Analysts have lauded the introduction of a flexible exchange rate model to the foreign exchange (forex) market by the Central Bank of Nigeria (CBN). They, however, warn that the initiative will be difficult at the initial stage. It will get better with time, Assistant Editor NDUKA CHIEJINA reports.
FOR months, Nigeria has been in the grip of acute shortage of foreign currency. As oil prices plummeted at the international market, so did the country’s foreign currency earnings. The consequence: less cash to pay for imports.
Bowing to pressure, the Central Bank of Nigeria (CBN) has now allowed the embattled naira to trade freely as part of ways to control the currency crisis. Being a major oil exporter, Nigeria, arguably Africa’s biggest economy, has been hit by the fall in commodity prices. But with the new policy, naira’s real value against other currencies will be decided by the gap between exports and imports.
The currency fix was introduced in February 2015 to stop the naira from falling. Then, lower oil prices sparked trouble for the local economy. But a prolonged period of holding a currency at an artificial level often has a disruptive effect with the reluctance of foreign companies to import goods when they are paid at unstable rates.
After months of haggling and pressure from outside and within, the CBN is finally taking the painful step not a few stakeholders have counselled it to take.
Such stakeholders insited: “Let market forces determine the value of the naira.”
On Wednesday, the CBN announced that the naira peg will be abandoned next Monday and the currency will be allowed to float freely, but with a proviso that the bank will intervene “as the need arises.” However, the decision is expected to lead to a significant devaluation of the naira. The CBN insists it has not devalued the naira.
A decision taken ‘reluctantly’
Reviewing the flexible foreign exchange rate model (NIFEX) as unveiled by the apex bank, analysts are saying the economy will, in the short-term, get ugly. But, in the long-term, things would pick up.
The CBN had long been expected to allow the naira to be more flexible and trade at a market-driven rate. But some reasons, the naira was pegged N197 to $1 with the black market rate soaring to as high as N370. The fixed currency rate had created a vast and thriving black market for US dollars and squeezed the economy.
Dr Wale Odutayo, Lead Economist at the Centre for Economic Development, Abuja, told The Nation in a telephone chat that “on the long-run, a weaker currency will help Nigeria’s economy by encouraging import substitution and attracting foreign investors, who have shunned the country for fear of devaluation.”
He warned: “The move will be painful in the interim because higher import prices will push up inflation, which reached 15.6 per cent year-on-year in April. This will probably force the authorities to tighten monetary policy.
“If the apex bank can’t get inflation back under control, then the country might end up getting stuck in a ‘vicious cycle’ of high inflation that leads to a weaker naira, which could lead to higher inflation.
“This is one reason devaluation can be so painful, as central banks typically jack up interest rates afterwards. Recessions are often post-devaluation consequences. Yet,if President Muhammadu Buhari has finally relented on maintaining what is viewed as an unsustainable peg, the longer-term outlook will improve.”
According to Dr Odutayo, “a weaker currency is, at best, a necessary but insufficient condition of an economic recovery. But, at least it’s a step in the right direction.”
As it is, the pressures from multilateral agencies and foreign investors to force the government to devalue the naira may have paid off as many foreign analysts and economic journals have been arguing that Nigeria will eventually have to capitulate and devalue its currency, given that the government’s controversial agenda of currency and price regulations created economic stress in the economy. Only recently, inflation soared to a six-year high of 15.6 per cent.
Some analysts argue that devaluing the currency peg will not magically fix all of the country’s problems. They say the local economy continues to suffer from numerous headaches, including lower oil prices, fuel-shortage threat at the least provocation, or policy shift by government, and ongoing oil-production disruptions by militants in the Niger Delta.
Only recently, the Nigerian Bureau of Statistics (NBS) alerted that the country’s economy shrank by 0.4 per cent year-over-year in the first quarter, which was way worse than expected, added to the stern warning impending recession by the CBN at last month’s Monetary Policy Committee (MPC).
There is the fear that Nigeria will be in full blown recession if the economy shrinks again for the second consecutive quarter, which means that by the end of this month, the government will have a major economic crisis to deal with.
Unlike other major petroleum producers, such as Russia, Nigeria refused to devalue its currency. President Buhari wanted indigenous manufacturers to produce what they could not import and to diversify the economy from the oil industry.
But that policy led to widespread shortages of raw materials and machine parts.
New policy as elixir
The new exchange rate policy will be welcomed by businesses that were forced to source forex from the black market to pay for their imports. At a point, they were paying almost double the official rate for dollars. Foreign investors may also be tempted to participate in the local economy with an assurance that they will get value for their money under the new policy.
But the new exchange rate is likely to further push up the already high inflation. And that will hurt tens of millions of Nigerians who live in abject poverty.
Recession worries
Last month, CBN Governor Godwin Emefiele warned of the imminence of a recession. A lower value of the naira will make domestic products cheaper and competing imports more expensive, which is hoped to help the struggling economy.
