Nigeria: Free Float Of The Naira: The Effect On The Nigerian Economy

1. INTRODUCTION

On the 14th of June 2023, the Central Bank of Nigeria ("CBN") published a press release on the Operational Changes to the Foreign Exchange Market.¹ The information disseminated to the public was to notify it of the abolishment of segmentation, and collapse into the Investors and Exporters (I&E) window. The CBN re-introduced the "willing buyer, willing seller" model at the I&E window. Simply put, the agreed price by the buyer and seller will determine the rate at which the Naira is exchanged for any foreign currency.

The Naira has been subjected to a free float and the exchange rate is no longer decided by the government or the CBN. It implies that the combination of the forces of supply and demand for foreign exchange will determine the exchange rate as opposed to CBN. The float was proposed in 2022, however, it did not come into fruition until now. Several financial analysts have noted that the float could result in the devaluation of the currency, but if appropriate policies and safety nets are put in place, then it might attract foreign investments and economic improvements.

The Naira which was sold at various rates on official and black market is supposedly now the same everywhere. Some financial experts say that the system will allow the Naira to respond to fluctuations in international markets and increase competition by allowing the currency to adjust to shifting economic conditions. While some other experts say that a rise in the volatility of the Naira might have unfavourable effects on the economy.

Floating any country's currency will have both economic benefits and repercussions. In this article, we will look at the recommendations of the World Bank Group and the International Monetary Fund, some probable effects of the free float, and some recommendations to cushion the effects the free float will have on the economy.

2. RECOMMENDATIONS OF THE WORLD BANK GROUP ("WBG") AND THE INTERNATIONAL MONETARY FUND ("IMF") ON THE FREE FLOAT

2.1 The World Bank Group ("WBG")

For several years, the exchange rate consisted of a highly managed official rate and a foreign exchange market lacking in distinct and expected pricing, including due to the use of multiple windows for multiple purposes. This led to limited foreign exchange supply at the official rate, pushing economic agents into a parallel market to meet their foreign exchange requirements, and caused rent-seeking opportunities.

The World Bank Group ("WBG") in its biannual Nigeria Development Update ("NDU") has been recommending and advocating for the adoption of a single and market-reflective exchange rate for the Naira.² This recommendation is to facilitate trade and boost domestic value added by removing import and foreign exchange restrictions on the currency. The country's prior foreign exchange rate management style hindered investment and growth, contributed to inflation, and weakened the efficiency of monetary and fiscal policies.

In the latest NDU published in June 2023³, the WBG posited some policy options to reduce inflation, address fiscal pressures, restore macroeconomic stability and invest in the future of Nigerians. The key policies in this regard include; unifying and adopting a market-responsive exchange rate, increasing non-oil revenues, removing the petrol subsidy and reducing inflation through a sequenced and coordinated mix of trade, monetary and fiscal policies to restore conditions for private investment and growth, and to protect Nigerians' welfare.

2.2 The International Monetary Fund ("IMF")

The International Monetary Fund ("IMF"), like the WBG has recommended the float of the Naira for the economic development of Nigeria.

The 2021 Article IV Consultation Report for Nigeria⁴ said the Nigerian economy is at a critical juncture and is recovering from a downturn emerging from policy support, rebounding oil prices and international financial assistance. It stated that policy adjustments and reforms are urgently needed to navigate the crisis and change the course of the economy. On the exchange rate policies, the report suggested a key move toward strengthening the external position to establish a unified and market-clearing exchange rate. Clear communications regarding exchange rate policy should be followed, and complementary macroeconomic and structural policies put in place to preserve competitiveness gains from any exchange rate adjustment.

In the 2022 Article IV Consultation Report for Nigeria⁵, one of the key recommendations was on monetary and exchange rate policy. It was recommended that the monetary policy should continue its course to prevent risks of short-term price shocks of long-term expectations. It is urgent that the Naira moves towards a unified and market-clearing exchange rate to restore confidence, build up buffers, address persistent foreign exchange shortages, and bring down high parallel market premiums, which contribute to elevated inflation.

In response to these recommendations, the Nigerian Government published the press release on the free float of the Naira.

3. THE EFFECT OF THE FREE FLOAT ON THE NIGERIAN ECONOMY

The free float of the Nigerian economy has had counterintuitive effects so far and we are looking forward to seeing a bright light at the end of the tunnel soon. Some of the effects are as follows:

3.1 Volatility in currency rates

Floating the Naira will cause more volatility in the currency rates. In a system with a floating exchange rate, supply and demand in the market determine how much a currency is worth. Therefore, the value of the Naira will change in reaction to a variety of economic factors, such as interest rates and foreign investment. There may be an upward surge in the economy and increased competition with this volatility.

