The effects of weakening the naira include more expensive imported goods. In an ideal world, this should discourage imports into the country. For Nigeria, weakening the naira will only increase its the current account deficit due to heavy reliance on imports and the unpopular policy on export sales. By increasing the imports prices and leaving the demand for domestic products unchanged, weakening the naira will provoke inflation in the country.
s opined by Blinder, central banking is a dark art which requires a useful scientific approach, and we can agree that it requires more than previous banking experience to lead the institution. The current central bank of Nigeria (CBN) Governor has not been successful in implementing a naira regime since he was appointed in 2014. One will not disagree that he met an inefficient and complicated system, and has also been inconsistent with currency regimes.
The persistently low oil prices have limited the inflow of foreign exchange into the Nigerian economy. It has created a hole in the country’s budget, given the sector accounts for about 65% of the government’s revenue. The coronavirus pandemic has added to the problem which has pushed the country to obtain several types of external loans and funding, as the viable way to fund its budget. It is not a secret that the government has been borrowing to fund growth after a 2016 recession. It has been weakening its currency as pressure from concessionary lenders mount. In the private sector, remittance from abroad has also declined. Remittance is second to oil revenue and more than foreign direct and portfolio investments in the country.
The weakening in the value of the naira is a response to the declining oil prices, the pressure from external lenders, and shortages of US dollar. The weakening of the naira was called depreciation by the CBN, while Goldman Sachs claimed it is a devaluation. The two names are used to differentiate what type of currency regime a country is adopting. Thus, a wide confusion about who to believe regarding what currency regime the CBN is adopting.
Every country manages its currency, usually through its central bank, in the foreign exchange market by adopting one of the three exchange regimes: fixed exchange rate regime, floating exchange rate regime, and managed floating regime. If the CBN were operating the fixed exchange rate regime, they would use devaluation and revaluation as the official changes to value the naira relative to other currencies.
If the CBN were operating a floating (flexible) exchange rate regime, the market forces would be allowed to generate changes in the value of the naira, as the naira depreciated or appreciated. The CBN adopted this currency regime in 2016 and is still recovering from the bitter experience.
There is also the managed floating currency regime, which is similar to the floating exchange rate regime, but with a lower degree of flexibility. In 2019, the CBN report to be adopting this system. Under this regime, the central bank regularly intervenes in the foreign exchange market to change the floating direction of the naira, and to support its balance of payments in during volatile periods. This type of regime is also called a dirty float exchange rate regime. The name might have been derived from the charter by International Monetary Fund (IMF) for its members to refrain from “controlling exchange rates to gain an unfair competitive advantage over other members.”
The mash things up, the CBN operates a dual exchange rate market following that adopts one of the three regimes above, namely: the official currency market and the parallel currency market. The parallel market is designed for every transaction in the economy except those classified under the official. On average, the parallel currency rates are 20% above the official market rate. The rates are set based on bids from the (un)liberalised Bureau de Change operators, who are an additional burden to the system. The official market is designed for special purposes like paying for medical bills, tuition fees, religious pilgrimage, and imports for specific items.
The implementation of these multiple regimes is significantly costly for the apex bank and the commercial banks. It can also be an avenue for illegal round-tripping. The system is unclear and complicated. It is creating confusion for foreign investors, external lenders, and Nigerians who remit money from abroad. In April, after getting the approval for the IMF emergency funding, the Governor promised to unify the country’s exchange rates, but no action has been taken since then.
Currently, the country is faced with a persistent shortage of dollars in the official and parallel currency markets. The government is also looking for other avenues to increase the foreign exchange inflow. Like the unpopular CBN policy of ensuring export sales are repatriated and sold at the official market rate. Overall, one can assume the country is not willing to spend its foreign reserve to manage-float its currency. It means the naira must be weakened to a level that it is able and willing to support with its foreign exchange reserves. It is why Goldman Sachs reported the news of devaluation. However, the timing and the extent to which the CBN weaken the naira is increasing uncertainty in the financial markets.
The effects of weakening the naira include more expensive imported goods. In an ideal world, this should discourage imports into the country. For Nigeria, weakening the naira will only increase its the current account deficit due to heavy reliance on imports and the unpopular policy on export sales. By increasing the imports prices and leaving the demand for domestic products unchanged, weakening the naira will provoke inflation in the country. Theoretically, the CBN could raise interest rates to control inflation at the cost of slower economic growth. However, subsequent open-market operations conducted in the past four years did not mitigate this issue. It left the economy to bear a higher interest rate for bonds.
Finally, there will be no solution for these glaring problems until a prudent central banker is appointed who truly understands the issues. It means we have to wait for the government to work on this.
– Sahara Reporters