Central Bank of Nigeria CBN, on Wednesday introduced a flexible exchange rate regime into the Nigerian foreign exchange market beyond the expectations of those yearning for a libralised market. The two sets of new operational guidelines published on the CBN website in the view of many analysts and foreign investors amount to bold steps. Unlike the tightly managed foreign exchange rate market, special access for “critical transactions” that gave room for discretion and possible corruption has been dropped. The much critised pegged exchange rate regime has now been replaced by a market driven exchange rate regime in which new primary dealers will transact with the CBN on large trades of $10 million minimum for spot foreign exchange.
The CBN in the new arrangement will participate in the market driven foreign exchange regime through what it terms secondary market intervention sales (SMIS). Looking at the policy proposal, the CBN as the largest single foreign exchange seller into the market will clearly bring some influence over the exchange rate. The CBN will out of necessity participate in the market as it has to convert the dollar Nigeria earns from crude oil to naira for payment into the federation account for distribution to the three tiers of government in the federation.
The critical question is will a flexible exchange rate allow Nigeria to earn more foreign exchange? It is doubtful if this will solve the foreign exchange crunch in the country. In the immediate term, it will result in the massive depreciation of the naira which will allow government to earn more naira from crude oil sales. This could bring a temporarily relief to state governments which are at the moment cash strapped as they will certainly get more naira from the federation account.
Yes, Nigerians abroad may now be willing to remit home what they have kept for a while since pegging of the naira at N197 to the dollar. The CBN will certainly relax its policy on deposit of dollar into accounts domiciled in local banks. This may encourage Nigerians who earn foreign currencies to bring them home. Also foreign portfolio investors may again come in with hot money and swell the Nation’s reserve, but for how long will this be?
Apart from this as Governor Emefiele has said the CBN’s monthly earnings has fallen below $1.0 billion from as much as $3.2 billion in 2013 before the latest oil price slide. The question agitating the mind is will this new policy generate the much needed foreign exchange to meet the current import demand in a contracting economy?
From the policy document authorised dealers, who are to transact with the primary dealers, are to purchase the proceeds of international money transfers as well as foreign investment inflows direct and portfolio. This certainly will capture some of the flows of remittances, which total $21billion annually. The guidelines show that the CBN hopes to smooth out spot foreign exchange demand with new foreign exchange forwards and futures products.
The new system may be market-driven but it is not without regulation. The governor gave a very clear warning that the CBN will not permit speculation and stated that inter-bank funds cannot be sold to bureaux de change. The 41 import items listed in the CBN circular of June 2015 remained ineligible for foreign exchange indicating that the new market will not be as free as expected.
What is not clear as at the time of writing this piece is what will be the rate of the naira to the dollar in the new arrangement. As trading on the inter-bank market opens today and the futures market subsequently, Nigerians will know the level of depreciation of the naira. Can the Nigerian economy sustain a massive decline in the value of the naira at this time, when the economy is cash strapped, there is galloping inflation, economy is at the brink of recession?
A weaker naira will have an adverse effect on industries that depend on imported raw materials. The avearage consumer will be hurt by the sharp increase in the naira cost of importing goods and services.
Moreover, all of Nigeria’s fuel is imported, implying higher power and transportation costs. In the immediate, the economy will contract further in 2016 and perhaps achieve a modest recovery in 2017.
Inflation, which climbed to 15.6 per cent in May, has already begun to reflect the impact of a weaker currency on naira prices of consumer goods and services. Inflation may inch higher in the next three months, following the move to a free float. The central bank will have no choice but to respond with bold rate hikes, from a policy rate of between 13 and 14 per cent.
The central bank has already said it would fight inflation despite current economic decline, because high inflation erods real incomes. It is the opinion of some economist that flexible exchange rate acts as automatic stabilizers to an economy. They argued that if the relative price of currencies is fixed and a country’s output, employment, and current account performance and other relevant economic variables change, the exchange rate cannot change. According to this line of thought, if exchange rates are allowed to change, they change in the appropriate direction, given the nature of changes in the variables affecting the exchange rates.
Following form this arguement when foreigners’ demand for a country’s exports declines, output also decline and the country’s currency depreciates. This situation helps improve the country’s export performance because depreciation makes the country’s goods cheaper to foreigners. The question is what does Nigeria export apart from crude oil? The price of crude and the volume produced in Nigeria are not determined by Nigeria. Crude oil like any other commodity in the global market is subject to the vagaries of international prices and swings in politics. If Nigeria had an array of exportable, a flexible exchange rate could earn it more foreign currencies.
Nigeria is essentially an import dependent country. It is argued that under a flexible exchange rate regime, countries can implement autonomous monetary policies to address problems with inflation and output. Because monetary policies affect inflation rates, countries can decide on their long-run inflation rate and do not have to import their trade partners’ inflation rate, as is the case under a fixed exchange rate. But here is the fallacy in the case of Nigeria; inflation has risen to 15.4 per cent in a matter of two months due to fuel price hike and the indexing of prices of imported products at the parallel market rate. Nigeria is at the moment facing imported inflation.
The economy is in stagnation and it is suffering from high level inflation, a phenomenon known in economic circles as stagflation.
It is a known fact that flexible exchange rate leads to exchange rate volatility. In the post–Bretton Woods era, one of the characteristics of flexible exchange rate is their excess volatility. The changes in exchange rates are more frequent and larger than the underlying fundamentals imply.
Can Nigeria manage this volatility?