The World Bank has criticised Nigeria’s current foreign exchange strategy as a restrictive and non-investment-friendly choice which may have cost the country its current inflation woe.
Revealed in the bank’s November edition of the Nigeria Development Update (NDU), the Central Bank of Nigeria (CBN) has encouraged investment flight and contributed to heating up the economy as a result of a foreign exchange policy choice that now proves to be sub-optimal in delivering its expected results for the country.
According to the report, the global lending body pointed that the local currency has been under undue pressure in response to the CBN’s constant involvement in manipulating the nominal official exchange rate. Citing a rigid foreign exchange management environment, the bank also expressed concerns over the resultant inflationary outcome that has made the Nigerian economic space uncomfortable for households and businesses.
Between the period when the pandemic struck, and the time it became largely subdued, the apex banking authority in Nigeria has raised the nominal official exchange rate thrice: the first by 15 percent in March 2020, another by 5 percent in August 2020 and the most recent by 7 percent in May 2021 respectively.
Furthermore, the NDU report also submits that the nation’s foreign exchange policy is too rigid and, consequently, shock inelastic. The World Bank believes that the CBN has not allowed the country’s FX market to enjoy sufficient flexibility, which can occasion its ability to respond appropriately to external impulses and correct any balance of payment (BOP) disturbances.
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When the foreign exchange is allowed to be market-oriented, then the price of the local currency relative to its foreign exchange will reflect its true value. If this happens, speculative interests will not be encouraged, and investors’ confidence in the trade and investment sector of the economy will be assured. According to the World Bank’s NDU report, “The NAFEX rate, which is now the guiding exchange rate for the economy, continues to be managed and is not fully reflective of market conditions. The parallel market premium over the NAFEX rate reached 29 per cent in August 2021 after the CBN cut off its weekly supply of $20,000 per bureau de change. The CBN has intermittently supplied forex to BDCs since 2005, providing ample opportunities for currency round-tripping.”
Suppose the exchange rate is allowed to free float. In that case, policymakers can enjoy non-restricted policymaking, and they will have the free will to pursue whatever policy they deem fit, depending on the broad-based target set for the period.
Prior to COVID-19, the CBN supplied an average of $2.5 billion to the Investors and Exporters (I&E) window but could only afford to funnel an average of $0.5 billion months after the pandemic. This represents an 80 percent decline on average in FX supply by the CBN over the observed period. This supply shortage has created room for vested interests in the market, thus, making it possible for reckless profiteering by arbitragers and round-trippers.
With the volatile nature of the country’s foreign exchange rate and the consequent thin supply of dollars in the economy, investors become risk-averse towards new investment commitments while a good number of existing investments are re-established elsewhere with more predictable macroeconomic statistics. Furthermore, the current nature of CBN’s exchange rate policy allows for policy conflict and compatibility issues, especially with other economic targets for growth, inflation and unemployment.
The current demand management-focused regime that the CBN runs leaves a large room for supply inefficiencies, and the consequent result as it is presently experienced is inflationary; scarce exchanges make the price of imports rise, and the cost of production for home-based producers jerks up as well. Eventually, the incidence of these price increases is passed onto the final consumers who must either part away with a more significant proportion of their disposable income to maintain the same level of utility or recalibrate their consumption preferences to fit their new real income.
Also, it may become difficult for the government to rapidly respond to the balance of payment crises and other external shocks while operating a restrictive FX regime. If the government must come to the aid of the economy during any unfavourable incidence, then a dip into the foreign exchange reserves becomes inevitable. If this move becomes a frequent practice, it can lead to international liquidity challenges.
In the Nigeria Development Report, the World Bank advised the CBN to pursue a more predictable, transparent, and flexible foreign exchange management system, a vital precondition to luring and sustaining new private investment flows into the country.
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