Exchange rate pressures will persist



The International Monetary Fund (IMF) says it anticipates that exchange rate pressures and volatility will persist for some time in Nigeria and other Sub-Saharan African countries, according to latest report posted on its website:



“African economies can expect exchange rate pressures and volatility to persist for some time. Shifts in commodity prices as well as in portfolio and other private capital flows are likely to continue given the highly uncertain trajectory of the global recovery, the geographic rebalancing of trade flows, and volatility in the exchange rate of the main currencies,” the IMF said after an analysis of the evolution of exchange rates of sub-Saharan African currencies in the context of the global financial crisis.



The report, which focused on the differences in the magnitude and volatility of the exchange rates among countries, was drawn from a sample of seven countries, four members of the East African Community (EAC) (Kenya, Rwanda, Tanzania, and Uganda), and three others, which experienced large exchange rate losses at the outset of the crisis: Ghana, Nigeria, and Zambia.



External Factors affected exchange rates


The IMF cited external factors that reflect the transmission of the global crisis through the trade and financial channels as well as the volatility of the U.S. dollar, the main international reserve currency.



Abrupt fluctuations in capital flows also contributed to exchange rate movements. “A tightening of credit conditions in global financial markets and a decline of confidence triggered a frantic race to safety by private investors at the onset of the crisis. As expected, the resulting depreciation was more pronounced in those countries that had received large portfolio inflows prior to the crisis (Ghana, Kenya, Nigeria, Uganda, and Zambia).”



The volatility of the U.S. dollar as a reserve currency also had a strong effect on African currencies. The dollar rose sharply against all currencies, amplifying the depreciations that were triggered by other external factors.



Challenges and implications


The IMF stated that exchange rate volatility could hinder progress with financial integration, skewing capital flows toward short-term options at the expense of longer-term investment.



Lydia Olushola, an economist and a consultant at Sky Trend Limited, a finance service firm, said that real exchange rate is one of the major relative prices in an economy, which actually defines the rate of exchange between domestic goods and their foreign counterparts, and as a result, its volatility has economy-wide implications.



“Exchange rate volatility has real economic costs on an economy. It affects price stability, firms’ profitability, and the country’s financial stability, as a whole. Exchange rate volatility is also influenced by and correlated to domestic economic uncertainty.” She added that countries have reasons to be worried about exchange rates volatility as it may hinder international investment flows. “Companies may also be reluctant to establish new firms or purchase existing ones in such countries as exchange rate uncertainty reduces the expected profits from such projects.



“Volatile exchange rates also create uncertainty about income expected to be earned on international transactions. It is one of the reasons some firms add some allowance to all they sell to be on the safe side. These costs are then passed on to consumers in form of higher prices, and then you know what happens. Even traders would also be reluctant in their businesses too as the volatility in the exchange rates adds additional risks to their expected gains,” she said.



IMF’s remedy


The IMF however, outlined ways of escape, both for the short and long term, to the countries that are still experiencing exchange rates volatility, adding that the deepening domestic financial markets is key to enhancing their capacity to handle external financial volatility over the long term:



“Broader bond markets will allow diversification into longer-term investment instruments—important for long-term investors. Developing forward hedging instruments would also generate some stability in the foreign exchange market by reducing forward settlement risks.”



Nigeria’s Naira stable


Bismarck Rewane, Managing Director, Financial Derivatives Company, a finance and research analysis firm and Member, National Economic Steering Committee, is however, confident that the Nigerian Naira would remain stable.



“The Naira is expected to remain stable because higher oil prices will boost the accumulation of external reserves, and this will also be supported by increased sale of Forex by oil majors. The Naira remained unchanged at N148.6to the dollar in the official market in February. In the parallel market, it appreciated marginally by 0.32 per cent to N152 to the dollar from N152.5 to the dollar the previous month. The FOREX demand however, surged 7% to approximately $1.2 billion in February.



“The gain in parallel market has been attributed to the increase in forex supply from the Central Bank. The Year on Year spread between the official and parallel rates narrowed by 87. 41% to 3.29 from 26.15 in 2009, indicating a relatively more stable forex macroeconomic compared to what obtained the previous year,” he explained.



Nigeria’s foreign exchange market has remained relatively stable since the 2010 year began. Sanusi Lamido Sanusi, the governor of the Central Bank of Nigeria, in November 2009, said the Naira will trade between the N150 to $1 band till it finally regains full stability.


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