Nigeria might make good its promise to unify its exchange rates and manage the naira sustainably to jumpstart the economy on recommendations of the country’s Economic Sustainability Committee as the new coronavirus and lower-than-expected oil revenues force a rethink in policy direction.
A unification, which is likely to come in the form of collapsing the official rate with the Investors’ and Exporters’ (I&E) FX Window rate, was promised as part of reforms to be implemented when coronavirus-hit Nigeria sought IMF’s financial assistance of $3.4bn in April.
Nigeria has the official window, the I&E window and the parallel market for sales of dollars.
The Economic Sustainability Committee (ESC), headed by Vice President Yemi Osinbajo, advised the country to “unify exchange rates to maximise naira returns to FAAC from foreign exchange inflows” and “manage the exchange rate in a sustainable manner”, according to a draft of the Economic Sustainability Plan obtained by BusinessDay. To that end, the ESC has directed the nation’s apex bank to roll out modalities to migrate to a single exchange window that would ensure greater price discovery for the value of naira.
“Nigeria wouldn’t want to breach its agreement on the IMF loan; we had promised to converge our exchange rates,” said Ayodeji Ebo, MD, Afrinvest Securities Limited, a subsidiary of Afrinvest (West Africa) Limited.
Beyond promises made, Ebo said a rate convergence is seen as a positive for monthly revenue (FAAC) shared between all tiers of the government which includes revenue generated from sales of crude oil.
“Now that things are tight, they should be able to share revenue based on prevailing rates and not one fixed by the CBN,” he said.
The long-standing argument has been that by unifying the windows and allowing market-driven pricing, there will be a scope for increased capital inflows into Nigeria and a boost in dollar liquidity.
The case of Egypt that utilised the 2016 oil crash to float its pound and the consequent inflow of investments into its economy could be an indication that Nigeria is in the right direction.
“The multiple exchange rates regime has been a major challenge for investors when bringing money into the Nigerian economy vis-à-vis peers in sub-Saharan Africa and emerging markets,” said Gbolahan Ologunro, equity research analyst at CSL Stockbrokers. “By collapsing the exchange rate, the country would also successfully de-risk the exchange rate from shocks in the external sector such as a decline in crude oil price.”
The existence of multiple windows is said to create the room for arbitrage and unfair pricing which discourages investors from buying Nigerian assets even if the opportunities to invest are attractive.
To attract dollars and keep the naira stable, the country has had to keep its main interest rate (MPR) elevated at the cost of domestic growth.
For an economy with growth concerns, this would be an opportunity to avoid costly trade-offs involved in currency stability and pro-growth mandate of the CBN.
“When you combine the improved capital from foreign investors with low-interest rates, you have the economy set on the path of growth and prosperity,” an economist who would rather not be quoted due to company policy told BusinessDay. “This is one of the key things we need right now for economic growth to happen.”
The consequent capital inflows into the economy from collapsing into a single rate will be critical due to Nigeria’s balance of payments, the economist said.
Window dressing
The creation of multiple exchange rates by the Central Bank of Nigeria (CBN) has been justified by the apex bank as a child of necessity to help the country manage its dollar shortage by selling at different rates to different sectors, hence ensuring critical needs are prioritised.
An economic crisis emanating from oil declines four years ago led to the creation of the I&E window in 2017 and the introduction of forward settlements in efforts to control demand for dollars and help keep the naira steady.
But the apex bank’s move has been criticised by many local and offshore economists and Bretton Woods Institutions such as the International Monetary Fund (IMF) and World Bank.
Part of the concerns was that the multiple exchange rate windows had led to currency round-tripping by those who have access to the official rate and can sell at the parallel market, and worries that the multiple exchange rate regime has also discouraged healthy competition among manufacturers as large-scale producers access FX at the official window for their raw materials while small-scale producers are left to access the FX at the parallel market.
Short-term pains, long-term benefits
Economists say one dilemma in implementing a unification of rates is in regards to the timing considering the shock brought by the global pandemic.
Initial reaction feared would be a steep depreciation in the currency which could further exacerbate the impact of the global pandemic and result in an increase in price levels.
But experts say providing a clear direction regarding FX, as well as providing liquidity, will result in business confidence.
“Investors need to be sure of the direction. This is a bigger problem than a depreciation or devaluation of the naira,” said Ebo. “If everyone knows its N500/$ today, they will work with that rate, but if they are not sure the rate will stay the same, then they get worried about losing money.”
Ologunro said the long-term gains would make up for the short term and the fact that there is greater price discovery before all the risks crystallise, the naira would be priced at its true market value.
In his view, Boboye Olaoluwa, an economist at CSL Stockbrokers, said convergence of rates is important for now while Nigeria works towards the unification of the exchange rate later.
“To make it more efficient, the exchange rate must be flexible where the interplay of demand and supply determines the rate at a particular time,” he said.
The apex bank’s intervention has seen the country’s foreign reserves which stood at $38.07bn at the end of 2019 tank to $34.9bn at the end of the first quarter of 2020. The depletion in external reserves rode on the back of FX sales to Bureau De Changes and Import & Export window as well as dwindling oil receipt.
