Will the Naira ever return to its former glory?
April 5, 2021834 views0 comments
By Lukman Otunuga,
Senior Research Analyst at FXTM
There was a time when the Naira was worth almost twice as much as the Dollar and equivalent to the British Pound.
Almost three decades later, the local currency is valued at N407 per Dollar and N559 per Pound on the spot rate, N380 per Dollar on the official CBN website. It does not end here. On the black market, the Naira is trading at a paltry N482 per Dollar and as low as N678 to the Pound. Over the past few years, the story defining the Naira’s fall from glory has revolved around multiple exchanges, contradicting statements from officials, Oil prices, shaky economic fundamentals, Dollar scarcity, and pegged exchanges.
Many major institutions have urged Nigeria to unify the multiple exchanges in an effort to promote transparency. The whole drama behind multiple exchanges was triggered by the crude oil crash in 2014 that saw the commodity tumbled almost 50%. Given how more than 90% of foreign-exchange earnings are from oil revenues, the heavy selloff in oil prices exposed Nigeria’s economy to downside shocks.
Rather than devalue the Naira in 2017, the central bank decided to enforce multiple rates for different transactions. There is one rate for government transactions, one rate for investors and exports, another for travellers and SME’s. Indeed, the intention behind this was to improve liquidity and boost Dollar inflows. However, looking at the Naira’s valuation today, ongoing issues with Dollar scarcity and untamed inflation – this move may have done more harm than good.
2020 was an incredibly challenging year for Africa’s largest economy. Although the economy expanded by 0.11% during the final quarter of 2020, full-year growth contracted by 1.92%. As oil revenues evaporated, the Nigerian Naira was devalued twice. Indeed, a weaker Naira would boost government revenue from oil exports – an encouraging development for the economy. If the Naira depreciates, this could boost revenues from crude oil which is sold in Dollar but converted in Naira. Despite the weakening of the spot and black-market rate, the central bank of Nigeria has left the Naira pegged to N380 on its official website.
For the Naira to return to its former glory, could a free-floating currency be the solution? Vice President Yemi Osinbajo said the government is committed to adopting a flexible exchange rate. While an artificially strong exchange could benefit Nigeria based on the fact that most products are imported, the negative impacts outweigh the positive. This continues to be reflected in the Naira’s valuation and health of the economy. When considering how a hefty chunk of foreign exchange reserves is acquired from oil sales, falling oil prices could complicate the Central Bank of Nigeria’s effort to defend the Naira.
Nigeria continues to face pressure from major institutions to reform its foreign exchange policy with confusion around the country’s multiple exchange rates haunting investor attraction. The question is whether Nigeria will be able to handle the aftermath from a free-floating Naira? The country spends roughly 70% of its revenue servicing public debt. A devaluation of the Naira could mean higher interest rate costs on the Dollar element of Nigeria’s debt will jump in naira terms. The price of electricity and gasoline may be impacted, something that will hit consumers and ultimately impact the economy.
If the natural forces of supply and demand are allowed the determine the equilibrium value of the official Naira exchange rate, this could result in a steep depreciation of the local currency. The rates in the black-market exchange are a testament to this. Such a development could turbocharge inflationary pressures and prompt the Central Bank of Nigeria to tighten monetary policy.
The idea of a unified exchange rate could bolster Nigeria’s economic outlook, offer transparency and rekindle investor attraction towards the country’s assets. But it remains unknown if or when the Naira could return to its former glory, especially when factoring in the domestic economic conditions at home and across the globe.