Tue. Feb 20th, 2024

Nigeria Naira is On a Free Fall, Here is Why

By Veritas Feb 2, 2024

Introduction

The Nigerian naira is the official currency of Nigeria and has been managed using a flexible exchange rate system since June 2016. This replaced the former system of a fixed peg to the US dollar. Under the flexible system, the naira’s value is allowed to be set by the market forces of supply and demand, with occasional foreign exchange interventions by the Central Bank of Nigeria (CBN) to prevent excess volatility.

Despite having this more flexible system for over 5 years now, the naira has come under intense downward pressure against the dollar in the past few months. As of February 2023, the naira has depreciated significantly to trade between 750-800 per dollar on the parallel market. This represents a steep 25-30% decline from about N600 per dollar at the start of 2022. On the official CBN window, the naira has also weakened to around N460 per dollar from the N415 peg earlier. This rapid fall against the dollar has huge implications for Nigeria’s import-dependent economy.

Factors Behind Naira’s Fall

There are several key factors that have driven the recent sharp devaluation of the naira against the US dollar:

Firstly, falling oil exports and declining dollar reserves have reduced the supply of dollars available to support the naira. With oil accounting for over 90% of export earnings, lower crude production and prices since 2014 have squeezed Nigeria’s foreign reserves.

Secondly, demand for dollars has risen sharply among Nigerian businesses needing to pay for imports. With Nigeria heavily dependent on imported refined fuel, wheat, and rice, dollar demand has outstripped supply. This has put downward pressure on the naira exchange rate.

Additionally, speculation by currency traders and investors as well as panic buying of dollars have stoked depreciation pressures. As the naira has fallen, expectations of further declines have driven demand for dollars even higher.

Finally, inconsistent foreign exchange policies and capital controls have negatively impacted the naira. Frequent changes to regulations have created uncertainty and deterred investment inflows which could support the currency.

Economic Impacts

The rapid devaluation of the naira is having major economic impacts in Nigeria. One of the most direct effects is substantially higher prices for imported goods and services as the weaker naira makes imports more expensive in local currency terms. This is feeding into surging inflation across Nigeria, with the inflation rate hitting a 17-year high of 21.09% in October 2022 according to the National Bureau of Statistics.

The plummeting value of the naira is also severely eroding purchasing power and tightening budgets for average Nigerians. With a majority of goods either imported or containing imported components, the average Nigerian’s money is buying less and less as the naira falls. This is making it difficult for households to afford even basic necessities.

In addition, the currency depreciation is deterring much-needed foreign capital inflows into Nigeria. Foreign investors are becoming wary of naira instability and converting their naira holdings to dollars at the first opportunity. Portfolio investment inflows were just $1.19 billion in the first half of 2022 compared to $4.3 billion in the same period in 2021 according to government figures.

The climate of economic uncertainty created by the naira’s decline is also directly hampering Nigeria’s economic growth and development. With businesses unsure about the future value of the naira, many are putting investment and expansion decisions on hold.

Government Interventions

In an effort to stem the tide of the naira’s depreciation, the Nigerian government and Central Bank of Nigeria (CBN) have taken some steps to tighten foreign exchange controls and prop up the currency. According to the CBN’s press release on the naira redesign policy[1], some of the key interventions include:

Tightened foreign exchange controls – The CBN has tried to manage demand for dollars by restricting access to foreign exchange for certain types of transactions like food imports, and limiting dollar availability for travelers and overseas tuition payments.

Banking restrictions to prevent dollarization – Nigerian banks have been prohibited from transacting with cryptocurrencies and barred from facilitating payments for foreign exchange purchases to curb black market trading.

Limited FX interventions by the CBN – Though reserves have fallen, the CBN continues to provide some amount of dollars to authorized dealers to meet trade, travel and PTA needs, and defend the naira.

Relaxed FX rules for industries – Exporters and manufactures have been exempted from the CBN’s requirement to only sell forex to authorized dealers. This aims to boost dollar inflows.

Potential Solutions

There are several measures the Nigerian government can take to stabilize the naira exchange rate and boost dollar reserves:

Allowing greater naira exchange rate flexibility could help stabilize the currency. The central bank has so far tried to manage the rate, but allowing more market determination based on supply and demand could curb speculation and prevent further black market discounts. According to analysis from Bloomberg (https://www.bloomberg.com/news/articles/2024-01-29/why-nigeria-s-naira-currency-exchange-regime-mess-is-so-hard-to-fix), a more flexible regime would align official and parallel market rates.

Boosting Nigeria’s dollar reserves through external borrowing and loans could provide more firepower for the central bank to intervene and manage volatility. According to experts at BusinessDay (https://businessday.ng/opinion/article/7-ways-to-stabilise-the-value-of-the-naira/), shoring up reserves is key to defending the naira.

Getting oil production back on track will also help the government earn vital oil export revenues that can support the currency. Addressing pipeline security, investing in maintenance, and stemming theft and vandalism could all help increase output.

Tighter monetary policy from the central bank to curb inflation can also help stabilize the exchange rate by making imports less expensive in local currency terms. Clear communication and transparency around monetary policy decisions could further support the naira.

Finally, improved coordination between fiscal and monetary authorities and a clear FX management framework could provide consistency and stability around naira policy.

Naira Outlook

The consensus among analysts is that the naira will likely see further depreciation against the dollar in the near-term before eventually stabilizing if certain conditions are met.

With Nigeria’s oil exports and foreign reserves still depressed, most forecasters predict the naira will continue to lose ground versus the dollar over the next 6-12 months. Some analysts see the USD/NGN rate reaching as high as 750-800 in 2023 before leveling out. According to USD/NGN rate predictions from CoinCodex, the naira could fall to ₦5,685 per dollar by the end of 2024.

Over the longer-term, stabilization of the naira is expected if Nigeria can restore stability in oil production, steadily grow its forex reserves, and curb rising inflation. However, the CBN’s ability to defend the naira will remain limited without sufficient dollar inflows …

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By Veritas

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