Nigeria has officially floated its naira after years of sticking with a hard peg that scared away investors and drained the country’s external reserve.
This floating means buyers and sellers of foreign currency in the official FX market are now allowed to quote rates they find comfortable, as against previous practice where rates were dictated by the Central Bank of Nigeria (CBN).
The Investors & Exporters (I&E) window quoted the exchange rate at N702.19/$ at the close of business on Thursday.
What is exchange rate?
It is the price of Nigeria’s currency (naira) expressed in terms of other currencies (USD, GBP, etc.) and vice versa. The exchange rate is an indicator of how valuable a currency is among other world currencies.
A country’s currency becomes valuable when that currency is needed for cross-border transactions I.e., imports and exports. This is what drives the value of the exchange rate.
What are the Exchange Rate Regimes?
The concept of exchange rates exists under what we call Exchange Rate Regimes and there are three broad categories:
Fixed exchange rate: The exchange rate is fixed at a specific point by the monetary authority.
Floating exchange rate: The exchange rate is allowed to determine itself based on the forces of demand and supply.
Managed floating exchange rate: The exchange rate is fixed to a certain range I.e., N450 to N500/ $ while the CBN works behind the scenes to ensure that it stays within this range. This is what Nigeria has used up till this point.
Read also: Nigeria officially floats naira as I&E rate hits N755/$
How does the CBN implement a managed float?
“When exports are made, Nigeria receives dollars, but dollars can’t be spent inside Nigeria and so these dollars are put into the CBN forex reserve. The CBN then pushes the naira equivalent of these exports into the economy,” Lawrence Mercy, an analyst at Infracredit, explained.
He said that: “In situations of high demand for dollars — which would force the naira to depreciate — the CBN would have to buy a lot of naira (this basically accommodates for the low demand for naira and then the exchange rate can stabilise.”
“In a situation where there is a low demand for dollars (I.e., demand for naira is high which would force the naira to appreciate) the CBN would buy a lot of dollars thus forcing the value of the naira to stabilise back to its intended range,”
He further said that the managed float isn’t a bad idea, but Nigeria is a highly import-dependent country.
“This means that the naira will often depreciate and the CBN will have to keep selling dollars to maintain the naira where it was,” he said.
What does floating the naira mean?
A floating exchange rate is generally defined as when a nation’s currency value is determined by the forex market according to supply and demand compared to other currencies.
Zeal Akaraiwe, founder of financial advisory firm, Graeme Blaque Advisory, in a tweet, said: “The FX market will now operate as a normal market.”
A normal market is such that the forces of demand and supply dictate prices. Previously, the price was pegged by the CBN.
“This means no subsidy on dollars, no regulated price, and no capital controls,” Kalu Aja, personal finance consultant, told BusinessDay.
Is floating the exchange rate a good thing?
Mercy explains that floating is a step in the right direction.
“Any policy can be good or bad, but in Nigeria’s case, I expect the exchange rate to possibly trade towards N800-900/$ in the short term.
It’s a step in the right direction because it frees CBN of that burden of having to expend so much capital to maintain the exchange rate,” he said.
According to him, it forces businesses to turn towards Nigerian-made products and services, thus relying less on dollars for imports.
“It will also incentivise higher interest rates so that there can be increased FDI (foreign direct investment) and FPI (foreign portfolio investment). For example, if Nigeria issues a bond or a treasury bill, foreign investors can invest but they can’t use dollars. They will need to use the naira to invest in these instruments. This in turn would cause the naira to appreciate (on its own) based on market mechanisms,” he said.
What happens to the CBN after the float?
Akaraiwe said in line with the operational guidelines released by the CBN, the apex bank will take a back seat and intervene only when necessary.
“This is what we ought to have, but I don’t know if the market will be able to support itself in the early stages). In summary, the circular is highly positive for market development.”
How do you apply for FormA, PTA/BTA and others?
In the circular by the CBN, it stated that the multiple windows have been abolished and collapsed into the I & E window and all Form A, medical, school fees, BTA/PTA would continue to be processed through deposit money banks.
What is the impact of this on our local and foreign reserves?
Lawrence Mercy, an analyst at Infracredit, said that in terms of reserves, it is difficult to know the ultimate impact, but in the short to medium term, there it will reduce pressure on external reserves.
“The CBN communique states that there will be a re-introduction of a willing-buyer-willing- seller model. What this implies is that forex sales will now be decentralised away from just the CBN as the sole provider of FX in the I/E window (essentially a marketplace). This will definitely relieve pressure on the external reserves but the extent to which that will happen is yet to be determined,” he said.
How does the naira float affect foreign investors?
Jude Dike, the founder of Getequity, said floating the naira allows banks and other institutions to buy and sell dollars at their own rate and makes it even more accessible because everybody doesn’t have to go to the CBN for dollars.
