The fall and fall of the naira

Since the wake of the 18th century, the relationship between the naira and foreign currencies, especially the United States dollar, has been sporadic due to various local and international constraints in form of economic instability, fluctuating crude oil prices, inflation among others.

The naira was last devalued in August 2017 as a result of persistent inflation the country had to deal with. Till late 2019, the dollar/naira exchange rate was pegged at N360 to one dollar. The dollar is the most popular foreign currency used in Nigeria since the U.S. is the country’s primary trading partner.

Since the Coronavirus Disease reared its ugly head in December 2019, the Central Bank of Nigeria has been grappling with stabilising the country’s exchange rate as a result of low crude oil prices and the stoppage of economic activities in major sectors and cities. The influence of COVID-19 traverses many sectors, including foreign exchange, domestic and international stock markets and energy, which hit the naira hard.

Since the virus’ first appearance in China late last year, the naira weakened by 1.3 per cent to N366.63 per dollar. However, the currency’s fall was quickly restored in February due to the fall in reserves to over 4.6 per cent.

The fall in the prices of crude oil in the international market negatively impacted Nigeria’s economy, because the effect of the pandemic led to lockdowns. As a result of the downturn in economic activities and the oil price war between Saudi Arabia and Russia, CBN devalued the naira in March 2020 by approximately 15 per cent from N307 per dollar to N360, in an attempt to converge the multiple exchange rates used to stabilise the naira, which relies heavily on crude oil sales. Almost 90 per cent of the foreign exchange earnings come from oil and this has come under pressure as a result of the Saudi/Russia oil price war.

After the initial devaluation, several sources predicted another round of devaluation, as the initial one was unlikely to stabilise the currency. And even after, the naira still remained strained. Some days ago, CBN further devalued the naira by 5.4 per cent at the official market. The devaluation, as expected, increased the exchange rate to N381 per dollar and, as reported, this move is a calculated attempt at unifying the exchange rate as demanded by the International Monetary Fund and World Bank. This consistent depreciation indicates that a supply gap exists in the foreign exchange market. While the demand keeps increasing, there is insufficient supply to stabilise the exchange rate. This move is, however, positive, because it would successfully unify the official and Investors & Exporters exchange rate.

Since Nigeria majorly depends on revenue from oil, the devaluation will result in a boost, although minor to the oil revenue contribution. While the move to devalue the currency is only a part of the whole process towards ensuring a stable naira, there is the concern that the government may not put in the flexibility needed in the I&E window where majority of FX trading occurs. Since the COVID-19 started, liquidity has been low, recording a dropping daily volume of $300m in January to $45m in May.

Although a rise in the I&E window occurred recently bringing the total to N400m, this points to an increase in liquidity. However, this can only be sustained if the government is willing and able to pump more dollars into the market. This has helped the FX reserves stabilise to around $36bn since the beginning of June. But this is only sustainable for a period of time. The reserves will remain under pressure obstructing recovery of oil prices and discouraging foreign investors.

The unification of the exchange rate is a good step towards stabilising the currency and could increase the supply of the dollar locally. The devaluation alone will not bring major benefits unless there is greater flexibility. The FX reserves should be reviewed and reformed, as this adjustment is just insufficient to ensure the stability of the naira.

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