The Nigerian Naira has experienced significant fluctuations in recent years, impacting businesses, investors, and the overall economy. This article delves into the intricacies of the Naira exchange rates, exploring the factors that influence its value and the strategies for navigating this dynamic market. As an advisor to investors and entrepreneurs who are pursuing opportunities in Nigeria, I am frequently asked about the intricacies of the country’s exchange rate system.
Nigeria’s foreign exchange market has undergone significant reforms, particularly with the Central Bank of Nigeria (CBN) introducing sweeping changes. The Central Bank of Nigeria recently announced changes to the way the country’s foreign exchange market will work. Foreign currencies can now be bought and sold at rates determined by the market - not by the central bank. This signals the intention of the Bola Ahmed Tinubu administration to allow market forces to determine the value of the naira.
In the past, there were multiple exchange rates for the currency. The International Monetary Fund has repeatedly called on Nigeria to end this. The huge gap between the official and unofficial rates caused severe shortages of foreign exchange by discouraging supply. In general, the existence of multiple exchange rates signals a dysfunctional economy. It erodes investor confidence. Capital does not flow in and foreign exchange becomes scarcer.
Historical Context and Key Problems
This is not the first time Nigeria will be liberalising the foreign exchange market. The first was in 1986; further efforts followed in 1995, 1999 and 2016. All were marred by various impediments. The three key problems that afflict Nigeria’s foreign exchange market are the lack of transparency, foreign exchange shortages and volatility.
Shortages occur mainly because about 90% of Nigeria’s foreign exchange earnings come from the oil sector. The market is volatile when oil prices drop with no corresponding fall in demand. Other African countries that grappled with shortages and volatility have also liberalised the market. Egypt floated its currency in 2016 and the value of the Egyptian pound declined by 50%. One lesson for Nigeria is that the stability of the naira depends partly on the country’s monetary and fiscal policies, as well as political stability, security and investor confidence in the economy.
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It also depends on whether the Central Bank of Nigeria will follow through with this new policy. Previous efforts were abandoned prematurely. As an economist, I have observed the various reactions of Nigerians to this policy. It’s too soon to decipher the full consequences, but it is possible to highlight some of what can be expected.
Before the creation of this window, the economy had cooled and entered a recession in August 2016, when the National Bureau of Statistics revealed that GDP had decreased by 2.06% for the second quarter of that year. From 2011 to 2014, Nigeria experienced an economic boom fueled by a thriving oil industry. Oil prices soared to an average of US$109.75 per barrel, which helped the CBN maintain a largely stable currency, as the naira traded within a range of NGN155-156/USD between 2012 to 2014.
In 2015, amidst a sharp decline in oil prices, the naira weakened to an average of NGN193 against the US dollar. Despite dwindling reserves, the government maintained a fixed exchange rate of NGN197, rejecting expert recommendations for devaluation. In June 2016, the Central Bank of Nigeria ended the fixed exchange rate between the Nigerian naira and the US dollar, causing a substantial devaluation exceeding 40%. The decision aimed to alleviate mounting pressure on the nation’s foreign reserves due to falling oil prices.
With oil prices averaging US$43.58 per barrel and hitting a low of US$26.21 per barrel, the Nigerian economy faced formidable challenges. Since 2018, the central bank has implemented numerous devaluations in pursuit of financial stability, yet by December 2022, the exchange rate had reached NGN488/US$.
On Wednesday, June 14, 2023, the Nigerian government, in a bid to mitigate the effects of currency rate volatility, announced the consolidation of the foreign exchange market, allowing market forces (I&E) to determine prices. The Naira traded between N750 to N755 but closed at N632. The naira has since significantly lost value, currently trading at N1,490/$1 as of Monday, May 20, 2024.
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The naira’s depreciation has affected foreign investors and local businesses in Nigeria. For investors, it impacts portfolios denominated in Naira, while businesses face increased production costs. Naira devaluation also fuels inflation, particularly in an import-dependent economy like ours. Pricing risks emerge from varied exchange rates, complicating price adjustments and potentially impacting sales.
Nigerian Naira Notes
Current Exchange Rate Dynamics
On January 30, 2024, the naira dropped to a record low of NGN 1,482:USD according to data reported by FMDQ, a local exchange bureau that reports the daily NAFEM spot rates. Since then, the value of the naira per USD has consistently hovered above the NGN 1,400 mark. This is the second devaluation in the span of six months, and coincided with the Central Bank of Nigeria (CBN) introducing sweeping reforms to the foreign exchange market. Central Bank Governor Olayemi Cardoso announced that FOREX obligations totaling USD 2.4 billion will not be settled following an audit that found irregularities tied to these obligations.
The CBN will temporarily succeed in managing the naira through a de-facto free float following the devaluation and reforms to the foreign exchange market. FOREX access through official channels will marginally improve over the next three months as the CBN works towards clearing its backlog and some market participants resort to the official market to sell their holdings of USD. In the next three to six months, the naira will fluctuate between NGN 1,400:USD to 1,600:USD at the official rate.
