The recent changes in Nigeria’s foreign exchange market, announced by the Central Bank of Nigeria, have sparked optimism. The shift allows market forces, rather than the central bank, to determine currency rates, reflecting the Bola Ahmed Tinubu administration’s commitment to market-driven valuation of the naira.
Previously, Nigeria had multiple exchange rates, a situation the International Monetary Fund consistently urged the country to address. The significant gap between official and unofficial rates created scarcity of foreign exchange, hampering supply and causing disruptions. This multiplicity of rates indicated an ailing economy, eroded investor confidence, and limited the inflow of capital, resulting in a shortage of foreign exchange.
It is worth noting that this is not the first attempt to liberalize Nigeria’s foreign exchange market. Similar efforts were made in 1986, followed by subsequent attempts in 1995, 1999, and 2016, but they faced various obstacles.
The Nigerian foreign exchange market faces three key challenges: lack of transparency, foreign exchange shortages, and volatility. Shortages primarily stem from the country’s heavy reliance on the oil sector, which accounts for approximately 90% of foreign exchange earnings. When oil prices drop without a corresponding decline in demand, the market experiences volatility. Additionally, a significant portion of non-oil foreign exchange, such as diaspora remittances, tourism, and non-oil product exports, flows through the black market, exacerbating the challenges.
Other African countries that tackled similar shortages and volatility have also pursued market liberalization. Egypt, for example, floated its currency in 2016, leading to a 50% decline in the value of the Egyptian pound. South Africa has a free-float policy, but it has not prevented fluctuations in the value of the rand.
Nigeria’s exchange rate stability relies on a combination of factors, including monetary and fiscal policies, political stability, security, and investor confidence. The success of the new policy also hinges on the commitment of the Central Bank of Nigeria to follow through. Past efforts were prematurely abandoned, highlighting the need for sustained implementation.
As an economist, I have observed the reactions of Nigerians to this policy, but it is still too early to fully comprehend its consequences. Nonetheless, some potential positive outcomes can be anticipated.
The new policy has the potential to yield several benefits. It may deflate Nigeria’s bloated parallel foreign exchange market, discourage rent-seeking behaviors, foster a stable macroeconomic environment, attract foreign investment, boost exports, stabilize the exchange rate, and curb the dollarization of the economy. These developments would improve the investment climate and stimulate economic growth.
Addressing the bloated parallel market is crucial. Nigeria’s black market for foreign exchange operates uniquely, handling a significant portion of the country’s transactions. Allowing market forces to determine exchange rates will eventually align the parallel and official rates. Consequently, the number of black market currency dealers in airports, hotels, and major streets is expected to decrease. However, some illegal activity, particularly related to money laundering and illicit financial transactions, may persist.
The large spread between the parallel and official rates has fueled rent-seeking practices in Nigeria. Some individuals exploit the discrepancy to acquire foreign exchange at official rates and sell it on the black market for a profit. This detrimental behavior is part of Nigeria’s pervasive crony capitalism, benefiting a select few who obtain foreign currency at lower rates from the central bank. Effective implementation of the new policy would require these speculators to engage in more productive ventures.
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