Towards a Unified Foreign Exchange Rate System in Nigeria

On this day, 2014, a Naira against dollar was N164. Comparing this figure against the current rate of N360, clearly the Naira has depreciated by 120% within a 6-year span.

In a bid to increase access to Forex, the CBN created the I&E FX (Investors and Exporters Forex Window) in 2017 for importers in order to ease the pressure faced by the businessmen in the foreign exchange market. However, there still have been disparities among the CBN official rate, I&E rate (also known as NAFEX) and the parallel market rate.

The CBN has always tried to keep the official exchange rate stable using a partial floating system by supporting the Naira against the greenback using the country’s reserves. However, since the reserve is under major threat, the CBN is incapacitated to do so. With this existing structure, CBN is still unable to meet its Forex demand creating millions of backlogs, and leaving exporters/Investors at the mercy of parallel ‘black’ market traders. It has been estimated that about $5 billion of forex demand is yet to be met by the CBN, if met will dip the nation’s reserve below the $30 billion threshold.

Covid-19’s effect on the economy is beginning to manifest. 90% of Nigeria’s export earnings is derived from sales of crude oil. With the ravaging impact of coronavirus, restrictions in movement, lockdowns in typically all countries across the globe, and ensuing crash in oil prices, Nigeria’s Bonny Light sold around $12 in this same period disrupting the $50 per barrel benchmark in the 2020 budget. Low sales of crude oil means low inflows into the country, directly translating into low Forex.

In a bid to mitigate the effect of the pandemic on the economy and add some funds to the nation’s financial war chest, the country approached the IMF and the World Bank for loans. Although at first, the loans looked like ones without conditions, that’s farther from the truth. Prior to now, Nigeria has not approached the IMF for loan due to the conditions usually attached to the loan, one of which is for the country to maintain a uniform exchange rate. The World Bank also has this kind of condition but have been lenient with the country in terms of ensuring the country adheres to it.

The system of supporting the Naira against the Green currency has been open to serious criticisms by experts. Some of the loopholes identified are:

• Overvalued Naira

Prior to CBN’s recent technical devaluation of the currency from N305 to N360 in its official window (March 2020), the Naira sold at N306/$ while in other windows, the average rate was N360/$. In August, 2019, USD was sold at N362.11 in the NAFEX window, N362.09 in the I&EFX window and N360 in BDC, while the CBN rate of N306/$ shows large disparity between these rates.

The CBN official rate of N306/$ did not depict the relative scarcity of the USD as portrayed by the demand and supply for it as well as the underlying economic condition of the country.

• Straining Reserves

In order to prevent the currency from further deteriorating, Emefiele’s CBN has fought to keep the Naira afloat through partial fixing of the rate. Weak demand for crude in the international oil market, cut in oil production as agreed by OPEC members would continue to contribute to fall in Nigeria’s dollar earnings. Hence, the ability of the CBN to meet Forex demand will wane given the depleted nature of the country’s external reserve.

• FDIs and FPIs are discouraged

Although the intention of the CBN is to encourage foreign investors, they actually find it hard to access the CBN official rate as well as the official rate not reflecting the market fundamentals. FDI in the country has been on a free fall for sometimes now, accounting for less than 4% of total capital imported ($934.34million)  into the country in 2019. Nigeria’s volatile investment environment has made the foreign investors prefer portfolio investments which they can exit at anytime, rather than direct investment which will be hard to exit.

• Massive Corruption due to arbitrage

Arbitrage is the purchase and sale of an asset (Forex) in order to profit from a difference in the asset’s price between markets. It is a trade that profits by exploiting the price differences of identical or similar financial instruments in different markets or in different forms. The persistent tolerance of multiple exchange rates creates an incentive for sustained arbitrage and short-selling of the local currency. Favoured merchants who have access to FX at the CBN official rate and through artificial hoarding sell at exorbitant rate on the parallel market rate, hence worsening the situation.

Devaluing the currency has thus clearly reduced the spread between these rates with a convergence around N360 – N380.

The IMF notes that “With the spread across the various exchange rate windows now very narrow, this is also a good moment to immediately move to full and formal unification—e.g., by converging all foreign exchange windows to the I&E window. This critical step to ensuring a well-functioning market would be helped by the CBN’s calibration of its foreign exchange sales in the market at a level commensurate with protecting central bank reserves while taking into account low international oil prices and reduced FX demand. A unified and more flexible exchange rate will be an important shock absorber, especially in turbulent times— with CBN FX interventions limited to smoothing large fluctuations in the exchange rate.”

In order to meet the loan requirement, the Economic Sustainability Committee stated that the country is on the path of unifying its FX. The CBN boss further reiterates this in a conversation with investors.  “Exchange rate unification is moving towards the NAFEX“, Emefiele stated. NAFEX (Nigerian Autonomous Foreign Exchange) rate is the reference rate for forex activities in the IEFX window.

With the relaxation of lockdowns and partial resumption of production and economic activities, demand for Forex by manufacturers, importers and exporters is expected to rise. As at 3rd July, 2020, I&E FX, CBN rate and BDC trades at N385/$, N361/$ and N450/$ respectively. The CBN on Friday July 3rd, asked bidders in the Secondary Market Intervention Scheme (SMIS) window to increase bidding price to N380/$. It’s obvious the CBN is on the trajectory of unifying the rates at the NAFEX rate excluding the parallel market. This is in line with the recommendation of the IMF as indicated above.

A unified and more flexible exchange rate will be an important shock absorber to the economy hereby restoring investors’ trust in the economy and attracting the much needed FDI. The CBN will lessen its burden given that the rate will be market driven and it only intervenes in case of large fluctuations. We also note that this is the condition of the World Bank before Nigeria can be able to access the $1.9 billion COVID-19 concessionary loan.

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