Unification of Exchange Rate Good News or…? 

Unification of Exchange Rate Good News or…? 

Exchange Rate
Exchange Rate

For years Nigeria had maintained a fixed exchange rate, opening multiple windows to maintain this pegged rate. This led to us having multiple exchange rates and led to a rather confused market. However, the new president made a bold move to float the exchange rate, a move investor reacted to positively. We delve into the implications of this in the rest of the reading.  

Before Wednesday the 14th of July, the CBN had operated 4 exchange rate markets: The interbank market, the I&E window, the Bureau de Change window, and the Small and Medium Enterprises window.  

The Interbank FX market: Was specifically for banks to trade foreign exchange at a determined rate. 

The Investors and Exporters window: Was created to encourage foreign direct investment (NB: investors don’t like exchange rate risk, they don’t want to bring in investments to your country at $400-₦1 and take out their money at $600-₦1. That would be making a foreign exchange loss) so, the CBN created this window to intervene when necessary and keep the naira fixed such that when these investors are exiting, there wouldn’t be much difference and their profits stay safe. This window was also created for exporters to participate in the market. 

The SME window: Was largely to cater for small businesses with FX needs. 

BDC Window: Was to allow BDC operators to trade FX and retail to consumers at a fixed rate. 

So, with all these windows, what happened? Why did the naira keep on weakening? 

Supply became an issue, while demand soared. The CBN wasn’t able to successfully supply these windows because its own FX sources were dwindling, majorly due to falling oil prices (Crude oil sales are our major source of FX). Meanwhile, the apex bank had historically been tapping into its reserves to artificially strengthen the naira such that if it kept on going, it would have used down its reserves. So, as reserves dwindled, it became difficult for many to access FX.  

What did the CBN do? They kept on devaluing in a bid to reduce demand and tried its best to service the rest. However, all of these (supply issues and devaluation) sent a wrong signal to foreign investors, and they started to flock out of the country (they didn’t like the devaluation, it was weakening their profits). This further worsened our FX supply woes, as foreign investors were also a source of supply (*when the bring in investments into the country, they change their dollar to naira) 

Meanwhile, because the CBN source of FX was declining, other parts of the market that couldn’t get FX from the official sources started to pay a premium hence, to buy from the parallel market became expensive. Thus, what we had was a case of increasing demand for the dollar, whilst supply dwindled. 

In all of these, FX access wasn’t equal 

In addition to the fact that the Central Bank couldn’t address the dollar needs, and supply all these markets timely, you had some sections of the markets (importers and small businesses) that couldn’t even access from the official window that was created for them. In order to manage and regulate the demand for foreign exchange (FX), the Central Bank of Nigeria (CBN) implemented measures such as the establishment of a list containing 43 items, which importers were prohibited from accessing FX at official rates. Additionally, there was a period when the CBN imposed restrictions on FX access for students traveling abroad. They placed restrictions on your cards, so you couldn’t pay for Apple music, or shop internationally. All of this was in a bid to tame demand, but the problem is you can’t be the custodian of demand and supply at the same time hence our FX policies were wobbly. Also, its important to note that the existence of multiple windows created room for arbitrage (in simple terms, getting FX at the official rate and going to the parallel market to sell, thereby making a profit.) 

The Solution? Free the market (Unification). 

Typically, market forces (supply and demand) determine prices. It is why you have seen the naira weaken to ₦704-$1. So, if there is less demand for the dollar, the naira will post gains, and the exchange rate value changes again. Moving on, it became apparent that the CBN could not sustain its support for the naira through its FX sales at the various windows. So, eliminating all of those windows and allowing just one to exist (unification), was the best way to go. This is because: 

  1. It eliminates the arbitrage problem, as all markets are now one. You can either source from the bank or your local aboki. Supply and demand will determine the pricing. This is bad for arbitragers and hoarders as it will be more difficult to predict pricing, thus forcing them to supply the market when they are opportune to.  
  1. The CBN doesn’t have to mandatorily supply the market. They will become like every other market participant, supply when they can. This may give respite to our reserves. 
  1. Although price volatility will still exist however, investors are more confident as there is now just one exchange rate they can reference and hedge against. Thus, they are happier to bring in their money, further improving the supply situation. 

On the flip side, the volatility this will create (prices acting on the mandate of demand and supply) may be bad for planning, but the good news is that you can hedge against this volatility by locking rates at the forward’s market.  

Also, because our economy is still very much import based, when the naira weakens, prices of goods and services will go up, as you now need more naira to buy 1 dollar.  

Nevertheless, this is a bold and progressive move by the Federal Government. In Economics there are trade-offs, and the trade-offs on this particular policy is more skewed to the positive side. 

Sign up for the newsletter

If you want relevant updates occasionally, sign up for the private newsletter. Your email is never shared.

Home

Marketplace

Learn

My Items

Home

Marketplace

Learn

My Items

More