With the policy of the monetary authorities to unify the Naira foreign exchange rates gaining traction, economic analysts have highlighted different ways the policy will impact positively on the economy, applauding the Central Bank of Nigeria for its pro-activeness in driving the policy. While there are also downsides to the policy, the positives outweigh them. BAMIDELE FAMOOFO writes.
With moves by the monetary authorities to unify the Naira foreign exchange rates gaining traction, economic analysts believe that the step may impact positively on the economy if the increased naira inflow into the federation account is judiciously utilized by the tiers of government.
In addition, experts also pointed out that if efficiently managed, the policy step will make the cost of doing business cheaper, attract more investments into the economy as investor confidence will become stronger and add impetus to the ongoing economic diversification of the government, amongst other potential benefits.
It was widely reported on Wednesday, June 14, following the CBN’s policy stance that the Naira traded at N381 per dollar and as at July 20, 2023, it has further depreciated to N790.51 against the greenback. Based on this, dealers cannot bid below this threshold, effectively devaluing the naira.
The policy has attracted the commendations from international organisations like the International Monetary Fund which threw its weight behind it and also applauded the Central Bank of Nigeria.
In a statement, IMF Resident Representative, Nigeria, Ari Aisen, said: “The Fund greatly welcomes the authorities’ decision to introduce a unified market-reflective exchange rate regime in line with our long-standing recommendations. We stand ready to support the new administration in its implementation of FX reforms.”
Commenting on the monetary policy stance, the Managing Director, Maxifund Investments and Securities Limited, Okechukwu Unegbu, noted that the removal of the dual exchange rate is a pointer in the right direction.
“The man who is there now is trying to do things right, he is trying to listen to elders in the banking industry to see how he can get things going well. The CBN has done well under him; the policies he has introduced would help the economy in the long-run. The removal of the dual exchange rate is a welcome development”
He frowned at the multiple exchange rates operated in the country before, describing it as injurious to the economy.
Unegbu argued that now that the multiple exchange rates have been abolished, it will help address the problems of the economy.
Though, he added, that the policy will hurt Nigerians in the immediate but said the sufferings of the present time will be forgotten in the medium to long term as the economy resets.
“It is good for us to have one exchange rate. It hovers around N800 to the Dollar now, but that is in the interim; once we start productive activities and we start exporting, the exchange rate will come down,” he said.
Unegbu expressed confidence in the leadership of the acting CBN Governor, Folashodun Shonubi, noting that he is making moves in the right direction.
His words: “The man who is there now is trying to do things right, he is trying to listen to elders in the banking industry to see how he can get things going well. The CBN has done well under him; the policies he has introduced would help the economy in the long-run. The removal of the dual exchange rate is a welcome development.”
A lawyer and human rights activist, Eze Onyekpere, argued that the policy of forex unification emanates from President Tinubu and not the CBN.
“Hence, it is Tinubu’s exchange rate, not CBN’s,” he stated.
Onyekpere, however, highlighted both the pros and cons of the policy, noting that in terms of benefits, it will make more money available for the Federal Government as the nation’s major source of income- crude oil is sold in dollars and when converted as it is currently, there will be more money for sharing. For exporters, the policy will equally help them earn more as the exchange rate continues to soar, as they are no longer compelled to withdraw their money at a fixed rate while it is difficult for them to get the same rate when they want to export.
He added that the policy will also encourage Foreign Direct Investments inflow into the country as investors are now convinced that the Naira is fairly priced and they are at liberty to retrieve their money in the open market without restrictions.
But on the other hand, Onyekpere lamented that the local economy is now suffering because of the absence of productive activities that can generate enough foreign currency.
He noted that crude oil production, which is Nigeria’s biggest foreign exchange source, has been at an all-time low in the last eight years as the country is unable to meet its OPEC quota; doing at most 1.3 million barrels per day.
“Unfortunately, we are importing petrol, and you can see the impact of the removal of subsidy, it has affected the price of everything. It is expected that the price of petrol will continue to increase since the value of the Naira continues to depreciate. The recent increase in the price of fuel is not due to the rise in the price of crude in the global market but because of the depreciation of the Naira,” he hinted.
Offering a solution, Onyekpere said, local production for export must be increased immediately to earn more forex that will translate into more Naira to be spent to drive economic development in the country.
“So, the issue is not just about the announcement of the policy but taking the necessary steps to boost the value of the Naira,” he reiterated.
Speaking on the policy from the perspective of an economist, the Chief Executive Officer, Financial Derivatives Company Limited, Bismarck Rewane, explained that the problem with a multiple exchange rate system is that it is a price-discriminating monopoly that creates arbitrage opportunities.
“It incentivizes rent-seeking activities, which not only distort the market but also engender a deadweight loss for the society.
“Thus, the opaqueness and administrative control associated with the multiple exchange rate system reinforce uncertainty, increase transaction costs, and dampen investor confidence.
“Before now, Nigeria operated five different exchange rates: the Importers and Exporters (I&E) window, the secondary market intervention sales retail window, the small and medium-sized enterprises (SME) window, the window for invisibles, and the parallel (or autonomous) market,” he said.
Imperatives for achieving stable exchange rate
Rewane warned that exchange rate unification is not an end but could be a means to an end.
