Thursday, 26 May 2016

Implications of Nigeria’s Floating Exchange Rate Regime: Way out

By Dr. Ahmed Adamu 

Following the decision of the Monetary Policy Committee (MPC) to fully implement the floating exchange rate regime in the country to allow competitive access to foreign currency and introduce flexibility in the currency exchange market, the economy will face certain shocks, which if not carefully managed will further endanger the economy.

With this new policy, the value of Naira in relation to foreign currency will be determined by demand and supply, which means the new value of Naira will be closer to, if not exactly as its value in the parallel market. The parallel market have been influenced by the forces of the demand and supply. So, there will be relatively similar naira values in the Forex markets. The government will not therefore fix the exchange rate, which normally distort the currency exchange market at the expense of the government.

Therefore, the value of Naira will immediately depreciate since at the parallel market which is the proxy competitive market, the Naira is sold around N350 per US dollar. This will mean Naira will now reach a market value of not less than N300 in the short term, which is up to 76% increase. This market adjustment will cause uncertainty and speculations, which will further depreciate the value of Naira. However, this policy will motivate more supply of foreign currency, making currencies like US dollars and Pound Sterling overflowing the market, because of the profit motive. The foreign reserve which has depleted by more than 130% in eight years, will then be relieved, as the resulting increase in interbank and Bureu De Change (BDC) transactions will cause increase in currency supply, which will offset the rising foreign currency demand. The increase in supply will also make importation easier but not cheaper.

Therefore, as the foreign currency supply curve shifts outward, its demand curve will follow it outward, moving the new equilibrium value at a higher position. And this may continue in the midterm except drastic structural economic changes took place, which will include measures to reduce importation especially of refined petroleum, which constitute the largest share of import to the country.

Under the previous fixed exchange regime, the central bank had to use the foreign reserve to meet up the market gap (excess demand) caused by import demand. The fixed exchange regime is not realistic for importing countries like Nigeria, as the continues oversupply of the country’s currency will continue to depreciate the value of the currency. And this leads to increase in the inflation and depletion of the foreign reserve.

So, setting the Naira at competitive value will cause depreciation of the currency, due to continuous rising importation in the country, every other thing being equal. So, we should expect further sharp decline in the value of Naira, which may likely reach somewhere around N500 in the midterm, and then it will stabilise.

Another implication of this is the suppression of the black market, as buyers and sellers can accept the interbank equilibrium rates, which are not so much different from the black market value. So, buyers and sellers will avoid the street and walk into banks for any transaction. The BDC will now compete with the banks, giving customers supplier options. Even though, the black market will not seize to exist yet, as they will still push frontiers of their prices no matter the efforts and there will not be convergence.

The need for strict regulation is imperative under the currency competitive market to ensure fair play, so that the economy will not be jeopardised for the benefit of profit seekers. Similarly, the cost of importation will immediately increase as more Naira is required to acquire a unit of foreign currency. In addition, the country will be more vulnerable to foreign inflation (imported inflation). These will lead to cost-push inflation, and with the already 13% inflation rate, the inflation may reach 15% in a near future. Consequently, local industries will underperform due to expensive factor inputs.

The prices of goods and services will continue to skyrocket, and no matter how much efforts are put in place to bring prices down, the price downward slope is going to be sticky and slow. Even though, the government will have window opportunity to acquire foreign currencies at concessionary rate to settle some critical responsibilities, still the cost of government will increase, as government will have to spend more in paying its local and external liabilities.  As a result, the performance of the government will reduce.

With the recent removal of subsidy, the cost of importing petrol will increase, which will push the ceiling price from N145/litre to around N160/litre depending on the crude oil price and stability of the exchange rate. The electricity tariff may also increase as more Naira will be required from the Discos to settle payments to some foreign Gencos in foreign currency.

So, this is Naira devaluation in disguise despite the president’s outright rejection of devaluation. However, whether to devalue or not to devalue, the economy is in danger due to continues reliance on importation of almost everything. So, the expansionary monetary policy will not alone stabilise the market unless it is accompanied with strategic public and private investment in critical areas like refineries, agriculture, automobile and machines production, technology, textiles, education and health. Once Nigeria can independently meet its local demand for these goods and services, the value of Naira can appreciate to even N100 per US dollar. Nigeria has the potential to achieve this, since the country’s exports still outweigh that of its import. Even though, the country is the 52nd largest importer in the world, but with its average annual import growth of 3.2%, this position may reduce over time.

Finally, strong measures must be in place to encourage local investors and producers, and provide the environment for their prosperity, importantly adequate provision of energy. In addition, the MPC should consider increasing the Monetary Policy Rate (MPR) to catch up with the inflation. The MPR should be increased to encourage savings, and reduce money in circulation to quell the pending rise in inflation. 

Dr. Ahmed Adamu,
Petroleum Economist and Development Expert,
Pioneer Global Chairperson of the Commonwealth Youth Council,
University Lecturer (Economics) at Umaru Musa Yar'adua University Katsina.


  1. Thank you Dr Ahmed for this analysis
    Can this be said to be a right move by the government, especially now that the economy is already nearly sulphocated largely due to non existence of a visible and termed workable economic blue print ?

  2. Interesting. The CBN policy of a fixed exchange rate (or managed float depending on who you ask) was always going to end this way. If a central bank does not have substantial foreign reserves to protect its currency there is only one cure, floatation.