Forex crisis in Nigeria’s economy

Perhaps, the biggest crisis faced by investors in the Nigerian economy today is the foreign exchange (forex) crisis.

This crisis has three major dimensions. The unprecedented sharp currency depreciation, the liquidity crisis in the foreign exchange market­ – manifests in the acute shortage of forex in the official window, and the volatility of the exchange rate that creates considerable uncertainty and unpredictability for investors.

Each of these dimensions of the crisis has a diverse impact on the economy. The unprecedented currency depreciation has the following implications for economic players: high cost of production because of the high import dependence of our manufacturing sector for imported raw materials, high operating costs across businesses in practically all sectors of the economy, and low sales and turnover because of the increase in price and effect on demand.

Others are erosion of profit margins because not all the additional cost can be passed on to consumers, increased business continuity risk for some segments of manufacturing and the severity of impact varies across sectors depending on the degree of business exposure to imports.

The liquidity challenges in the forex market pose numerous challenges to investors. Forex liquidity measures the degree of availability of forex to investors in the economy as and when needed. This has been a major challenge to investors in the economy in the following ways: It makes planning difficult because of the uncertainty; profits, income, or dividend repatriation by foreign investors has become difficult, creating huge backlogs, and it compels investors to patronise the parallel market at a more prohibitive exchange rate.

Also, patronage of the parallel market creates compliance and regulatory issues for investors; capacity utilisation is impacted when access to forex is constrained and poses a risk to business continuity.

The exchange rate volatility has also taken its toll on investors in the following ways: It worsens uncertainty for investors including the SMEs, undermines investors’ confidence, makes planning difficult and heightens investment risk.

Forex exclusion list

In the bid to reduce the pressure on foreign reserves, the Central Bank of Nigeria had excluded over 40 items from access to foreign exchange in the official window. Some of the products on this list are intermediate products for some manufacturing firms. This has negative effects on the operations of some manufacturing firms.

Forex policy management

The sharp depreciation of the naira exchange rate in the parallel market remains a cause for concern. It is a trend that should not be allowed to continue and all necessary steps need to be taken – and urgently too – to stem the slide and volatility. These developments should not be ignored. It is as much of an issue to consumers as it is to producers and other stakeholders that create value in the economy. It calls for an urgent review of the current foreign exchange policy.

We propose that the CBN should adopt a flexible exchange rate policy regime. It should be clarified that this is not a devaluation proposition. Rather it is a pricing mechanism that reflects the demand and supply fundamentals in the forex market which allows for rate adjustments as and when necessary. It is a model that is predictable, transparent and sustainable. It is a policy regime that would reduce uncertainty and inspire the confidence of investors. It is a policy framework that would minimise discretion and arbitrage in the forex allocation mechanism.

To promote better conceptual understanding, it would be useful to define these concepts. Devaluation is a policy choice often adopted to boost export and discourage imports. Countries adopt this measure, not necessarily because they have a forex or balance of payment crisis, but as a deliberate trade policy strategy to make their exports cheaper.

A flexible exchange rate regime, on the other hand, is adopted to cope with changing demand and supply conditions in the forex market. The benefits of a flexible exchange rate model are as follows: It enhances liquidity in the forex market, reduces uncertainty in the forex market and therefore enhances the confidence of investors and it is more transparent as a mechanism for forex allocation.

Similarly, it reduces opportunities for round tripping and other sharp practices, and minimises discretion in the allocation of forex and reduces corruption vulnerabilities.

A fixed exchange rate regime, on the other hand, creates the following outcomes: widening gap between the official and parallel market exchange rates which allows forex round-tripping to flourish, and collapse of liquidity in the forex market resulting in acute forex scarcity. It also fuels demand for forex because of the incredible rent opportunities created by the huge parallel market premium, creates a major disincentive for forex inflows into the economy, thus suppressing forex supply, mounting trade debts and increasing factory closure as many manufacturers are not able to access forex for raw materials and other inputs, among others.

In the light of the foregoing, the following policy options could be explored to mitigate the current crisis: adoption of a flexible exchange rate regime – this would improve liquidity in the forex market, reduce uncertainty and enhance investors’ confidence, deepen the autonomous forex market through the liberalisation of inflows from export proceeds, diaspora remittances, multinational companies, donor agencies and diplomatic missions, among others, and market rates should be allowed to prevail in the autonomous window.

Lastly, the Nigerian economy can weather the current forex crisis if forex policy contexts are right. We have the market, investment opportunities, people and natural resources to attract the forex inflows. But the policy barriers have to be removed.