These are tough times for Nigeria. For months the country has been struggling with inflationary pressures, with inflation now at 22.41%. To tackle this, the Central Bank of Nigeria (CBN) has raised its main interest rate eight times in a row; it now stands at 18.5%. These high interest rates have dampened economic activity and increased unemployment.
On top of this, one of the first moves by new President Bola Tinubu was to scrap the country’s fuel subsidy, exacerbating the cost-of-living crisis. Now this is set to deepen, thanks to the recent restructuring of Nigeria’s system of multiple exchange rates into one single rate.
Tinubu, who was sworn into office in May, has pledged to prioritise Nigeria’s economic problems. One of his first acts was to suspend CBN governor Godwin Emefiele over his handling of currency and monetary policy. Emefiele has since been arrested, although the reasons for this remain unclear.
The new president’s unification of the exchange rates has taken some by surprise
Surprise move
The decision to consolidate the exchange rates, which has led to a significant rise in the prices of goods and services in the import-dependent country, has taken some by surprise.
Introduced by the Central Bank of Nigeria (CBN) in 2016 as a means to protect the value of the country’s naira currency, the multiple rate system had three strands. First, there was a rate at which the CBN did some of its business including monetising proceeds of oil sales and funding ‘invisibles’ such as travel allowances, foreign school fees and medical expenses. Next came the investors and exporters (I&E) rate at which transactions such as capital importation and repatriation were carried out. Finally, there was a parallel market rate at which ordinary Nigerians could transact exchanges freely. At some point, the CBN and I&E rates became one official rate.
A multiple exchange rate system is of itself not a bad thing
Temporary solution
Until the recent consolidation of these rates, the official (I&E) rate stood at around N461 per US dollar (US$), while the parallel market rate stood at around N750/US$. The large difference between the official and parallel market rates provided an arbitrage opportunity and meant that anyone lucky enough to obtain US dollars at the official rate could profit by flipping it at the parallel market rate. There would be no incentive to produce anything, and there were plenty of stories of companies and individuals who did just this.
It’s important to note that the establishment of a multiple exchange rate system is of itself not a bad thing. Many central banks, especially in emerging markets, have had to employ such policies to wade through stormy currency waters. In fact, as of May this year, 24 countries had such a system. However, the strategy is ideally a temporary solution; Nigeria had kept its system in place for far too long.
Nigeria’s dependency on crude oil makes the country vulnerable
Reserves concern
To maintain a single exchange rate and keep the currency valuable, a country needs enough reserves from exports of goods and services. For obvious reasons, the more diverse these goods and services are, the better. Nigeria’s dependency on crude oil, which accounts for close to 90% of foreign exchange (FX) inflows, makes the economy vulnerable to shocks in the international crude oil market.
At the time the CBN set up the exchange rate regime, it may have been the best way to tackle the pressure on the currency. The country was in a recession, the price of crude oil was down, strife in the Niger Delta region meant a big dip in oil production and sales, and the petrol subsidy bill was on the rise. All these meant that the CBN was not seeing enough FX inflows and therefore did not have enough reserves with which to maintain a single exchange rate.
A palliative system should be put in place to ensure the most vulnerable get some reprieve
Time to change
These are indeed tough times for Nigerians and managers of Nigeria’s economy but they are inevitable. The multiple exchange rates had to go at some point and this is as good a time as any. The different parts of the economy now have to work together to ensure there is no social upheaval driven by lack in the country.
In the short term, some FX savings from ending the subsidy regime need to be channelled towards building reserves to enable the CBN to arrest any potential rapid declines in the currency. A well-designed palliative system should be put in place that ensures the most vulnerable get some reprieve from the present hardship; cash transfers have not been effective so government must think of other innovative ways.
In the medium to long term, the country must diversify its export base
In the medium to long term, the country must seriously diversify its export base. For over three decades, it has paid lip service to this but now it must actually take proactive steps to achieve it. Agricultural produce and solid minerals are good candidates for elevation as FX earners.
Finally, the government must show the people that it knows what they are going through and communicate a clear strategy for reducing the extra hardship brought on by the unification of exchange rates.