Local companies have suffered from the crisis with the commercial banks not forthcoming in making forex available at the regulated rate and left with no other option than sourcing forex from the black market to pay for imports of goods and equipment. It is believed that the expected devaluation will restore investors’ confidence as foreign companies.
A number of foreign airlines recently suspended their flights to Nigeria for being unable to repatriate up to $600 million (£417 million) in ticket sales, according to the International Air Transport Association (IATA).
According to Time Economics Ltd: President/Chief Executive Officer Dr. Ogho Okiti, the decision was a decision taken almost too late by the authority.
His words: “These measures are long overdue while some of the innovations introduced to the forex market today will not only ensure liquidity and access to foreign exchange but will also deepen the Nigerian financial market.
“Without doubt, the policy will remove uncertainty and lure back the inflow of foreign investments into the Nigerian economy. Though it could take several months, we anticipate the gradual erosion of the huge backlog of unmet forex demands.
“Once the newly established single market is in full operation, we also anticipate that much of the forex demands currently lined in the parallel market will be pushed back into the inter-bank market which will markedly reduce the significance of BDCs (Bureaux De Change”.
Okiti said the flexible exchange rate measures “are in line with the expectations of the market. For a long time now, the market has called for a more flexible exchange rate mechanism, with the expectations that this will attract foreign exchange inflows and improve liquidity, ease restrictions on access, and provide a basis for a market determined rate.”
In its Article IV conclusions earlier this year, the International Monetary Fund (IMF) had strongly called for a more flexible exchange rate measure.
It said it “underscored the need for credible adjustment to the large terms-of-trade shock, including through greater exchange rate flexibility and speedy unwinding of exchange restrictions to facilitate an exchange rate consistent with fundamentals.”
In preparation for yesterday’s changes, the CBN had reduced liquidity in the system by as much as N1 trillion in the recent past, with the expectations that this will help strengthen the naira in the market.
Many Nigerians, who faulted the delay, argue that the consequences would linger for some time.
“They finally float the naira, nine months late. It will take us two years to recover from this unnecessary stubbornness,” one analyst posted on the social media.
Another bitter commentator posted: “So, we crashed our whole economy, killed businesses, killed bank jobs, suffered hyper-inflation for NOTHING. We have floated the naira — too late.”
From outside the shores of the land, Kevin Daly of Aberdeen Asset Management said he was “pleasantly surprised.Many had expected the government to devalue. “It remained to be seen what the government can do to provide liquidity with foreign currency reserves some $10 billion below the published figure of $26 billion”
Daly said the weakened naira would fuel inflation but that “this is the price they have to pay for a failed policy … which has been like a noose round the neck of Nigeria’s economy.”
Three-month non-deliverable naira forward contracts surged 1.9 per cent to N310 per dollar after the announcement, suggesting traders expect the local currency to trade around that level in the market, compared with the current official rate of N197. Nigeria’s 2023 dollar bonds gained the most since 2014, with the yield falling 55 basis points to 7.1 per cent, and stocks jumped 3.2 per cent.
“It’s probably the best that the markets could have hoped for,” Ridle Markus, a Johannesburg-based analyst at Barclays’ Africa unit, told Bloomberg news. “It certainly seems like it will be a normal, free-floating currency. That would be positive.”
In his remarks, Kunle Ezun, an analyst at Ecobank Transnational Inc. said: “It is something the market will want to see in operation to fully be able to take decisions concerning future investment, especially foreign investors. The takeaway is that the central bank has not committed to any exchange rate.”
What asset managers say
Nigerian asset managers are united in their assessment of the new forex policy, stating that a flexible exchange rate would provide opportunity for inflows from other sources other than crude oil sales. The decision to allow foreign remittances to be converted at the interbank rate as well as inflows from foreign investment would help to address the disincentive that operators and other players in those areas had witnessed in the last couple of months, forcing inflows from those sources to dry up.
They also believe the Federal Government should support the new policy with other fiscal policies, particularly as it relates to investments and in an area like infrastructure by making the infrastructure sector attractive for private sector investments to help drive inflows.
The Head of Research, at Centre for Economic Development Abuja, Mr. Sebastian Nkwere, described the decision by the apex bank as a positive and a good move for the economy, but noted that “though it was delayed, it is better now than never.”
He went on: “The adoption of flexibility around the interbank market is a policy that would help bridge the gap that had existed in the forex market in the past, particularly the gap between the official and parallel markets.
“But with the adoption of a floating exchange rate, what this means is that we would see the interplay of demand and supply. That would by extension determine the true value of exchange rate in the country.
“By extension businesses would be able to plan with respect to their forex requirements and that is very critical. It would also help reduce the volatility we have seen in the market over a long period of time.”
So far, stakeholders have described the introduction of the flexible forex policy as a step taken in the right direction. They hope it would allow for demand to be met and that operators can hedge in their transactions to develop proper business plans.
