Examining the Impact of Exchange Rate Volatility in Nigeria

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Friday August 06, 2021 / 8:50 AM / By FDC Ltd / Header Image Credit: Nasdaq

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The stability of the exchange rate is a major macroeconomic indicator used to measure the performance of an economy. Nigeria's forex market has undergone significant changes over the years. The forex market has evolved from a fixed regime in the 1960s to a pegged arrangement between the 1970s and the mid-1980s, and to various types of managed floating systems since 1986 (the structural adjustment program period).


The country currently has multiple exchange rates (parallel, bureau de change, IATA, investors and exporters window, but to name a few) and currently adopts the managed floating exchange rate system. On May 24 2021, the CBN officially replaced the official exchange rate with the more flexible Nigerian Autonomous Foreign Exchange Fixing Rate (NAFEX) rate in an attempt to unify the country's multiple exchange rates. This replacement means a technical devaluation of the naira by 7.56% to the NAFEX rate (N410/$) from the previous official rate of N379/$.


However, the exchange rate has remained volatile at the parallel market, driven by speculative activities and panic buying. The uncertainty about the CBN's forex policy has not only spurred profiteers into action but also kept investors at bay, thereby halting FPI inflows.

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Exchange Rate Volatility and Its Impact

Two sectors that are highly 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 nation and this makes it highly vulnerable to exchange rate volatility. As of Q1 2021, Nigeria's total import bill was N6.85trn compared to N2.91trn in export earnings. Rising global prices coupled with the naira depreciation have made imported goods more expensive, resulting in a higher import bill for the government. This has also led to an increase in the cost of goods manufactured in the country as manufacturers pass on the cost burden to consumers in the form of higher prices. The CBN's forex rationing has pushed many a manufacturer to adopt a blended exchange rate to meet their forex needs. Also because of the forex shortages and the high cost of imported items, the trade sector has been affected as traders both retail and wholesale struggle to stock up on their inventory levels. As a result, many imported items are either scarce or very pricey when available.


Way Forward

There are two options the CBN could adopt in its forex reform path. One is a full convertibility of the naira and the other option, to adopt a crawling peg and gradual convergence of the multiple exchange rates.

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Both options have their pros and cons. While a full convertibility of the naira will impact positively on the country's trade balance which is in a deficit of N3.94trn7, Nigeria's capacity utilization remains low. Countries that benefit from a full convertibility exchange rate have a high export base and can increase their exports to take advantage of the weaker currency. Nigeria's major (or only if we are being frank) export is oil. The unintended consequence of having a full convertibility currency is the sharp increase in external debt service costs due to the weaker currency. This would be exacerbated when global interest rates start to rise. The other option of a crawling peg reduces the impact of a sharp spike on prices. However, this will encourage speculative activities and panic buying in the autonomous markets.

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