3.2 Increase in exports

There may be increase in exports as a result of the Naira float. The value of the Naira may decline with the free float, thereby making Nigerian goods for foreign consumers less expensive. This can encourage companies that are focused on exports, boost revenue from foreign exchange, and lessen the nation's dependency on oil exports. It would encourage economic diversification and contribute to the creation of a stronger, more durable economic system.

3.3 Inflation on imports

The increased costs for businesses and consumers may result from a major depreciation in the value of the Naira. This might raise the cost of imported goods and raw materials. Nigeria has always depended on imports, and now with the devaluation, these imports will become more expensive to maintain.

3.4 Foreign debt and financial instability

The foreign debt and financial stability of Nigeria may be impacted by the Naira's float. A lot of these debts are in foreign currency, and the country's debt commitments will rise when converted if the Naira fell in value. This might make it harder for the government to repay its debts.

3.5 Decline in investor confidence

The Naira volatility may trigger a decline in investor confidence, and endanger the stability of the financial system. Any country that hopes to trade in foreign exchange needs to have investors that have confidence in its currency. As a result of this float, any decline in the Naira value will cause investors to lose confidence and refuse to transact with any industry in the country.

4. MEASURES TO CUSHION THE EFFECTS OF THE FREE FLOAT

The effect of the free float of the Naira on the Nigerian economy hinges on finding the right balance between market-driven exchange rate dynamics and proactive government interventions. With prudent management, a free float has the potential to attract foreign investments, boost exports, and contribute to long-term economic growth and stability in Nigeria. Let us look at some specifics below.

4.1 Inflation on imports and increase in exports

To control inflation and uphold price stability, the Government would need to undertake efficient monetary policies and measures, such as interest rate changes and stringent fiscal controls. Tariffs should be instituted on foreign imports in order to protect businesses and consumers and promote use of domestic products. Price control regulations and measures should be put in place to prevent hikes due to the devaluation of the Naira. Support and priority should be given to the agricultural industry to increase productivity, reduce imports and increase exports of quality products. The Government should set up policies that would be favourable and promote exports, so as to motivate companies to produce high quality goods for export. This will generate revenue and boost the inflow of foreign exchange to create a more secure economy.

4.2 Foreign debt and financial instability

For Nigeria's debt commitment not to rise, it is necessary policies and measures like plugging revenue leakage and generating additional revenue streams by investing in key sectors of the economy should be put in place. The Government should prioritise job security, skill development programs, entrepreneurship support to enable the people gain financial stability. The richer the people, the richer the economy.

4.3 Volatility in currency rates and decline in investor confidence

Measures should be taken to increase the value of Naira and reduce Naira volatility so as to build investor confidence, encourage economic adjustments and boost competition. When investor's confidence rise in the economy, then more investors will want to transact in various industries in the country.

5. CONCLUSION

Floating the Naira can be interpreted as an indication of economic reform and draw in outside capital. International investors may have more faith in a country's ability to implement market-driven policies if the exchange rate mechanism is flexible.

For a free float of the Naira to have a positive effect on the Nigerian economy, it requires careful monitoring and appropriate policy interventions by the Government and the CBN. Implementing measures to manage exchange rate volatility, promoting export-oriented industries, and encouraging investment in critical sectors can help maximize the benefits while mitigating potential risks.

Footnotes

1. See, Press Release: Operational Changes to the Foreign Exchange Market, Central Bank of Nigeria available at https://www.cbn.gov.ng/Out/2023/CCD/Operational%20Changes%20to%20FX%20Market.pdf accessed on 24th July 2023.

2. See "World Bank Group: Nigeria Development Update, December 2022" available at https://thedocs.worldbank.org/en/doc/74e2f8585c426106f79f30a7b5fbc879-0360012022/original/World-Bank-Nigeria-Development-Update-december-2022.pdf accessed on 20th December 2023.

3. See "World Bank Group: Nigeria Development Update, June 2023" available at https://documents1.worldbank.org/curated/en/099062623065078024/pdf/P17990608d087c05f0868f041fca331108b.pdf accessed on 20th December 2023.

4. See "International Monetary Fund 2021 Article IV Consultation — Press Release; Staff Report; Staff Statement, and Statement by The Executive Director for Nigeria, February 2022" available at file:///C:/Users/user/Downloads/2021%20ARTICLE%20IV%20CONSULTATION%20REPORT%20.pdf accessed on 20th December 2023.

5. See "International Monetary Fund 2021 Article IV Consultation — Press Release; Staff Report; Staff Statement, and Statement by The Executive Director for Nigeria, February 2022" available at file:///C:/Users/user/Downloads/2022%20ARTICLE%20IV%20CONSULTATION%20REPORT.pdf accessed on 20th December 2023.

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