What is Happening to the Naira? (2024)

Floating Naira. Collage by THE REPUBLIC.

• Chinenye Iwuh
• July 21, 2024

• Chinenye Iwuh
• July 21, 2024

In today’s globalized world, exchange rates play a significant role in shaping a nation’s economy, especially for an import-dependent country like Nigeria. Exchange rates determine how much of a particular currency one can obtain with another currency. Given the current global economy, exchange rates matter in various areas including foreign education, international travel, mortgage payments, foreign trade and investments. A country’s currency increasing in value against that of another may indicate a healthy economy or the promise of one. This is because the rise of a country’s currency implies increased demand, which is interpreted as viability for good functionality of trade and investment in that country. Several factors could positively or negatively affect a country’s exchange rate. They include but are not limited to foreign trade, market expectations, interest rates and inflation, domestic production and export, social and political climate, and public debt. A higher exchange rate would mean higher prices of goods, inflation, higher cost of living, etc.

The value of a currency is determined by the demand for it, and this demand is in turn mostly determined by trade and international transactions. A country that exports more than it imports would have a high demand for its goods and thus, its currency. As per the laws of demand and supply, high demand means high prices and an appreciation in the currency’s value. In the same way, where a country imports more than it exports, there would be less demand for its currency. Its prices would decline, and the currency would depreciate.

A currency is strong when it compares well to others, i.e. where the value is high compared to other currencies. A currency’s value can have a far-reaching impact on different aspects of the economy. For consumers, a low currency value means that imported goods would be more expensive, while a high value signifies the inverse. For investors, it could affect their return on investments because the turnover becomes of lesser value when the currency depreciates. A strong currency means that you get more value in other currencies for each unit of your currency, which is indeed an advantage. However, a strong currency could discourage patronage of a country’s exports as such goods and services would naturally cost more so it is best to maintain a good balance.

Determining a currency’s value in relation to others is mainly done based on two systems: a floating exchange rate and a fixed one. A floating exchange rate system occurs when a government allows the exchange rate of its currency to be determined by market forces i.e. the level of demand and supply of the currency. Under this system, there is no attempt by the government to influence the exchange rate or peg it at a certain level. This contrasts with a fixed exchange rate system where a government determines or fixes the price its currency sells for, against a certain value of another currency.

Think of the mallams in Nigeria that you purchase foreign currency from at the black-market rate. The exchange rate is not determined by anyone nor is it fixed at any rate. You can exchange naira for dollars at a certain rate in the morning, but by evening or the next day, the value would have changed because they operate a free-market rate using a floating system. The need and availability of a certain currency at any given time determines the value of the currency at that time. The higher the demand for the currency, the higher the value and vice versa. Also, if the supply of the currency is low, its value increases and vice versa.

It should be emphasized that given the sensitivity of a floating exchange rate, certain conditions prove unsuitable for it. Floating exchange rates are prone to fluctuations and are highly volatile by nature because there is no regulator. The rates are left to the whims of the forces of demand and supply. Thus, a currency’s value could deteriorate in just one trading day. This system would not be advisable for a developing country with a struggling economy. Economist, Ejike Nwolisa, in a 2023 essay, noted that this system is impractical for developing countries because of the lack of well-developed deep financial markets and limited implementation capacity. The lack of control over floating exchange rates can limit economic growth or recovery. Moreover, where a country is suffering from high unemployment or inflation, floating exchange rates may intensify the existing problem, potentially leading to increased inflation and further deteriorating the state of an already struggling economy. In contrast, a high-export country may benefit from a floating exchange rate as high demand for its currency would result in a positive increase in the currency’s value.

When Nigeria switched to the naira from pounds in 1973, it also switched from a fixed exchange rate system to a managed float regime. This is a mixture of a fixed and a floating rate where each regime is applied as necessary. The change was instituted to create a balance between maintaining stability for the exchange rates and allowing economic realities and market forces to influence the rates. Eventually, Nigeria was able to adjust itself to the volatile global economic climate and effectively handle its foreign exchange reserves.

