Single Exchange Rate in Nigeria: Conditions and Process

  Ahmed Adamu, PhD

In 1985, one Naira was equivalent to one dollar. In 2023, one dollar equals N760, representing a 75,900% Naira depreciation in just 38 years. In the previous eight years, Naira depreciated by 265%. Based on the trend, the dollar may keep increasing towards N1000 per dollar if nothing is done.

 This depreciation implies that the things we buy abroad are 75,900% more expensive in just 38 years and 265% more expensive in the last eight years. The items we purchase are costly because of exchange rate inflation. If the Naira value falls, the cost of importation and inputs becomes more expensive.

 A Naira/Dollar exchange rate affects our income and spending. Once the dollar becomes more expensive, our pockets are slighter and our spending smaller. Inflation will also go higher. Businesses will incur more costs and reduce their employment potential, increasing unemployment. Unemployment leads to insecurity and cripples productivity. So, all our problems are caused by the Naira depreciation.

 The Naira's weakness to the dollar affects the exchange rate with other currencies too. For example, if $1=N710 and $1=£0.82, then £ to N becomes 0.82/710 =£0.001 for N1. Making all imports from all destinations more expensive.

 The Central Bank of Nigeria (CBN) is primarily responsible for the bad management of the exchange rate regime and its complacency in brokering the dollar for personal gains. One of the problems with the exchange rate is the two different dollar markets. We must merge it into one, but how?

 First, we must evaluate the current exchange rate regime to assess the reasons for having a dual exchange rate regime and its associated challenges.

 The Central Bank cannot meet the Nigerians' demand for dollars. As a result, a separate market allows Nigerians to source and sell dollars at a willing-buyer-willing-seller rate. This created two markets for the dollar; the one that CBN sells to banks and the open market, commonly called the black or free market.

 Rent seekers are taking advantage of the two markets and conspiring with bank officials to divert the dollars to the black markets. Customers with genuine demand could not get the dollars and were forced to buy at the expensive black market.

 The continuous arbitrage and rent-seeking are partly responsible for the expensiveness of the dollar in the free market. The inefficiency of the official market led to an increase in dollar demand in the black market. People import raw greenbacks (paper dollars) into Nigeria for sale. The dollar supply comes with no value addition but just for some personal gain purposes.

 The CBN had abolished selling dollars to BDCs because no one brings dollars to the banks, and everyone takes their dollars to black markets. Exporters do not remit to the Nigeria Export Proceeds (NXP) account.

 The CBN will get drained and cannot continue like this. Even if they continue, it will not meet the demand, and the dollar will still be scarce. The CBN created windows for people to become billionaires through the two exchange windows in a few weeks. So, why the double losses - loss of reserves and loss of naira value?

 Having two markets for the dollar, one cheaper and the other expensive will always create arbitrage, which makes the economy lose for some people’s gains. Therefore, having two exchange rates is bad for the economy. Therefore, there should be only one exchange rate market.

 One of our best options is the managed floating exchange rate. Under this regime, a particular currency band will be set, beyond or below which the exchange rate will not pass. The CBN will clear any extension beyond the bands to keep them back within the band by flooding the market - band realignment. So, the two markets should be unified, starting at a specific equilibrium rate that is fair for both markets but blocked within a range.

 Unification under managed floating will discourage speculators. Speculators anticipate the future and act now. If they expect the dollar to appreciate more, they will buy forward. If they anticipate the dollar to fall, they will sell forward. They are profit driven. However, when the exchange rate is blocked within a range, there will not be a high speculation motive. The market will be for only commercial needs.

 The currency band could be +/-2% from the equilibrium point daily or 10% annually. This will continue until the maturity of the export sectors and more forexes are received. The government can then flexibly appreciate or depreciate the currency through the demand and supply of foreign currency. This regime will be highly effective when we have huge reserves.

 The quantity of Forex that CBN is spending on incentivizing rent-seeking within banking systems and other windows should be used to stabilize the market within the threshold. The CBN should block the black-market rate to reduce its volatility.

 This system is suitable for stabilizing the currency and bringing in more investors. Countries practicing this regime include China, Brazil, South Korea, South Africa, Mexico, Israel, Turkey, New Zealand, etc.

 The government should avoid making abrupt announcements to migrate into the managed floating regime. It should get involved in the black market and gradually flood it to decrease the exchange rate. The CBN should phase out its dollar allocation to the banks. The banks will have to source the dollars at the market. The black and official markets will converge into a single market. The rate at the single market should be pushed lower down through monetary and fiscal policy means.

 The money in circulation is already being reduced, the removal of petroleum subsidy has reduced the purchasing power of Nigerians’ income, and spending substitution is in effect. Therefore, the demand for the dollar will be reduced, while its supply will be high through the CBN action.

 With the liberalization of the petroleum products markets, upcoming local refineries, and expected improvement in oil production, the CBN foreign exchange reserves will increase to enable it to manage exchange rate fluctuations within the band.

 Rather than an abrupt shift, the government should consider a gradual convergence towards the single exchange rate regime. Initially, narrow the gap between the two exchange rates by reducing the spreads and minimizing distortions. This can be achieved through market-based reforms and easing restrictions on foreign currency transactions.

 The government must carry the citizens along, explain the new system’s benefits to them, and create room for addressing people’s concerns and uncertainties. The political appointments in the economic sector must be based on merit. The CBN governor should be an Economist. We can consult other countries that have transitioned to a single exchange regime to learn from their experience and adapt the best practices to our country’s specific circumstances.

