Contrary to market perception that the naira remains overvalued, the Central Bank of Nigeria (CBN) on Tuesday said the currency of Africa’s largest economy is now determined by market fundamentals.
Hassan Mahmud – Director, Monetary Policy Department, Central Bank of Nigeria made this known during a panel discussion; ‘Navigating an Economic Recovery Amid a Pandemic’ at the
12th Annual Pan-Africa Investor Conference by Renaissance Capital.
“Yes, we have moved from N379 to N410 against the dollar that shows there must have been issues of overvaluation earlier on but at the level, we are now we expect that the current rate is the reflection of demand and supply within the market,” Mahmud said at the virtual event.
If market fundamentals depict differently, we expect the market to flow in that direction, he added.
Nigeria, unlike its African peers, has continued to operate multiple exchange rate windows. The International Monetary Fund (IMF) and the Presidential Economic Advisory Council hold the view that ditching the multiple exchange rates practice, which Nigeria started in 2016 in reaction to lower oil prices, will open up the economy to badly-needed investments.
But the Central Bank of Nigeria in May 2021 adopted the NAFEX rate of N410.25 per US dollar on its website, a move industry players tagged a ‘major step’ towards full exchange rate unification.
When asked by Yvonne Mhango – Head of Research Africa, Africa Economist, Renaissance Capital about the market estimate that put the naira at N458 against the dollar, Mahmud said it depends on who is doing the econometrics and the underlying assumptions and the objective of such estimation.
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“Issues around overvaluation and undervaluation will be determined by demand and supply but if you have issues of instrumental market failure then that price discovery role of the market is lost within that crack in the transmission. That is why you have the interventions that come into the market because of the characteristics of market failure,” the Director said.
The gap between the CBN official exchange rate and the free market rate, which many investors regard as the clearest mirror of the market-determined rate, deepened on Tuesday as liquidity challenges persisted.
Naira fell in the free market to its lowest level in 10 months at N532 against the dollar, the weakest since November 30, 2020, when the currency depreciated to N510/$.
Data collated from the black market implies a gap of N122 between the now official NAFEX rate and the free market rate commonly known as the parallel market rate.
According to Mahmud, the CBN is not bothered about the overvaluation or undervaluation of the naira because it expects market fundamentals to determine the rate.
“What we are more interested in is the supply side and the integrity of the financial system in terms of the confidence that investors will have in that market to be able to bring in their funds and leave when they want,” he said.
The naira at the CBN’s FX window has depreciated by an average of 7.7 percent annually in the last 10 years, according to Ayodeji Ebo, head, retail investment, Chapel Hill Denham.
The continuous devaluation of the naira is a key concern for both local and foreign investors who are looking to preserve the purchasing power of their savings and investments. Foreign investors have had their money trapped in Nigeria’s debt market since March 2020 amid dollar shortage.
Dollar supply challenges in Nigeria come from its dependency on the foreign earnings from crude oil, which has continued to account for over 90 percent of the export of Africa’s largest economy. Although on the rise, the falling global crude price always reduces FX supply in Nigeria and affects the exchange rate like in 2016 and 2020.
“To have stable currency Nigeria must diversify the sources of its FX supply,” Ebo states.
On inflation Mahmud also said that he admits that some of the CBN’s monetary policies might be fuelling inflation but the structural challenges are the real problem.
“I think inflation has reached the peak and the interventions of the CBN such as the Anchors Borrowers Program are yielding fruits as inflation has been on the decline for four months now. We expect this to impact the agricultural sector and food supply and we should see single-digit inflation by 2022,” he said.
