Why Nigeria Exchange Rate Policy Is Such a Minefield

Navigating Nigeria’s foreign exchange rate policy is tricky. There are multiple exchange rates; officials issue confusing and contradictory statements; promised reforms don’t materialize; and the central bank and finance ministry don’t always appear to see eye-to-eye on how to manage the naira. Economic fallout from the pandemic, including a deterioration in state finances, has made the need for clarity all the more pressing.

1. Why does Nigeria have multiple exchange rates?

Nigeria is Africa’s largest producer of oil, which accounts for more than 90% of foreign-exchange earnings. Plunging crude prices starting in 2014 caused an economic squeeze. Rather than devalue the naira, the central bank in 2017 opted to implement one rate for government transactions, pegged to the U.S. dollar, and a weaker, market-determined rate for investors and exporters. That weaker rate is known as the Nafex. Other rates were instituted for travelers and small and medium-sized enterprises. The idea was to improve liquidity and encourage dollar inflows. (There’s also a thriving currency black market, which values the naira at about 18% less than the Nafex rate.)

2. How did the pandemic make things worse?

As oil revenues plummeted during the Covid-19 crisis, the naira was devalued twice in one year. More recently, on March 22, the authorities announced that the Nafex will also be utilized for government transactions. Still, the central bank continues to list the pegged exchange rate of 379 naira to the dollar on its website, and its governor, Godwin Emefiele, insists Nigeria isn’t transitioning to a flexible exchange-rate regime.

3. What is gained by expanding use of the Nafex?

Nigeria has faced pressure from the International Monetary Fund and World Bank to reform its foreign exchange policy. The World Bank has been withholding a $1.5 billion loan until the government begins instituting currency reforms to attract investment. Extending use of the Nafex moves the government a step closer to restarting talks on the facility, which it needs to cover a widening budget shortfall and boost foreign-exchange reserves. Devaluing the naira for official transactions will also help boost government revenue, because all the nation’s crude is sold for dollars and the revenue is converted to naira in its books.

4. What’s the downside?

Nigeria spends about 70% of its income servicing public debt. Adoption of the Nafex for government transactions means interest costs on the dollar component of Nigeria’s debt will rise in naira terms, negating part of the budgetary benefits of a weaker currency. Moreover, the nation’s Debt Management Office uses an exchange rate of 380 naira to the dollar. If it, too, switches to the weaker Nafex rate, the nation’s debt metrics would deteriorate, making it more difficult and expensive to raise new financing. Electricity and gasoline prices are also linked to the exchange rate and will rise with the adoption of Nafex, placing further pressure on government to cut costly subsidies at the risk of stocking social unrest.

5. What does this mean for investors?

Nigeria may be moving toward more conventional management of its currency. Vice President Yemi Osinbajo said the government is committed to eventually adopting a single exchange rate. That might draw foreign investors who have been deterred by the current system. The adoption of the Nafex by government agencies for all their transactions would also provide motivation for the central bank to keep the naira stable through increased dollar supply to the Nafex market. That would help address low liquidity, a major shortcoming of the current currency regime.

The Reference Shelf

  • A Bloomberg story on the bank’s move toward the new exchange rate regime.
  • More from the central bank governor on the changes in policy.
  • The International Monetary Fund’s home page on Nigeria.
  • The Central Bank of Nigeria’s home page.

©2021 Bloomberg L.P.

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