Research Document: Pricing of Exchange Rate: Sustaining the Initial Gains

Posted Fri, May 24, 2024 5:49 PM

The pursuit of exchange rate stability is one of the critical macroeconomic objectives of every country. Meanwhile, developing countries, including Nigeria, have struggled to achieve this objective due to persistent exchange rate volatility driven by domestic and external economic conditions, thereby stoking macroeconomic instability. In Nigeria, exchange rate volatility is exacerbated by the country’s over-dependence on imports, limited foreign exchange (FX) earning sources due to the overreliance on crude oil exports, FX market illiquidity, high inflation, and speculative activities. Meanwhile, the Central Bank of Nigeria (CBN) has allowed the Naira to trade more freely on a willing-buyer, willing-seller basis since June 2023 and leaned towards inflation targeting instead of controlling the money supply. In March 2024, the Apex Bank declared that it had cleared a US$7 billion backlog of demand for FX.

In April 2024, the CBN offered to sell dollars to the country’s Bureau de Change (BDC) at market-reflective rates and announced that it would ban the use of dollar collateral for Naira loans, except for government Eurobonds and foreign bank guarantees. The International Monetary Fund (IMF) and World Bank have lauded these FX management measures, even though Nigerians continue to face skyrocketing fuel and food prices. The headline inflation stood at a record high of 33.2 percent in March 2024, primarily driven by exchange rate depreciation and higher gasoline prices. Following the exchange rate adjustments, the Naira has lost more than 30 percent of its value against the dollar at the official market since June 2023. However, the Naira has been tagged as the world's best currency performer since the beginning of March 2024, as it appreciated from over N1,800/US$ and over N1,600/US$ to N1,150/US$ at both the parallel and official markets.

Despite these initiatives especially as they relate to the demand side, the limited FX earnings from non-oil exports have given rise to an unfavourable net trade balance position across many products. Based on the National Bureau of Statistics (NBS) data, the net import value of agricultural products stood at N1.3 trillion and N1.0 trillion in 2022 and 2023, respectively. Similarly, the net import value for solid minerals stood at N67.3 billion and N53.1 billion in 2022 and 2023, respectively. The net import value for raw materials increased by 57.1 percent to N2.2 trillion in 2023 from N1.4 trillion in 2022. Similarly, Nigeria’s net import value for manufactured goods jumped to N17.6 trillion in 2023 from N10.2 trillion in 2022. This raises more concern regarding the sustainability of the recent Naira appreciation over an extended period.

While the Naira appreciation is a welcome development, there exists a perennial challenge of FX shortage in Nigeria, despite the country having great potential to enhance the productivity and export volumes of the non-oil sector activities, including agriculture and manufacturing. To this end, this Report analyses the FX market, particularly with respect to the recent Naira appreciation and its drivers, addresses issues around the sustainability of the gains and proposes strategies for the government and the Central Bank of Nigeria (CBN) to sustain the gains in the country's FX market over an extended period.