Between 1960 and 1970, foreign exchange (FX) earned in Nigeria was from agricultural exports. The earnings were saved in banks abroad, mostly in the United Kingdom. With the British Pounds pegged at par against Naira, convertibility of the foreign exchange earned was quite easy. By the early 1970s, proceeds from oil export surged and the CBN discovered the need to be an active player and build a domestic FX market. Once the domestic market surfaced, demand for FX soared and in 1986, the CBN faced an FX crisis detailing excess demand, particularly from importers.
With the FX crisis in 1986, the Second-Tier Foreign Exchange Market (SFEM) was introduced to determine the Naira exchange rate and allocate foreign exchange based on market forces. By 1989, Bureaux de Change was licensed to cluster the retail segment and enlarge the domestic FX market. Two major subsequent developments were the liberalization of the FX market with the introduction of the Autonomous Foreign Exchange Market (AFEM) in 1995 to sell FX to users through authorized dealers and the Inter-Bank Foreign Exchange Market (IFEM) in 1999.
The challenge with the CBN is their participation in two parallel lines which may never meet. These lines are the pricing of Naira and the supply of FX. The CBN fixed the exchange rate at N306/$ for a long time and recently, ‘adjusted’ the fixed rate to N360/$ when oil price plunged to an all-time low in March/April 2020. Abased oil prices led to a shrunk FX reserve and hence, the CBN lost its firepower to support the N306/$ fixed exchange rate. To make matters worse for the CBN, the demand for FX in Nigeria continues to grow because of import preference. The more the level of imports, the more the FX reserves required to support a fixed exchange rate.
Clearly, the CBN is sitting on an imbalanced scale with demand for FX weighing more than its supply. In 2015 and 2016, the International Monetary Fund (IMF) urged the Nigerian government to devalue the exchange rate because the wide variance between the official and parallel market was discouraging foreign investors. In clear terms, foreign investors face FX scarcity because of the ‘fixing’ of the exchange rate in the official market and the ‘relax’ in the parallel market. In April 2020, the IMF again urged the CBN to scrap its multiple FX windows and unify all of it into a single market-determined system.
The CBN, trying to control the price and supply of FX simultaneously will lead to no reasonable end. Taking a cue from China, the People’s Bank of China was forced to devalue its exchange rate in the heat of the trade war despite the fact that it has the biggest FX reserve in the world. The lesson for the CBN is that since the demand for FX cannot be controlled, operating a managed float system that has a wide variance with the parallel market is a wild goose chase. Price and supply cannot be controlled at the same time, especially for a country whose FX reserve is vulnerable to oil price shock and undiversified. This explains the recent report by Business Day Newspaper that Nigeria has a backlog of US$7 billion in FX demand.
It is important to admit that there is a wholesome politics when it comes to devaluing the exchange rate or not. There are powerful politicians who would go the extra length to get FX at favorable rates to fund their import needs. This is still the major bane to unifying the multiple FX windows in Nigeria. However, this leaves the CBN in limbo and keeps Nigeria short of stable capital importation from abroad. With the economic complexities in Nigeria, the consensus remains that Nigeria survives on foreign investments like foreign portfolio investment, foreign direct investments, and remittances. Therefore, for Nigeria to consolidate economic growth from foreign investments, the CBN should either unify all FX windows and float the exchange rate or find a way to keep its reserves growing steadily. The latter would require changes in Nigeria’s export portfolio, which is likely not happening soon.
Written and edited by Michael Ogunremi
Such a good read!