However, the parallel market will remain a source of foreign currency for a significant portion of market participants; companies and individuals in Nigeria will be reluctant to instantly switch their sources of foreign currency given the history of difficulties accessing FOREX through official channels.
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The parallel rate, averaging around NGN 1,440:USD, is currently lower than the intra-day high of NGN 1,520:USD (reported by FMDQ) and almost on par with the average daily exchange rate reported by the CBN.
At any point in the last few years, Nigeria’s naira has always had multiple exchange rates. As of Friday (Nov. 27), the parallel market rate was 24% higher than the investors window rate provided by the country’s central bank and that was, in turn, 2% higher than the Central Bank of Nigeria’s official rate. The divergent rates have long been a striking feature of Nigeria’s economy but more so in the last half decade as the country’s financial authorities have attempted to micro-manage the supply of foreign exchange and “defend” the naira.
The recent push stems from monetary policy trends in 2016 when, amid a recession, Nigeria’s government stubbornly refused to devalue the naira despite a widening gap between official and black market rates. And, when it eventually did, it turned out to be a managed float as it simply moved the currency’s value from one peg to another.
But with the proverbial genie out of the bottle, the past five years have been a never-ending experiment on how to manage a currency crisis of varying proportions. Things reached a head last week when Godwin Emefiele, Nigeria’s central bank governor claimed the parallel market rate “cannot be the basis” to determine the naira’s real value.
Emefiele’s argument included describing parallel markets as “illegitimate” and “shallow.” Yet, with the parallel market rates not fixed by the central bank unlike others, black market operators often deliver a more accurate verdict on the levels of the supply, demand, and prices of the dollar.
While it’s difficult to capture the exact size of the parallel market, what’s clear is that “it plays a significant role that interprets the true value of the greenback to the common person in the economy,” says Oghenefejiro Eduviere, Lagos-based foreign exchange trading associate at African currency broker, AZA.
The naira, which started the year at around 360 naira to the dollar on parallel markets, is now on the verge of crossing the psychologically important “red line” of 500 naira.
To be clear, a high black market exchange rate is terrible for import-dependent businesses that cannot access foreign exchange from official government channels given existing restrictions. As such, a recourse to black market operators is done only out of necessity on the back of the government’s ongoing currency policies.
It’s a curious situation that continues to stump analysts who advocate for more flexibility on the part of the government to mitigate the ongoing effects of its currency policies. But, as many have found, in government circles, conversations about the naira’s exchange rate appear to be more focused on political optics than economic expediency.
Given its obvious utility amid the central bank’s policies, Eduviere says Emefiele’s comments disparaging the parallel market may have been in a bid to discourage speculative buying as well as “restore confidence in the market and reassure foreign investors that their assets are safe.”
Yet those comments are unlikely to reduce pressure on the naira. “It will not be surprising to see further depreciation in the parallel market as we approach the festive season,” says Janet Ogunkoya, senior research analyst at Tellimer Research. As it turns out, increased dollar demand through the Christmas season is a prospect that could yet bring an even more unpalatable economic reality for the Nigerian government.
In my role as an investment advisor at CrossBoundary Advisory, I collaborate closely with numerous off-grid renewable energy companies. Just like businesses in other sectors, they grapple with exchange rate challenges. In Nigeria, the fluctuating exchange rates of local and foreign currencies have complicated investor planning and added to market uncertainty.
Despite robust demand for crude oil, Nigeria’s foreign currency production capacity was hampered by the sharp decline in global oil prices during 2015 and 2016. The stark depreciation of the naira against the dollar has discouraged investors, resulting in diminished foreign cash inflows into the country. Consequently, a weaker exchange rate may inflate import costs for goods and services, adversely affecting businesses reliant on imported materials.
In the off-grid sector, companies may face challenges affording equipment and materials for sustainable power solutions in remote areas. According to a USAID Power Africa report by Deloitte, hard currency financing accounts for 93% of capital deployed into the off-grid sector since 2018. This reliance exposes most off-grid companies to the fluctuations of the foreign exchange market, significantly impacting their profitability.
Nigeria’s off-grid companies predominantly generate revenues in naira. However, capital expenses (generation and distribution components) are mostly imported and incurred in foreign currency, which exposes them to foreign exchange risk due to currency creating a mismatch. The reluctance of local financial investors, primarily commercial banks, to fund solar off-grid initiatives exacerbates challenges for the sector. Typically, funding is sourced from entities experienced in off-grid processes, such as the US$550 million Nigeria Electrification project, supported by the World Bank (US$350m) and African Development Bank (US$200m), which was initiated in 2018 when the exchange rate averaged NGN361/$.
Co-movement between financial stress and the volatility of the Naira’s exchange rate against USD, Euro and Pounds
Key Factors Influencing the Naira
Several factors influence the Naira's exchange rate, including:
- CBN Monetary Policy Committee Decisions: A substantial interest rate rise of at least 500 to 600 basis points is required to send a signal to the markets that the CBN is intent on implementing traditional monetary policy that prioritizes exchange rate and price stability.
- Fuel Price Changes: A further reduction in the magnitude of fuel subsidies is required to minimize FOREX demand through official channels.
