The implications of unifying Nigeria's exchange rate

Despite the election controversy, Nigeria’s recently-sworn in President, Bola Ahmed Tinubu, has “hit the ground running” as promised during his campaign. In his first speech delivered at the swearing-in ceremony, which was held on May 29, 2023, he reiterated several macroeconomic initiatives aimed at creating employment and improving overall productivity.

Two major highlights of the stated initiatives were removing government subsidies on Premium Motor Spirit (PMS) and unifying the country’s exchange rate.

The man on the street would feel the gruelling effects of these policies in the short term as the cost of living rises. Staples like food and transportation are most vulnerable to price shock. For example, with the removal of fuel subsidy, pump price has jumped by over 150% to ₦490 from ₦188 per litre in Lagos, the country’s commercial centre. In practice, it will now cost ₦24,500 to fill up the 50-litre tank of a 2010 Toyota Corolla instead of the one-time price of ₦9,400.

Meanwhile, investors have taken the news positively as they see the policies as necessary to curb public waste, efficiently reallocate resources, increase investor confidence and drive overall productivity. This article by the Financial Times communicates the investors’ sentiments.

In anticipation of the exchange rate unification, there have been rumours of a naira devaluation to ₦630 per dollar. Even then, word on the street is that there is still an over ₦100 arbitrage, as the black market was trading at $1 for over ₦730. However, as the Central Bank of Nigeria (CBN) debunked the rumour, our imagination and juxtapositions have been cut short.

A week after, on June 9, 2023, President Tinubu suspended the CBN Governor, Godwin Emefiele, while investigating his office. In our latest newsletter, you can read more about Emefiele’s suspension and subsequent DSS arrest.

The Central Bank’s Deputy Governor of Operations, Mr Folashodun Adebisi Shonubi, was put in as the acting Governor.

Barely two weeks after the first rumour of a naira devaluation, today, June 14, 2023, some media sites reported that the CBN had instructed banks to float the NAFEX/I&E Market to $1/N755 officially—more on the I&E window below.

Now, we have the context of what’s been happening on the policy front since President Tinubu took the reins. So, let’s answer why we need to unify the exchange rate before discussing its implications.

Why do we have widely varying prices of dollar to naira. Such that we need to unify the exchange rate?

For there to be a unification, it means there’s been fragmentation. Indeed, in Nigeria, there are four foreign exchange (FX) markets: the Interbank FX market, the Investors and Exporters (I&E) window, Bureau De Change (BDC) window and the Small and Medium Enterprises (SME) window.

In the interbank FX market, authorised dealers like banks can trade foreign currencies at an agreed exchange rate.
The I&E window was introduced in April 2017 to encourage foreign direct investment (FDI) and enhance transparency in the FX market. It allows investors, exporters, and other participants to trade foreign currencies at market-determined exchange rates.
SME window was established to provide small and medium-sized enterprises with access to FX for their business operations.
BDC window allows licensed Bureau De Change operators to buy and sell foreign currencies to retail customers at approved exchange rates. Thus, the most accessible to the average consumer.

All four FX markets are legal and intended as the markets provide different sectors of the economy access to foreign exchange at varying rates.

However, due to the limited FX supply from exporters and foreign investors, the CBN played a significant role in supplying FX (in this case, USD) to these windows. The CBN mediating the FX market like this for a prolonged period artificially propped up the rates and inevitably strained Nigeria’s external reserves.

As reserves dwindled, foreign investors and local businesses could not access dollars easily. Thus, this FX scarcity placed a premium charge on windows with more straightforward access (i.e. BDC window). However, the challenge was that the BDCs could only serve a fraction of the total market.

The I&E window would have been most suitable for sophisticated investors. It was designed as an exchange rate window reflecting Nigeria’s market forces of demand and supply of dollars. But year-on-year, the turnover (i.e. the volume of dollars traded) was declining, thereby forcing the value (price) of the dollar to accelerate wildly against the naira. For instance, the volume of dollars traded in the I&E window declined by 69% from $4.88 billion in October 2021 to $1.5 billion in October 2022.

As expected, the CBN intervened in that market by setting the trading price of the dollar to naira (as recently as June 9, it was pegged at $1 to ₦462) instead of allowing the market forces to determine it. The added pressure on the BDC window as holders of dollars refused to sell at the CBN’s price, which was less than its market’s worth.

So, what happened today was that through informal communications with authorised dealers (Banks), the CBN allowed transactions in the window to be reported at fair market prices.

So, what does the unification of the exchange rate in Nigeria mean?

Three critical implications exist for the unification of the exchange rate in Nigeria.

First, it will lead to improved price discovery. As prices across the multiple windows become unified and transparent, it will reduce the arbitrage opportunity whereby well-connected and influential people (like politicians) in the country can buy dollars at an undisclosed, but often lower rate from one window and sell it at the parallel market rate on another window (often via BDCs). Thereby profiting off the spread and leading to a reduction in available dollars for other legitimate use cases.

Second, it will lead to an increased supply of dollars. One of the ways this will come to be is from what we’ve discussed in point one already—because these powerful people can’t just buy and hoard dollars to sell higher at a later date; there will be more dollars available on the market. But more importantly, local and foreign institutional investors will become more comfortable importing their dollars into the Nigerian economy for trade. Likewise, remote employees will feel more comfortable receiving their salaries in local banks’ domiciliary accounts than in offshore wallets and cross-border apps like Revolut and Payoneer.

They (investors and privileged individuals) know that they will get a fair naira market value when they decide to exchange their Fx for spending in Nigeria. Investors will be confident that when it’s time to repatriate their shareholder dividends in Fx, they can purchase it at a fair market value. Likewise, remote employees will feel more comfortable receiving their salaries in local banks’ domiciliary accounts than offshore wallets.

Third, more Nigerians will be able to access dollars more readily. The prevailing Fx crunch has meant that the average Nigerian cannot purchase dollars from their local banks to fulfil international duties like paying the fees of a school outside Nigeria. For those that even received remittances from relatives in the diaspora or salaries from multinational companies, many have been unable to access their hard-earned Fx deposited into their domiciliary bank accounts. By increasing transparency and boosting dollar availability across the different windows, retail consumers can get dollars easily and at a fair value from the BDCs, their main Fx window.

On the flip side, we envisage a temporary rate hike as a reaction from the market. But rates will eventually adjust due to competition and the influx of dollars. We’ve seen signs of this already. Data from FMDQ—the organisation authorised to publish I&E rates—reveals that dollars traded at ₦790 shortly before the market closed for the day. This should not be taken as the official rate; if anything, it’s an outlier as the median rate was still ₦476 with some occurrences (8% of the total number of recorded rates) above ₦700.

Finally, as noted above, the cost of living should go up in the short term, but if the policy is properly executed, the upsides we’ve listed will come to fruition.

Joshua Ishola and Benjamin Dada co-authored this article. Joshua is a Financial Consultant and Global Markets Associate with many years of experience at Coronation Merchant Bank and Deloitte.