Nigeria’s Foreign Exchange Dilemma

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Thursday, September 07, 2017 / 10:19AM /FDC

The regulator has since introduced new windows for foreign exchange transactions, including for small and medium sized enterprises and personal and business travel allowances.

Nigeria has one of the world's most complex foreign exchange systems, with at least five exchange rates simultaneously available until recently. Reforming the system to establishing a coherent and unified foreignexchange market that can gain the confidence of its users is one of the biggest challenges facing the administration of the president, Muhammadu Buhari.

But his government, like all previous Nigerian governments, appears set on maintaining the myth of a strong naira and the belief that the state needs to subsidise and channel scarce resources to certain sectors of the economy and society.

After ostensibly floating the naira and ending a 16monthlong dollar peg in June 2016, which caused the local currency to immediately plummet from N197:US$1 to N282:US$1, the Central Bank of Nigeria (CBN) soon reverted to its old habit of endeavouring to manage the market, resulting in the reemergence of multiple exchange rates. The regulator has since introduced new windows for foreign exchange transactions, including for small and medium sized enterprises and personal and business travel allowances.

This has further fragmented the market. The authorities have also continued to prohibit importers of 41 categories of goods and services from accessing the country's foreign exchange markets, a policy introduced in June 2015 in an effort to suppress demand for hard currencies.

Devaluation by stealth
In April, faced with persistent shortages of foreign exchange in the country, partly due to the drop in the nation's oil revenue but also the reluctance of investors to bring money into the country, the CBN opened a special Investors' & Exporters' (I&E) foreign exchange window where investors and exporters trade currencies at market determined rates.

These rates, known as the Nigerian Autonomous Foreign Exchange Rate Fixing (Nafex), started at N372.89:US$1 when the window was launched and was around N362:US$1 at the end of August, compared with an official rate of N305:US$1. The opening of the I&E window therefore amounts to a partial and unofficial devaluation of the naira.

This devaluation by stealth has allowed the government and the CBN to maintain the illusion that the country has a stable and relatively strong official exchange rate, enabling them to continue channelling cheap dollars to selected users.

Following the introduction of the I&E window the nation's private banks began quietly trading with each other based on the Nafex rates rather than the official rates. In early August the FMDQ OTC Securities Exchange, a Lagos based trading platform, asked banks to start quoting Nafex rates, in effect merging that I&E window with the main interbank one and aligning them with the parallel market. 

With the dollar now being sold between banks, at the I&E window and bureaux de change and on the black market at around market rates, it is probably the case that most business related foreign exchange transactions in the country are now being conducted at market rates. The official rate is primarily used for government transactions, to dispense cheap dollars to some privileged buyers and as an administrative tool.

A single rate is unlikely
By allowing banks to align their rates with market rates the government appears to be moving closer to a single rate for the naira, but a number of factors make it unlikely that the government will completely scrap its official exchange rates. There are implications to liberalisation that would be politically and economically objectionable to the government and members of the nation's broader political elites. 

A multiple exchange rate system allows the government to subsidise certain sectors of the economy that it regards as important to support for economic or political reasons. For instance, by selling hard currencies to petroleum products importers at official rates, the government is indirectly subsidising fuel prices, despite its claim that subsidy payments have ended.  

If fuel importers were to buy foreign exchange at market rates to pay for products they would have to either increase pump prices above current regulated prices or incur significant losses. Petrol pricing is a politically sensitive issue in Nigeria where price hikes have tended to trigger national protests.   

Many Nigerian politicians view the ability of the government to set exchange rates as a necessary mechanism of social intervention by the state. For example, on July 20th the Senate (the upper house) recommended that the CBN enable Muslim and Christian pilgrims travelling to their respective holy lands to buy dollars at a concessionary rate of N200:US$1, which is well below the already generous CBN rate.  

A shrinking economy
A major devaluation of the official naira rate would also have an impact on the calculation of Nigeria's GDP, diminishing its standing in global economic rankings. For example, if The Economist Intelligence Unit's projection of Nigeria's 2017 GDP at current prices, currently N119.3trn, were to be converted to dollars at a market rate of N360:US$1, the size of the economy would be US$331.4bn, instead of US$391.1bn using an official rate of N305:US$1. 

The revised figure would put Nigeria back behind South Africa as the continent's largest economy and further dent the long held official ambition that Nigeria become one of the world's 20 largest economies by 2020. It would also show that Nigeria's share of the world's GDP is less than estimated using the official rate. A more important consideration is that an adjusted GDP figure would result in a drop of around 15% in the country's income per head, indicating that poverty is more widespread than the current GDP statistics indicate.  

The myth of strong currency
Nigerian politicians have long seen a strong national currency as an indication of economic virility, whereas weakness is seen as a symptom of political failure. This view stems at least partly from a mercantilist perspective, in which currency weakness is regarded as evidence of overconsumption of foreign goods and under consumption of locally produced products. Nigeria's president has long been a staunch opponent of devaluation and a proponent of economic nationalism.  

In his first stint in power as a military ruler in the 1980s, Mr Buhari severed ties with the IMF rather than accept the Fund's call on his government to devalue the naira. The current CBN governor, Godwin Emefiele, is of a similar mindset to the president. Mr Emefiele has repeatedly mourned what he sees as Nigeria's overdependence on imported goods, especially foodstuffs, and urged Nigerians to look inwards and stop importing stuff they can produce locally.  

Having gone through many ostensibly market oriented adjustments to its foreign exchange system since the mid1980s but always ending up with multiple exchange rates, it is evident that a lasting reform of the system would require fundamental change in the mindset of Nigeria's rulers and the way policymakers view the role of the state in the economy. This seems unlikely in the medium term.

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