- Reforms to Crude Oil Revenue Management: The Domestic Crude Allocation system, which dates back to the 1990s, has become ineffective in ensuring that Nigeria capitalizes on its oil production for FOREX inflows. A major overhaul to the management of crude oil production and its commercialization (i.e., an end to crude for refined product swaps and introducing more stringent reporting measures on the Nigerian National Petroleum Company) is required to guarantee a consistent inflow of FOREX.
- Reaction by Foreign Investors: The willingness-or lack thereof-of foreign investors to announce major investments in Nigeria will indicate to what extent the CBN has succeeded in its new reform drive.
I believe that the new policy could have several positive results. It should reduce Nigeria’s bloated parallel market for foreign exchange, discourage rent-seeking, foster a stable macroeconomic environment, attract foreign investment, boost exports, stabilise the exchange rate and prevent the dollarisation of the economy.
Nigeria’s black market for foreign exchange is not like any other in the world. Allowing market forces to determine the exchange rate will eventually bring the parallel and official rates together. Evidence of this will be a decrease in the huge number of black market currency dealers at airports, hotels and major streets.
The large spread between the parallel and official rates has fuelled rent-seeking behaviours in Nigeria. If the new policy is put into practice effectively, these speculators will have to engage in more productive activities. The new policy will foster exchange rate stability and predictability. Previously, it was unclear how the central bank determined the exchange rate.
This prompted speculative buying and selling. With the new policy, the value of the naira will be determined by market fundamentals. It will discourage the hoarding of foreign currencies. This may also increase supply, which will stabilise the exchange rate. This is good for the economy. What matters for economic growth and development is not the exchange rate itself but whether it is likely to change rapidly.
The volatility that comes with multiple exchange rates and speculation makes it difficult for individuals, businesses and investors to plan. It becomes very challenging to forecast the return on investment. People then “wait and see” before doing business or sending remittances. This causes a fall in the supply of foreign exchange. Speculators hoard foreign currencies (depleting supply), while those awash with naira mop up whatever foreign currencies they can find - increasing demand. The result is an upward spiral in the exchange rate.
The new policy will encourage capital inflow into the country. Foreign investors will reinvest more of their earnings in the country. Nigerians in the diaspora will deposit more money in their Nigerian bank accounts without fear of losing value. The new policy will help prevent over-valuation of the naira. This will ultimately make Nigerian goods cheaper in the international market and increase the flow of foreign exchange through exports.
The naira’s value will stabilise. Importers, however, would be negatively affected by a fall in the value of the naira, which would raise the cost of imported raw materials. With the removal of the fuel subsidy, manufacturers and retailers may have to raise their prices to remain profitable. It is therefore reasonable to expect Nigeria’s inflation rate to increase as a result of the new policy.
The new foreign exchange policy will reduce the pressure to use US dollars. Businesses in Nigeria have tended to demand payment in hard currencies. The US dollar has been used as a “store of value” because of inflation and the fall in the naira’s value. Preference for hard currencies will lessen if the new policy stabilises the exchange rate.
In the final analysis, what determines the stability and effectiveness of a country’s exchange rate policy is the state of the economy and the quality of the country’s economic policies. People should not expect the new exchange rate policy to work wonders.
Additionally, I see the recent unification policy of the new administration as a significant step in restoring confidence in the market, although it is not without its flaws. J.P. I believe this policy will improve transparency, level the playing field for Nigerian businesses, eliminate arbitrage from multiple exchange rates, and attract more foreign direct investment. Successful exchange rate unification hinges on careful planning and coordination among the government, the Central Bank of Nigeria, and private sector stakeholders.
Given these considerations, I argue that the government should implement transparency and accountability measures, such as regularly publishing economic data, developing regulatory frameworks, and upholding the rule of law, to build market trust.
Implications for Businesses
Currency depreciation will sustain inflationary pressures in 2024, leading to continued price sensitivity for consumers and diminished purchasing power. Consumer-facing firms should be flexible in responding to changes in consumer demand and ensure their local teams are collecting insightful information on the latest consumer trends. B2B firms are advised to offer their customers flexible payment plans to minimize the effect of possible payment delays.
Multinationals should prioritize working with financially resilient local partners with stable access to FOREX, which will help ease the effect of an uncertain exchange rate environment. Multinationals should ensure their assumptions for 2024 are in line with the latest devaluation and the impact this will have on pricing and planning.
Based on the information above, here is a summarized table:
| Factor | Impact on Naira Exchange Rate |
|---|---|
| CBN Monetary Policy | Interest rate adjustments can stabilize or destabilize the exchange rate. |
| Fuel Subsidies | Reduction minimizes FOREX demand, potentially strengthening the Naira. |
| Crude Oil Revenue Management | Improved management ensures consistent FOREX inflow, supporting the Naira. |
| Foreign Investment | Increased investment indicates confidence, positively impacting the Naira. |
| Transparency and Accountability | Build market trust, fostering stability in the exchange rate. |
This table provides a quick reference to the key factors influencing the Naira exchange rate and their potential impacts.
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