 Most importantly, for any policy to work, Nigerians must play their roles. At this moment, the government cannot do it alone. It requires everyone's sacrifice. People must learn to be patriotic and forfeit some gains that hurt the economy.

 Nigerians must believe that they are somewhat responsible for this country. More than half of the foreign exchange crisis in Nigeria is because of our attitude. These attitudes range from rent-seeking, dollar hoarding, dollar brokering, and preferring foreign goods and services to local ones to extravagance and excesses.

 Another condition for the single regime is that we must make people from foreign countries come and seek Naira. And to do that, we must produce what those people want locally. That is the way to create demand for Naira, which is exports. We should focus on building the solid mineral and agricultural sector to achieve this objective. That is why the Nigerian constitution should be amended to allow states to own and develop solid mineral deposits in their states.

 According to a PWC report, Nigeria is losing over 10 billion dollars annually from Agro export worldwide. With value addition, the gain might be higher. These are quick ways of creating demand for the Naira. Our comparative advantages are mainly solid minerals and agriculture. We should focus on them first and then diversify into industrialization.

One of the fiscal actions to stabilize the exchange rate is to reduce government foreign spending. The cost of governance should be reduced. Dollarization within government institutions should be reduced as well.  Fixing the dollar issues is solving Inflation. All exchange rate policies fix the inflation problem. 

Ahmed Adamu, PhD

Petroleum Economist

ahmadadamu1@gmail.com

 

Finally, Petroleum Subsidy is Gone: The Implications

The final removal of petroleum subsidy in Nigeria is a welcome development. It means the market will determine the fuel price, i.e., willing buyer, willing seller price. It also means that many companies can import petrol and sell it at a price they want to recover their costs and make a profit.

Many suppliers will be posting their market prices. We will see variations in posted prices by companies—no more regulated prices by the government.

The petrol price will fluctuate periodically as crude oil prices and dollar exchange rates change. NNPC Limited and other importers will post their prices whenever there is a change in the variables that affect the cost of their fuel. These could be the distance from which the fuel is imported, its quality, or variation in profit margins.

NNPC Limited posted prices will be the benchmark for the petrol market because it is a fairer and stronger player.

Prices will be coming down in the event of lower crude oil prices. However, there could be collusion by the importers to stick to a higher price even at a low crude oil price. But, higher prices attract more supply, and less demand, leading to excess supply, which brings prices down.

When the Dangote refinery starts operation, the petroleum products importers will then buy from the local refiner, thereby saving the extra costs of distance transportation costs and foreign inflation from the source country. They will be able to reduce their posted prices then.

The marketers will get Dangote's fuel at least N30 less than the imported fuel per liter. They will enjoy Dangote's economy of scale (producing more at cheaper costs) and local production. This cost-saving could be higher due to cheap labor in Nigeria. However, this does not remove the possibility of some marketers sourcing the product cheaper elsewhere.

Marketers that buy from the Dangote refinery will sell first. And if they can meet the local consumption, those that import expensive fuel will be pushed out of the market.

With the sudden increase in fuel price by more than 170% due to the subsidy removal, the economy will shrink in the short run as productivity reduces. There will be less demand for petrol, and overall spending will decrease. Businesses will lay off staff to cope with the increasing cost of doing business, and general welfare will reduce.

However, there will be new inventions as people start looking for alternatives. They will explore alternative transport systems or fuel or adjust their lifestyle. More business opportunities will emerge from this development. People will now begin to organize collaborative transportation means to share or reduce the cost of transportation per head.

There will be efficiency of demand and reduced wastages, and Unnecessary trips will reduce. There will be fewer cars on the road and reduced carbon emissions. The NNPC Limited remittance to the government will increase because the cost of the subsidy is being removed. This enables the government to do more development projects and borrow less.  

Even though the approach by President Tinubu needed to be more systematic, it has minimized the chances of prolonged speculative buying by retailers in the event of scheduling the removal on a designated future date.

However, because of his sudden announcement, there are now excessive supplier surpluses. Retailers of petrol that bought their products at a subsidized price just before the announcement are selling them at higher market prices, causing consumer losses and abnormal profit for the suppliers. That is the immediate effect of such a sudden pronouncement.

For example, a retailer that bought a truck of 45 thousand liters at an ex-depot price of N179 per liter just before the announcement is now selling it at N540 per liter, making a surplus of more than N15 million per truck.

Consumer losses are still inevitable even if a future date of the removal is announced, as retailers will engage in even more speculative buying ahead of the date to hoard as many large inventories as possible, wait for the removal date, and make abnormal profits.

The good news is that many filling stations will open, and long queues will disappear, but consumers will lose. One of the conditions for removing the subsidy is sufficient local refining capacity. With the Dangote refinery, there will be a lower price of about N30 or more per liter compared to the imported one due to the advantage of local production.

The Dangote refinery will reduce Nigeria's import bill because, as of now, imported petroleum products are the biggest bill in Nigeria's import basket. So, the Dangote refinery will reduce the supply of Naira, leading to its appreciation. It will positively affect Nigeria's balance of payment due to the exports of petroleum products by the refinery.

Other countries will also bring their crude oil for refining in Nigeria and pay in dollars, thereby growing the impact of the oil sector on GDP. However, Dangote will buy Nigeria's crude oil in dollars, sell the refined petrol in Naira only to Nigerians, and exchange any desired quantity of the Naira receipts for Dollars at the CBN.

Therefore, from the economic perspective, these two developments favor the economy's growth. They will create new business opportunities and lifestyles. The short run will be challenging, but the long run will be stable.

Ahmed Adamu, PhD
Petroleum Economist,
ahmadadamu1@gmail.com