In the 1970s, the world experienced an oil boom. As a nation with many oil reserves, Nigeria benefited immensely from this event. The price of oil soared globally, and Nigeria enjoyed substantial revenue from oil exports. This influx of oil revenue strengthened Nigeria’s foreign exchange reserves but in turn created an overdependence on oil, neglecting other economic sectors. For instance, agricultural production of cocoa, rubber, cotton, and groundnut fell by 42, 29, 65, and 64 per cent respectively, between 1970 and 1985.

During this oil boom, Nigeria’s economy experienced significant growth as there was an encouragement of economic activity spurred by infrastructure development. However, when oil prices took a downturn in the 1980s, the over-reliance on oil revenue and corresponding neglect of other sources of revenue led to a series of fiscal deficits and foreign exchange shortages. It was obvious that there was a need for diversification of revenue streams. As a solution to the problems in the foreign exchange market, the ruling Ibrahim Babangida regime in conjunction with the World Bank and IMF, in 1986, introduced the Structural Adjustment Program (SAP).

Under the SAP, Nigeria switched between several floating exchange rate regimes: the Second-Tier Federal Exchange Market, the Dutch Auction System, the Deregulated Exchange Rate System, etc. These policies were incorporated on and off, and at different times, between the 1980s and late 2010s. Nigeria ultimately moved towards a fixed exchange rate system by 2017. However, a parallel market emerged, creating a dual rate of the official CBN rate and a floating free market rate. This unofficial, floating rate is commonly referred to as the black-market rate. The official currency rate was used for necessary transactions, like payments for foreign debt, government business, and vital imports such as fuel and necessities for sustenance. The unofficial exchange rate was used for a variety of more personal, immediate and small-scale transactions for individuals and businesses, and frequently provided a more accurate reflection of market forces than the official rates.

In April 2017, Nigeria took steps to streamline and unify its exchange rate system by reducing the difference between the official and parallel market values. It did so via the Investors and Exporters FX window, which provided rates that struck a balance between the black market and the official CBN rate. The objective was to establish a more consistent and transparent exchange rate system. Nevertheless, using different currency rates brought about problems, such as market imbalances, potential for arbitrage, and corruption. To minimize the differences in exchange rates, Nigeria implemented reforms like restricting the bureaux de change from buying foreign exchange as agents of the CBN and even reaffirming the illegality of the parallel market. The need to rid the country of this parallel rate and save the plummeting naira led to CBN’s decision on 14 June 2023 to end the era of deregulated exchange rates.

The CBN’s floating of the naira could be attributed to the need to salvage Nigeria’s foreign exchange reserves, foster economic expansion, and maintain the value of the national currency by unifying the naira exchange rates. In his inauguration speech on 29 May 2023, President Bola Ahmed Tinubu noted that the unification of the exchange rate would refocus funds on industrial development in the country. While the CBN had previously experimented with various exchange rate regimes, declining oil revenue and a myriad of economic challenges made it clear that Nigeria was far from having a stable currency. Maintaining a fixed rate risked depleting Nigeria’s foreign reserves as the CBN continuously intervened to defend the currency. Jeff Grills, head of emerging market debt at Aegon Asset Management, added, in favour of the policy, that the strategy is generally beneficial for Nigerian assets, whilst emphasizing the need to support the members of the population who are more negatively affected by the policy because of the increased pressure placed on the currency.

The new float policy is targeted at reducing Nigeria’s bloated parts. The policy to float the currency is geared towards discouraging rent-seeking, fostering a stable macroeconomic environment, attracting foreign investment, boosting exports, stabilizing the exchange rate and preventing the dollarization of the economy. All these should improve the investment climate and spur economic growth.

While economists like Benedict Oramah, president of the African Export-Import Bank, are optimistic about the float policy (stating its necessity for the renewal of the economy, and assuring that relief is imminent) public perception of the policy’s effectiveness leans towards the contrary. The key element in this assessment is not the concept itself but rather the concept’s execution. As discussed earlier, this system has been effectively adopted in numerous countries. However, to understand Nigeria’s struggles, a closer look must be taken at the implementation of the policy, considering timing, other existing policies and Nigeria’s unique economic situation.

It is pertinent to note that a float policy needs to sit for a while to see the full effect. An initial disruption of the economy due to a fall in the value of the currency is expected. However, it would not be amiss to say that the challenges Nigeria is experiencing arising from the float could have been avoided or mitigated. Due to the mechanism of floating, certain conditions are essential for its effective functioning. One of them is a stable economy. In an economy struggling with inflation, low GDP, and a high unemployment rate, as is the case with Nigeria, floating the currency will worsen its economic state.

