Monday, January
10, 2022 / 02:21 PM / by FDC Ltd / Header Image Credit: TheCable
In
2021, manufacturers were forced to adopt a blended exchange rate of both
official and parallel market rates. This blended rate ranged from as low as
N430/$ at the start of the year before deteriorating to as high as N550/$. This
had an impact on the prices of consumer goods. In reality, the impact of an
adjustment of the official rate and rate convergence could lead to an
adjustment of the blended rate used by manufacturers.
The
official exchange rate moved sharply (N435/$) on the last day of 2021, after
trading relatively stable around N415/$. This is the second consecutive year in
which the rate was arbitrarily moved on the last day of the year. This brings
to fore the question on everyone's minds, if indeed there is really a crawling
peg or are we just playing with mirrors? This is also occurring at a time when
oil prices are trading at $80pb. However, for the Nigerian external sector,
there seems to be no direct correlation between the price of oil and the level
of forex supply and appreciation of the naira. Adjusting the official exchange
rate albeit temporarily could send the wrong signal to investors and further
stoke the flames of market uncertainty.
SSA: How did the Currencies Perform?
Most
African currencies have depreciated in value in the last three years, with the
Angolan Kwanza and Nigerian naira recording the highest loss. However, in 2021,
the Angolan Kwanza reversed its downward trend to be the only African currency
under our review to appreciate in value in the last year.
Trend of the IEFX-parallel market spread
Impact Of Forex Rates Convergence
Reduces the spread between the IEFX and parallel rates
Naira
convergence will help reduce the IEFX-parallel market spread which will in turn
decrease 6 FMDQ and FDC Think tank 15 the incidence of speculative trading at
the parallel market. A reduced spread will decrease the incentive (arbitrage)
for speculators to obtain forex at the official market and resell at the
parallel market. This may result in panic dumping of dollars at the parallel
market due to the concern of lower demand for forex and appreciation of the
dollar at the parallel market.
Encourages traders and investors to source forex at the official market
(IEFX)
Closing
the gap between the official and parallel market rates is likely to reduce the
demand for forex at the parallel market, pushing investors and traders to the
official market. This will lead to increased forex transactions at the official
market (IEFX).
Positively impact foreign trade and investment
The
wide IEFX-parallel market spread and the low forex supply at the official
market have been the main factors driving investors and traders to source forex
at an expensive rate from the parallel market. Reducing this spread, coupled
with an improved forex supply at the official market, will decrease uncertainty
(volatility) at the forex market and bolster the ability of the IEFX window to
meet a higher demand for dollars. The resulting impact of this is that a
reduced exchange rate volatility and improved forex supply will make it easier
for foreign investors to repatriate their funds. It will also ensure that
traders and manufacturers can access forex at a uniform rate from both the
official and parallel markets. Reduced naira volatility and improved forex
supply are positive for foreign direct investments and foreign portfolio
investments as well as the country's external trade. This is because of the
increase in the volume of dollar available for foreign trade and investment.
What Needs to be Done?
Flexible or floating exchange rate system
Incorporating
a flexible or floating exchange rate system would allow the value of the naira
to be determined by the invisible hand of demand and supply at the official
(IEFX) market. Countries like Zambia and South Africa use the floating exchange
rate system; this strategy could partly explain the positive performance of
their currencies. According to Bloomberg, the Zambian kwacha is the second
best-performing currency globally in 2021, as it has appreciated by 27.04% YTD
Improve the supply side of the economy
Nigeria
must complement shifting to a floating exchange rate system with increasing its
forex supply. To achieve this, the productive side of the economy must improve.
This improvement would increase the volume of goods and services available for
domestic consumption, thereby reducing the country's import costs which are a
major drain on the external reserves. It would also increase the goods
available for export to other countries and the inflow of revenue from export
could be used to boost the external reserves and forex supply at the official
forex market. Countries with a wide balance of trade surplus have relatively
stable exchange rates. For instance, Zambia and Angola maintain a trade surplus
of $269.12mn and $4.95bn respectively, which are positively impacting their
external reserves and exchange rate stability relative to Nigeria who has a
trade deficit of N3.02trn ($7.28bn). Angola's kwanza has appreciated by 15.73%
in 2021 compared to the naira which has depreciated by 16.96% (parallel market)
and by 5.69% at the IEFX window.
Revisit the country's import restriction list
More
than 40 commodities, including agricultural goods, are on the CBN's forex restriction
list. This drives traders and investors to the parallel market to satisfy their
forex obligations, which adds to the forex demand pressure. The forex
restriction policy will only be effective if the productive side of the economy
is significantly improved. The CBN may have to relax some of these restrictions
in the short term, as Nigeria is a net-importer of most of these commodities.
This may be a short-term solution to reducing the forex demand pressure at the
parallel market and could result in the reduction of imported inflation.
Conclusion
Although
the CBN has implemented some forex management policies, like the naira4dollar
promo and the recent exchange rate adjustments to improve naira stability and
forex inflow, they are insufficient to ensure a naira convergence. Hence, there
is the need to improve the productive side of the economy and leave the
official forex rates to be market-determined. This will promote naira
convergence in the medium to long term.
Related News
Signup with Facebook
Signup with Twitter
