• Tuesday, July 16, 2024
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BusinessDay

Explainer: Why gap between official, parallel FX rates is widening

Can Nigeria benefit from China’s decision to halt LNG sales to Europe

The gap between the naira-dollar exchange rates at the official and parallel foreign exchange markets has continued to widen due to demand pressure.

The naira closed at N747 per dollar at the parallel market after trading on Wednesday, while at the official market, dollars was quoted at N441.25/$ on Tuesday. This shows a gap of N305.75 per dollar between the two markets.

Despite high crude oil prices, Nigeria’s external reserves have faced pressure since the second quarter of 2022 amidst lower inflows, a report by the FSDH Research said.

Foreign investment inflows were subdued owing to the tough business climate while crude oil theft limited FX inflow from crude oil. With this, the report said the Central Bank of Nigeria (CBN) limited its intervention in the FX market, triggering a depreciation of the official exchange rate from N415/$ in July 2022 to the current rate.

Nigeria’s external reserves, which give the central bank the firepower to defend the local currency, has declined by 6.76 percent to $37.76 billion as of October 18, 2022 compared to $40.50 billion recorded at the beginning of the year.

“Nevertheless, we see lingering pressure on the exchange rate due to FX illiquidity and higher input costs as major headwinds,” analysts at Afrinvest said.

According to the CBN, the Nigerian FX market has witnessed tremendous changes. The Second-tier Foreign Exchange Market was introduced in September 1986, the unified official market in 1987, the autonomous Foreign Exchange Market in 1995, and the Inter-bank Foreign Exchange Market in 1999. The Retail Dutch Auction System, Wholesale Dutch Auction System and Interbank Rate System were used between 2002 and 2015. The managed floating exchange rate regime was introduced in June 2016.

Bureaux de Change (BDC) operators were licensed in 1989 to allow access to small users of FX and to deepen the officially recognised FX market. Exchange rates in the BDC are market-driven. However, on July 27, 2021, the central bank stopped the sale of dollars for legitimate needs to the BDCs.

The FX parallel market has been in existence since the exchange control era. It has been established that scarcity in the official sector and prevailing bureaucratic procedures necessitated the growth and development of the parallel market, the CBN said.

Read also: Nigeria to convert vast CBN loans to 40-Year Bonds

“Unorthodox foreign exchange policy of the Central Bank has adversely impacted on the naira stability across all markets, and created a huge premium between official and parallel market rates,” said Aminu Gwadabe, president of the Association of Bureau De Change Operators of Nigeria.

He explained that selling FX earnings at a fixed rate of N430/$ while the open market rate is N730/$ is unorthodox practice that lacks credibility and transparency.

“That singular act encourages rent-seeking, currency substitution that continues to hurt real sector operators and the overall economy,” Gwadabe said.

The International Monetary Fund has said inflation is rising in sub-Saharan Africa and that the countries with floaters are experiencing double the rates compared with pegged exchange rates.

The World Bank had in June 2022 advised the Nigerian government, through the CBN, to allow further adjustment of the naira at the official window, to reduce the persistent foreign exchange pressure in the country.

“Allowing further gradual adjustment in the Investors and Exporters Foreign Exchange rate, where the CBN manages the price, would help eliminate misalignment and alleviate persistent FX pressures,” the World Bank said in the report titled ‘Nigeria Development Update’.