Due to the volatile nature of the floating exchange rate system, it can limit economic growth because it is complex and sensitive to handle. Floating exchange rates can expose a country to volatile currency movements, potentially triggering inflation and weakening the currency’s competitiveness in the global market. Hence, this system should be accompanied by plans and policies that would cushion the expected hardship. These include safety nets and welfare programs for citizens and small and medium enterprises. In the case of Nigeria, it seems as though the policy was sprung on the nation without any preliminary measures in place. The immediate effect of the float, coupled with the shock and panic of the citizens, worsened an economy already grappling with the devastation of the fuel subsidy removal.

Although the policy does have benefits, the positive effect is naturally delayed in comparison with the negative. With the haphazard implementation, citizens are left to live in unnecessary endurance of avoidable hardship, with inflation at an all-time high of 29.9 per cent as of January 2024, businesses closing down and unemployment rising. The impact of the policy took a toll on businesses, especially those reliant on imports, as the cost of goods increased drastically and rapidly. The effect of the float extended to homes due to the country’s high import rate. As of 2021, almost 50 per cent of Nigeria’s imports were consumer goods.

Nigeria’s experience with the floating exchange rate can be contrasted with that of China and Egypt, who have benefited from implementing the system. China is the largest exporting nation in the world. It produces and exports on such a wide scale that its currency, the yuan, is always in demand so much so that the floating of the yuan was done to decrease the currency’s value and ensure that Chinese goods retain their affordability on the global market. This works because there is a high export rate that acts to strengthen the economy. In 2005 when China floated its currency, it did not operate a free float but a managed float. China, which is in a better economic position than Nigeria, was careful about floating its currency, knowing the highly volatile nature of the foreign exchange market and understanding the need to step in where necessary.

Egypt, on the other hand, floated its currency on 28 February 2024, nearly a year after Nigeria did. It had a similar issue with Nigeria, a parallel market, which it sought to eliminate. Rather than follow the path of Nigeria, on the same day that the currency was floated, the Central Bank of Egypt increased interest rates by 600 basis points thereby increasing Egypt’s potential to attract foreign investors due to the potential for increased returns. This is in contrast to CBN’s increase of interest rates by only 200 basis points, despite the high inflation rate. In addition, Egypt agreed to more than double its rescue programme with the IMF to $8 billion. Egypt also agreed in February that it would transfer all the development rights to Ras al-Hikma, a prime Mediterranean resort destination, to Abu Dhabi for $34 billion. Egypt was strategic and methodical in executing a floating system, by following it up with actions that will make the policy work in its favour.

As it stands in Nigeria, the damage has already been done. All that the government can do is learn from its mistakes and try to salvage the existing situation. It is not too late to implement policies and mechanisms to enhance the welfare of the people and encourage foreign investment and forex inflows. Alternatively, the government could adopt a managed float like China did.

The CBN, in June of 2023, announced that the float of the naira is actually a managed float. Even then, Nigeria has unsuccessfully operated a managed floating exchange rate in the past so this is not a sure solution. From the circ*mstances, it is apparent that the country needs to address the root cause of the problem. Whether the exchange rate is fixed or floating, the crucial issue is that there is simply not enough demand for the naira in the foreign exchange market. Switching exchange rate policies is akin to treating symptoms rather than the illness. No matter how potent the medicine is, if the source of the problem is not dealt with, it will continue to manifest. It all boils down to Nigeria’s weak economy. Low production, lack of infrastructure, high unemployment rate, lack of investor confidence, political and social insecurity are features of the country’s economic condition. This makes it unsuitable for foreign investment and incapable of much international trading. Thus, reducing the demand for the naira and, consequently, reducing its value.

The word from the CBN is that they are waiting for the market to set a price for the naira, but that policies to cushion the effect of the float should be expected. This begs the question of whether the CBN had a preconceived plan before implementing this policy or if it was just winging it, expecting a magical fix to the economy and the naira’s value. Regardless, the Nigerian government still has the opportunity to establish appropriate mechanisms and save the currency and the economy⎈