Fetishising the strength of the currency does the Nigerian economy more harm than good by commandeering scarce FX resources, says Okey Umeano FCCA
This article was first published in the June 2020 Africa edition of Accounting and Business magazine.
In March, the Central Bank of Nigeria (CBN) adjusted the naira exchange rate with the US dollar, effectively devaluing the market rate by about 6% and the official rate by about 7%.
This devaluation was long in coming, and CBN once again let its hand be forced by the fall in foreign exchange (FX) inflows brought on by low oil prices and reduced sales resulting from the coronavirus pandemic. It did the same in response to the global financial crisis in 2008, when it devalued the currency by over 30%, and in response to the 2016 recession in Nigeria, when it devalued again on a similar scale.
The latest devaluation was not as much as expected. Like many others, I believe the currency is still overvalued. As at early April, CBN’s non-deliverable forward contracts put the value at about 415 naira to the dollar. If the low FX inflows persist, then CBN’s hand may be forced yet again.
CBN adopts a managed float for the naira. In other words, it does what it can to keep the currency within a certain value range against the dollar. To achieve this, it has, over the years, had to buy the naira with US dollars mostly obtained from monetising the proceeds of crude oil sales. There has always been pressure to buy naira with US dollars, and rarely the other way round. This approach has cost CBN about US$1.5bn–US$3.5bn a month over the past decade, and made it the largest supplier of FX in Nigeria, with pressure to keep up the supply.
CBN has tried to manage this pressure by entering swaps with banks in Nigeria as the US dollar receiver, and entering a US$2bn bilateral swap with the People’s Bank of China that lets it sell renminbi in the FX market. It introduced a market for non-deliverable FX forwards, and for many years, had to maintain multiple exchange rates for the naira. In spite of all these measures, CBN remains under pressure to continue feeding the voracious appetite of FX consumers – a pressure heightened by the politicisation of the exchange rate.
Nigerian politicians often tout the exchange rate as a gauge of economic performance, and during election campaigns promise to strengthen the currency by unrealistic amounts. This heaps more pressure on CBN, as a falling currency becomes a proxy for economic non-performance.
It is high time CBN reviewed this expensive, market-distorting method of managing the currency and implemented a market-determined value instead. Spending heavily to keep the naira strong is not the best use of scarce FX resources. A market-determined value would lead to more certainty and encourage FX investment inflows, as exchange rate forecasting models would work better. Politicians need to understand they do more harm than good by politicising the exchange rate. CBN needs to educate them in the mechanics of currency management and why they should keep their hands off the exchange rate as a political tool.
Now is as good a time as any for CBN to set the naira free.
Okey Umeano FCCA is head of risk management at Nigeria’s Securities and Exchange Commission.
"The central bank spends US$1.5bn–US$3.5bn a month to maintain the naira’s exchange rate against the US dollar"