Post by Trade Forum on Jun 21, 2023 21:33:04 GMT 1
Nigeria's new foreign exchange policy is good news - but it can't work wonders for the economy on its own
The Central Bank of Nigeria recently announced changes to the way the country’s foreign exchange market will work. Foreign currencies can now be bought and sold at rates determined by the market – not by the central bank.
This signals the intention of the Bola Ahmed Tinubu administration to allow market forces to determine the value of the naira.
In the past, there were multiple exchange rates for the currency. The International Monetary Fund has repeatedly called on Nigeria to end this. The huge gap between the official and unofficial rates caused severe shortages of foreign exchange by discouraging supply.
In general, the existence of multiple exchange rates signals a dysfunctional economy. It erodes investor confidence. Capital does not flow in and foreign exchange becomes scarcer.
This is not the first time Nigeria will be liberalising the foreign exchange market. The first was in 1986; further efforts followed in 1995, 1999 and 2016. All were marred by various impediments.
The three key problems that afflict Nigeria’s foreign exchange market are the lack of transparency, foreign exchange shortages and volatility.
Shortages occur mainly because about 90% of Nigeria’s foreign exchange earnings come from the oil sector. The market is volatile when oil prices drop with no corresponding fall in demand.
To make matters worse, much of the foreign exchange from non-oil sources (such as diaspora remittances, tourism and export of non-oil products) is channelled through the black market.
Other African countries that grappled with shortages and volatility have also liberalised the market. Egypt floated its currency in 2016 and the value of the Egyptian pound declined by 50%. South Africa also has a free-float policy, but that has not prevented the rand from fluctuating.
One lesson for Nigeria is that the stability of the naira depends partly on the country’s monetary and fiscal policies, as well as political stability, security and investor confidence in the economy. It also depends on whether the Central Bank of Nigeria will follow through with this new policy. Previous efforts were abandoned prematurely.
As an economist, I have observed the various reactions of Nigerians to this policy. It’s too soon to decipher the full consequences, but it is possible to highlight some of what can be expected.
I believe that the new policy could have several positive results. It should reduce Nigeria’s bloated parallel market for foreign exchange, discourage rent-seeking, foster a stable macroeconomic environment, attract foreign investment, boost exports, stabilise the exchange rate and prevent the dollarisation of the economy. These would all improve the investment climate and spur economic growth.
Deflating a bloated parallel market
Nigeria’s black market for foreign exchange is not like any other in the world. It handles most of the foreign exchange transactions in the country.
Allowing market forces to determine the exchange rate will eventually bring the parallel and official rates together.
Evidence of this will be a decrease in the huge number of black market currency dealers at airports, hotels and major streets.
But some black market activity will remain, not least for money laundering and other illicit financial transactions.
From rent-seeking to productive investment
The large spread between the parallel and official rates has fuelled rent-seeking behaviours in Nigeria. There are people whose main preoccupation is to mop up foreign exchange at the official rate and then flip the currency at the black market rate.
This perverse practice has become part of Nigeria’s widespread crony capitalism, whereby a few privileged individuals and companies obtain foreign currency from the central bank at low rates.
If the new policy is put into practice effectively, these speculators will have to engage in more productive activities.
Macroeconomic stability and economic growth
The new policy will foster exchange rate stability and predictability. Previously, it was unclear how the central bank determined the exchange rate. This prompted speculative buying and selling.
With the new policy, the value of the naira will be determined by market fundamentals. It will discourage the hoarding of foreign currencies. This may also increase supply, which will stabilise the exchange rate.
This is good for the economy. What matters for economic growth and development is not the exchange rate itself but whether it is likely to change rapidly.
Attraction of foreign and portfolio investment
The volatility that comes with multiple exchange rates and speculation makes it difficult for individuals, businesses and investors to plan. It becomes very challenging to forecast the return on investment.
People then “wait and see” before doing business or sending remittances. This causes a fall in the supply of foreign exchange.
Speculators hoard foreign currencies (depleting supply), while those awash with naira mop up whatever foreign currencies they can find – increasing demand. The result is an upward spiral in the exchange rate.
The new policy will encourage capital inflow into the country. Foreign investors will reinvest more of their earnings in the country. Nigerians in the diaspora will deposit more money in their Nigerian bank accounts without fear of losing value.
Export growth and long-term exchange rate stability
The new policy will help prevent over-valuation of the naira. This will ultimately make Nigerian goods cheaper in the international market and increase the flow of foreign exchange through exports. The naira’s value will stabilise.
Importers, however, would be negatively affected by a fall in the value of the naira, which would raise the cost of imported raw materials.
With the removal of the fuel subsidy, manufacturers and retailers may have to raise their prices to remain profitable. It is therefore reasonable to expect Nigeria’s inflation rate to increase as a result of the new policy. This will be a short-term effect, as a more stable exchange rate will boost the economy’s productive capacity in the long run, and subsequently curb inflation.
A decrease in the pressure for dollarisation
The new foreign exchange policy will reduce the pressure to use US dollars. Businesses in Nigeria have tended to demand payment in hard currencies.
The US dollar has been used as a “store of value” because of inflation and the fall in the naira’s value.
Preference for hard currencies will lessen if the new policy stabilises the exchange rate.
Conclusion
In the final analysis, what determines the stability and effectiveness of a country’s exchange rate policy is the state of the economy and the quality of the country’s economic policies.
People should not expect the new exchange rate policy to work wonders. The naira will become more stable only when the country attracts investors and tourists, diversifies the economy and exports more non-oil products.
