria currently operates a multiple exchange rate system. This ranges from the NAFEX, SMEIS, BDC & Parallel market rates, with a premium of N74/$ currently between the NAFEX and parallel market rates.
The multiplicity of exchange rates has been frustrating to businesses and investors. The World Bank and the IMF have been vocal in their calls on Nigeria to accelerate currency reforms which include unifying the multiple exchange rates around the IEFX window and gradually shifting to a market-determined exchange rate mechanism. According to the IMF, a unified and flexible exchange rate should ease external imbalances and achieve economic growth. The IMF is also of the opinion that the ability of the Nigerian economy to absorb external shocks is significantly impaired by exchange rate rigidities.
The CBN's actions amount to neither a devaluation nor a shift from a managed float to a flexible exchange rate system. The managed float allows the CBN to monitor events in the forex market and intervene occasionally when it deems it necessary - which guides the market towards price discovery.
While the road to unification is fraught with snags, chief of which is dollar shortages, which continue to trigger currency pressures, the CBN may just have signaled its readiness to conform to market realities.