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The fate of the naira 15 Aug 2022

In July, the naira depreciated against the US dollar in the more accessible parallel market by 12 percent. As the exchange rate climbed to an all-time high of N710 during the month, it was time to poke fun at President Muhammadu Buhari who had vowed to bring the naira into parity with the dollar while campaigning for election in 2015. But since he came into office at the end of May 2015, the local currency has depreciated by 123 percent.

The exchange rate was more stable in the official FX market managed by the Central Bank of Nigeria. Last month, the rate at the CBN’s Investor and Exporters window depreciated by only 0.23 percent, moving from N415.72 to one dollar, to N416.68. But the CBN was nevertheless disquieted in its oasis of calm as it has watch over the unofficial market.

As Nigerians hope that the roundly bad economic indicators won’t get worse, they have continued to see exactly that happen. Thus, many people were concerned about how low the naira can fall in the foreseeable future. Nigerians, whether rich or poor, are affected by the inflationary impact of sharp depreciation in the value of the naira through higher cost of foreign inputs of local manufactures or imported products on the shelves of our local stores and supermarkets.

The downward volatility in the value of the naira in July was in large part driven by external factors. To curtail inflationary pressure in the US and the euro area, the two most important central banks in the world – the US Federal Reserve and the European Central Bank (ECB) – have had to raise interest rate. With two consecutive interest rate hikes by 0.75 percent on each occasion, the Fed in June and July made a very aggressive effort to fight inflation and avoid a recession. By signalling this direction of monetary policy earlier, the US dollar gained strength against the world’s major currencies, including the euro, British pound, yen, Canadian dollar, and others.

The US dollar gained strength as investors launched a scramble for safe haven in the US where the monetary policymakers, willy-nilly, uses interest rate as a competitive economic tool. A higher interest rate increases the attraction of portfolio investment into the US, sparking financial outflow from other advanced economies, and emerging and frontier markets. The US dollar strengthens in value against other currencies in this scenario. For instance, the euro had depreciated by 13 percent against the dollar since the beginning of the year to July 12.

The ECB on its own launched a counter-measure by raising interest rate in the euro area by 0.5 percent in July, contrary to its forward guidance on maintaining the status quo until 2023. The euro has begun to pare its losses since the monetary policy decision, appreciating against the US dollar, as most currencies have. This adjustment has also seen the dollar and euro exchange rates retreated against the naira. While the CBN rate marginally went up to N416.9 on August 2, BDC rates had fallen to N682. Thus, we see that the naira exchange rate can follow economic principles and obey gravity.

But the outlook of the naira will continue to generate concerns. Rates will continue to diverge sharply between the official and parallel markets in the immediate term. Even as the gap stands scandalously at around 60 percent, President Buhari is resigned to inaction against the unsustainable situation, as his disposition also is on ending the regime of subsidy for petrol. While rates in the official market will continue to be relatively stable, high volatility in the parallel market is to be expected.

But the fate of the naira in the longer term is up in the air. There is a big policy call for a market equilibrium, or unified, rate, which narrows the gap between the official and parallel market rates within 15 percent. In this regard, calls are being made for a floating exchange rate regime. Even if this resulted in higher rates above the current official rate, it is hoped that the elicited investor confidence will drive down rates in the long run through improved FX supply. Currently, capital importation into the country faces constraints including the sharp disparities in FX market rates.

Also, higher productivity of the economy, in which increases in the production of primary and value-added products for domestic consumption and exports dominated by the latter, will support upward valuation of the naira against other currencies.

In these interconnected scenarios, however, the appropriate strength of the naira to make the country’s exports competitive will require policy calibration – or, to be blunt, policy interference – from time to time.

Whether or when these will happen is uncertain. Successive governments have avoided taking the supposedly hard, but beneficial, market-leaning policy decision. But the major blowback from a market exchange rate in Nigeria will come from weak enforcement of market rules. Leaving the naira to float in an environment of high level market abuse with impunity is a recipe for disaster.