He explained that achieving exchange rate stability requires a combination of sound macroeconomic policies, effective management of external risks, and management of forex demand and supply fundamentals.
“Changing from one exchange rate management system to another (Retail Dutch Auction, Wholesale Dutch Auction, interbank system, Second-tier Foreign Exchange System, etc.) cannot guarantee a stable exchange rate,” he reiterated.
Speaking further on how to make the policy work, he said the monetary authority must prioritise boosting forex supply near to medium term.
This, he said, can be achieved through an improvement in the current account balance, an increase in both investment and invisible flows, an increase in real returns, maintaining political and economic stability, strategic and coordinated intervention in the forex market, and an improvement in the country’s terms of trade.
Also, he noted, that there is a need for a policy shift from import restriction policies to import substitution policies as import restrictions are distortionary and suboptimal.
“However, a long-term commitment to import substitution could moderate forex demand pressures and strengthen the naira,” he said.
Economic impact of 2023’s exchange rate unification
Here are the economic impacts of the exchange rate unification policy of the CBN according to Rewane:
“Government revenue: An exchange rate unification that results in the effective devaluation of the official exchange rate will bolster government revenue in Naira terms. For instance, if the exchange rate settles at N656/$ in H2’23; the naira value of dollar fiscal receipts is expected to increase by 42 percent. Overall, it is expected that exchange rate unification will buoy FGN and subnational government revenues for H2 ’23 by N1.3 trillion and N1.7trillion respectively.
“A unified exchange rate eliminates the need for investors to engage in complex currency hedging strategies, simplifying their decision-making process, thereby leading to an increase in foreign investment inflows as it becomes easier for foreign investors to calculate potential returns and repatriate profits”
“Public debt profile: The exchange rate devaluation will have significant impacts on sovereign debts, depending on the structure of the debt and the currency denomination. Given that exchange rate unification leads to a decrease in the value of the naira relative to the dollar, dollar-denominated debts become relatively larger in domestic currency terms. Total external debt stock stands at N20 trillion (Q1’23) and could edge higher to N32 trillion by the end of Q3’23. In the same vein, the debt service costs of dollar-denominated debt will spike as the interest and principal payments on foreign debt become more expensive in naira terms. Our estimate shows that debt service costs could increase by about 17% in FY2023 to N7.3 trillion from N6.3 trillion earlier budgeted for FY2023.
“Inflation: A traditional consequence of exchange rate devaluation is inflationary pressure. However, in Nigeria’s case, we do not expect the realisation of this one-for-one relationship. This is because before the unification, imports and other transactions were priced at the parallel market rate; those that get forex at the official rate consider the premium a rent. However, if the post-reform exchange rate overshoots its market equilibrium for a longer period, inflationary pressure may crystallise. Another source of inflationary pressure is the valuation of import tariffs at the current market rate (N770/$) as against the former official rate of N460/$.
“Exports: First, the removal of the implicit tax that multiple exchange rates impose on exporters incentivizes exports. The administratively controlled multiple exchange rate system compels exporters to exchange their earnings at the official rate of N460/$ against the market rate of N750/$. This means that exporters lose about N288 on every dollar earned from exports. The removal of this tax is expected to spur exports. Also, devaluation makes a country’s exports cheaper in international markets, potentially increasing their competitiveness and boosting exports.
“Investment: Exchange rate unification removes the various anti-investment distortionary tendencies of multiple exchange rate systems. This can engender improvement in investment by bringing stability, transparency, and predictability to the currency market.
“A unified exchange rate eliminates the need for investors to engage in complex currency hedging strategies, simplifying their decision-making process, thereby leading to an increase in foreign investment inflows as it becomes easier for foreign investors to calculate potential returns and repatriate profits.
“Balance of payments: How exchange rate unification impacts the BoP depends on its effect on the trade balance, invisible flows, and debt servicing costs. A resultant increase in foreign investment and invisible inflows fosters a favourable balance of payments position. Also, the expenditure-switching effect and export competitiveness associated with exchange rate devaluation could support an increase in net exports, thereby improving the BoP. However, on the flip side, an increase in debt service obligations could deteriorate the capital accounts, thereby worsening the BoP. If the reform agenda is sustained, we expect the upside effects to more than offset the downside effects on the BoP.
“Relative wealth valuation: Exchange rate unification can have significant impacts on the balance sheet and relative wealth valuation of individuals, businesses, and countries. When unification leads to devaluation, the value of assets and liabilities denominated in foreign currencies will be affected. The value of dollar assets denominated in naira will decrease, while the value of domestic assets denominated in foreign currency will increase in naira terms. Conversely, the value of foreign liabilities denominated in naira will increase.
“Disruptive reconstruction: Exchange rate unification and the adoption of the “willing buyer-willing seller” model could initiate a process of disruptive reconstruction—a process of discovering the true price of the naira.
“Characteristically, exchange rate unification could cause the nominal exchange rate to initially fluctuate or even overshoot more than is justified by the underlying economic fundamentals. The announcement of exchange rate unification first creates uncertainty and speculation in the foreign exchange market. Traders and investors tend to overreact to these changes in the short run, leading to an exaggerated fluctuation in exchange rates. However, as hypothesized by Dornbusch, exchange rates will eventually correct themselves and converge towards their long-run equilibrium values as economic fundamentals adjust.”