Source: www.econotimes.com/Nigerias-new-foreign-exchange-policy-is-good-news-but-it-cant-work-wonders-for-the-economy-on-its-own-1658129
The Central Bank of Nigeria recently announced changes to the way the country’s foreign exchange market will work. Foreign currencies can now be bought and sold at rates determined by the market – not by the central bank.
This signals the intention of the Bola Ahmed Tinubu administration to allow market forces to determine the value of the naira.
In the past, there were multiple exchange rates for the currency. The International Monetary Fund has repeatedly called on Nigeria to end this. The huge gap between the official and unofficial rates caused severe shortages of foreign exchange by discouraging supply.
In general, the existence of multiple exchange rates signals a dysfunctional economy. It erodes investor confidence. Capital does not flow in and foreign exchange becomes scarcer.
This is not the first time Nigeria will be liberalising the foreign exchange market. The first was in 1986; further efforts followed in 1995, 1999 and 2016. All were marred by various impediments.
The three key problems that afflict Nigeria’s foreign exchange market are the lack of transparency, foreign exchange shortages and volatility.
Shortages occur mainly because about 90% of Nigeria’s foreign exchange earnings come from the oil sector. The market is volatile when oil prices drop with no corresponding fall in demand.
To make matters worse, much of the foreign exchange from non-oil sources (such as diaspora remittances, tourism and export of non-oil products) is channelled through the black market.
Other African countries that grappled with shortages and volatility have also liberalised the market. Egypt floated its currency in 2016 and the value of the Egyptian pound declined by 50%. South Africa also has a free-float policy, but that has not prevented the rand from fluctuating.
One lesson for Nigeria is that the stability of the naira depends partly on the country’s monetary and fiscal policies, as well as political stability, security and investor confidence in the economy. It also depends on whether the Central Bank of Nigeria will follow through with this new policy. Previous efforts were abandoned prematurely.
As an economist, I have observed the various reactions of Nigerians to this policy. It’s too soon to decipher the full consequences, but it is possible to highlight some of what can be expected.
I believe that the new policy could have several positive results. It should reduce Nigeria’s bloated parallel market for foreign exchange, discourage rent-seeking, foster a stable macroeconomic environment, attract foreign investment, boost exports, stabilise the exchange rate and prevent the dollarisation of the economy. These would all improve the investment climate and spur economic growth.
Deflating a bloated parallel market
Nigeria’s black market for foreign exchange is not like any other in the world. It handles most of the foreign exchange transactions in the country.
Allowing market forces to determine the exchange rate will eventually bring the parallel and official rates together.
Evidence of this will be a decrease in the huge number of black market currency dealers at airports, hotels and major streets.
But some black market activity will remain, not least for money laundering and other illicit financial transactions.
From rent-seeking to productive investment
The large spread between the parallel and official rates has fuelled rent-seeking behaviours in Nigeria. There are people whose main preoccupation is to mop up foreign exchange at the official rate and then flip the currency at the black market rate.
This perverse practice has become part of Nigeria’s widespread crony capitalism, whereby a few privileged individuals and companies obtain foreign currency from the central bank at low rates.
If the new policy is put into practice effectively, these speculators will have to engage in more productive activities.
Macroeconomic stability and economic growth
The new policy will foster exchange rate stability and predictability. Previously, it was unclear how the central bank determined the exchange rate. This prompted speculative buying and selling.
With the new policy, the value of the naira will be determined by market fundamentals. It will discourage the hoarding of foreign currencies. This may also increase supply, which will stabilise the exchange rate.
This is good for the economy. What matters for economic growth and development is not the exchange rate itself but whether it is likely to change rapidly.
Attraction of foreign and portfolio investment
The volatility that comes with multiple exchange rates and speculation makes it difficult for individuals, businesses and investors to plan. It becomes very challenging to forecast the return on investment.
People then “wait and see” before doing business or sending remittances. This causes a fall in the supply of foreign exchange.
Speculators hoard foreign currencies (depleting supply), while those awash with naira mop up whatever foreign currencies they can find – increasing demand. The result is an upward spiral in the exchange rate.
The new policy will encourage capital inflow into the country. Foreign investors will reinvest more of their earnings in the country. Nigerians in the diaspora will deposit more money in their Nigerian bank accounts without fear of losing value.
Export growth and long-term exchange rate stability
The new policy will help prevent over-valuation of the naira. This will ultimately make Nigerian goods cheaper in the international market and increase the flow of foreign exchange through exports. The naira’s value will stabilise.
Importers, however, would be negatively affected by a fall in the value of the naira, which would raise the cost of imported raw materials.
With the removal of the fuel subsidy, manufacturers and retailers may have to raise their prices to remain profitable. It is therefore reasonable to expect Nigeria’s inflation rate to increase as a result of the new policy. This will be a short-term effect, as a more stable exchange rate will boost the economy’s productive capacity in the long run, and subsequently curb inflation.
A decrease in the pressure for dollarisation
The new foreign exchange policy will reduce the pressure to use US dollars. Businesses in Nigeria have tended to demand payment in hard currencies.
The US dollar has been used as a “store of value” because of inflation and the fall in the naira’s value.
Preference for hard currencies will lessen if the new policy stabilises the exchange rate.
Conclusion
In the final analysis, what determines the stability and effectiveness of a country’s exchange rate policy is the state of the economy and the quality of the country’s economic policies.
People should not expect the new exchange rate policy to work wonders. The naira will become more stable only when the country attracts investors and tourists, diversifies the economy and exports more non-oil products.
Source: www.econotimes.com/Nigerias-new-foreign-exchange-policy-is-good-news-but-it-cant-work-wonders-for-the-economy-on-its-own-1658129
