IMF says Nigeria's FX reforms revived monetary policy as floating naira reshapes inflation

Nigeria’s foreign exchange reforms have restored the effectiveness of monetary policy after years of distortions under a multiple exchange rate regime, while making currency movements a more important driver of inflation, according to the International Monetary Fund (IMF).

In a Selected Issues Paper accompanying its latest Article IV consultation on Nigeria, the IMF said the June 2023 unification of the foreign exchange market and the subsequent transition to a floating exchange rate regime marked a fundamental shift in the country’s economic policy framework.

The reforms ended a decades-long system characterised by multiple exchange rates, administrative controls and persistent gaps between official and parallel market rates, allowing the naira to trade more freely and strengthening the transmission of monetary policy decisions through the financial system.

“The June 2023 unification reform marked a fundamental shift in the exchange rate framework, culminating in the transition toward a floating arrangement by 2024,” the IMF said.

According to the Fund, the exchange rate overhaul significantly reduced distortions in the foreign exchange market. Before the reforms, the premium between official and parallel market exchange rates averaged about 30 percent and exceeded 70 percent during periods of acute stress between 2016 and 2017 and again from 2020 to 2022.

Following the unification of exchange rate windows in June 2023, the premium narrowed sharply to an average of about 9 percent, while the exchange rate became more responsive to market forces.

The IMF noted that the increase in naira volatility following the reforms reflects a transition from infrequent and often abrupt devaluations to a system of more frequent two-way market adjustments.

“Since then, the exchange rate has adjusted continuously, with volatility rising to around 11.6 percent, reflecting the shift from infrequent, stepwise adjustments to more frequent two-sided fluctuations under a market-determined regime,” the report said.

The Fund said the reform package was accompanied by a major tightening of monetary policy aimed at restoring price stability and anchoring inflation expectations.

Since the exchange rate unification, the Central Bank of Nigeria has raised the Monetary Policy Rate to 27.5 percent, while money market rates and Treasury bill yields have adjusted significantly higher.

According to the IMF, one of the most significant outcomes of the reforms is the restoration of monetary policy transmission, which had weakened considerably under the previous exchange rate regime.

The report showed that under the managed exchange rate arrangement that existed before 2016, policy rate changes were transmitted only partially to market rates. During the period of multiple exchange rates and administrative controls between 2016 and 2023, however, transmission effectively broke down.

“During the stabilised arrangement (2016–2023), transmission broke down entirely,” the IMF said, noting that efforts by the Central Bank to defend the exchange rate through liquidity injections often offset the intended impact of policy rate changes.

Following exchange rate unification, the pass-through of policy rate changes to wholesale market rates surged, indicating that monetary policy signals are once again influencing financial conditions.

The report found that the interbank call rate now exhibits near one-for-one pass-through with changes in the MPR, while Treasury bill yields also respond significantly to policy adjustments.

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However, transmission remains uneven across the financial system. Deposit rates have remained relatively sticky despite aggressive monetary tightening, suggesting that savers have yet to fully benefit from higher interest rates.

The IMF also identified a pronounced asymmetry in how banks respond to monetary policy changes.

“Interest rate transmission displays a clear ‘rockets-and-feathers’ pattern, with borrowing rates adjusting upward rapidly during tightening cycles but declining only gradually when policy is eased,” the report said.

According to the Fund, a 100-basis-point increase in the Monetary Policy Rate typically raises Treasury bill and lending rates by about 175 to 180 basis points, while an equivalent rate cut lowers borrowing costs by only 25 to 30 basis points.

The IMF said the findings underscore the importance of strengthening the operational framework of monetary policy to ensure that policy signals are transmitted more effectively throughout the economy.

While acknowledging the progress achieved since exchange rate unification, the Fund said transmission remains incomplete and called for improvements in liquidity management and a gradual streamlining of the banking sector’s cash reserve requirement, currently set at 45 percent.

The report also highlighted a major shift in Nigeria’s inflation dynamics under the floating exchange rate regime.

Under the previous framework, the official exchange rate functioned largely as a policy instrument rather than a market price. With the adoption of a market-determined exchange rate system, currency movements now play a more direct role in shaping domestic prices and financial conditions.

“With the move to a flexible exchange rate regime, exchange rate pass-through becomes a central element of macroeconomic transmission, as currency movements now play a more direct and continuous role in shaping domestic prices and financial conditions,” the IMF said.

The Fund noted that greater exchange rate flexibility typically increases the speed and magnitude of price adjustments because businesses respond more quickly when currency movements are persistent and visible.

However, it added that stronger monetary policy credibility and better-anchored inflation expectations could help reduce the inflationary impact of exchange rate fluctuations over time.

“Progress in strengthening the monetary policy framework can help mitigate the inflationary impact of exchange rate movements over time,” the IMF said.

The IMF noted that understanding the interaction between exchange rate pass-through and interest rate transmission will be critical as Nigeria continues its transition toward a modern inflation-targeting framework, with the effectiveness of monetary policy increasingly dependent on both channels.

Hope Moses-Ashike

Hope Moses-Ashike is an Associate Editor, Banking and Finance, with more than a decade of experience reporting on Nigeria’s financial system and broader economy. She closely tracks market movements, monetary policy decisions, company disclosures, regulatory actions, economic indicators, and global developments, and interprets what they mean for businesses, investors, policymakers, and households. Her reporting helps readers understand complex issues such as inflation trends, foreign exchange market dynamics, interest rate decisions, bank performance, and investment risks. She also covers major international events and periodically travels to Washington, D.C., to report on the World Bank/IMF Spring and Annual Meetings. Her dedication to financial journalism has earned her multiple recognitions and invitations to high-level professional development programmes. She is an alumna of the International Visitors Leadership Programme (IVLP) in the United States and holds an Advanced Financial Journalism Certificate from the Press Association Training in London, UK. Her other notable achievements include completing the Lagos Business School CMC Programme, the Bloomberg Media Africa Initiative Programme, and a Master Class in Journalism at Rhodes University in South Africa.