The Central Bank of Nigeria and the Exchange Rate Challenge

The exchange rate’s significance as a major macroeconomic variable cannot be overstated. The exchange rate is the price of one currency in terms of another, and it helps to define a country’s economic health and citizens’ well-being. Countries earn foreign currency through producing and exporting goods and services, and the volume of foreign currency and external reserves influences the exchange rate.

Import-export activity effects the exchange rate and other significant economic factors, emphasising the importance of a country’s imports and exports in determining the health of the economy. When imports and exports are increasing, the economy is healthy.

A low exchange rate encourages foreign exchange, FX, inflows, and exports, whereas a high exchange rate encourages imports. Because of its structural imbalance, Nigeria’s economy faces an ongoing exchange rate difficulty.

The economy is one-dimensional, factor-driven, and import-reliant. As a result, FX is always in high demand. The Central Bank of Nigeria, CBN, has devised and executed several policy alternatives over the years to address the recurring FX difficulty, which occasionally degenerates into a crisis situation.

There was a severe dollar shortage in 2016, which depreciated the naira to a low of N530/US$1. The CBN blamed the incident on individuals harbouring unlawful money, those desperate to get illicit earnings out of the nation at any cost, and speculators.

Currency speculation has a destabilising effect and inhibits real economic growth since it is not supported by underlying economic activity and is motivated simply by the desire to profit from currency gyration.

In response, the CBN continued to pump dollars into the market, which was enabled by an increase in external reserves and the conservation of foreign currency through one of its FX demand-management strategies, namely the exclusion of 41 goods from the Interbank Foreign Exchange Market.

From February 21 until August 21, 2017, the CBN maintained a dollar infusion. The bank pumped $9.964 billion into the foreign exchange market until the naira strengthened to N360/US$1 in the interbank market and N361/US$1 in the parallel market.

In the future, the CBN will also launch Naira-Settled Over-the-Counter, OTC, FX Future Products in cooperation with FMDQ OTC Securities. The FX Futures Market was established in order to, among other things, “minimise disequilibrium in the Spot FX Market and cause the rate to moderate, attract significant capital flows to the Nigerian Fixed Income Securities and equities market, and achieve exchange rate stability.”

The foreign exchange futures market was supposed to provide opportunities for foreign portfolio investors, FPIs, importers, exporters, governments, and other end-users to manage their foreign exchange requirements. The CBN previously used a multiple exchange rate/managed float regime. As Professor Mike I. Obadan, a member of the CBN Monetary Policy Committee, MPC, pointed out, the choice of exchange rate was critical for self-protection from speculative attacks.

Godwin Emefiele, the suspended CBN Governor, stated that the exchange rate regimes he oversaw were designed to “preserve the value of the domestic currency and maintain a favourable external reserves position.” Emefiele stated in a news release that developing economies, particularly Nigeria, where import demand is high, needed to establish an exchange rate system that would “safeguard capital outflow and ring-fence external reserves.”

He went on to say that a floating exchange rate regime is better suited to industrialised countries because the bulk of them utilise convertible currencies that are less vulnerable to currency gyration. He went on to say that “countries rarely take the extreme of the regimes, that is, fixed or free floating, except in certain cases,” and that emerging countries’ exchange rates were geared towards preventing huge capital outflows and currency crises.

Mr. Folashodun Adebisi Shonubi, Acting Governor of the Central Bank of Nigeria, has embraced a uniform and free-floating currency rate decided solely by market forces. He did away with all segmentations and merged all FX windows into Importers and Exporters, I&E, FX windows.

The World Bank backed the new currency rate system, noting that it was vital to restore macroeconomic stability. However, in the aftermath of the new FX regime, the naira fell to an all-time low of N945/US$1 on the parallel market, as demand for the dollar vastly outpaced supply. The CBN emphasised that the development was not solely driven by market forces of demand and supply, but rather by “unofficial diaspora remittances.”

Mr. Shonubi stated that many diaspora remittances went unnoticed and ended up in the black/parallel market.

The CBN intervened to stabilise the naira, including the creation of the Price Verification System, PVS, a site for importers purchasing foreign currencies.

The PVS would specify how clients may obtain foreign currency and at what exchange rate. In order to increase the efficiency of the FX market, the Bank also directed Bureaux de Change, BDCs, to trade foreign currencies at rates comparable to those available on the I and E windows.