By Baffa Kabiru Gwadabe
Over the past few months, Nigeria has been suffering from continuous depreciation of its currency, the naira. The naira has depreciated from barely ₦600/$ in the last three months to ₦1,300/$ today, the 27th of October 2023. This is enormous, considering the loss of value by more than 120%. Many are worried, including my little self, about this development. But the recent propositions of solutions by many provoke such a write-up.
It is good to start with some questions concerning the crisis. What is happening? What went wrong? Who is to blame? What are the ways out? What will be the lasting solutions?
The above questions may not be provided with answers, as many out there know the answers already. The focus should remain on some best practices or exchange rate regimes to hinge on. Let me start with some highlights on the developments in Nigeria’s foreign exchange market.
In 1971, when the Gold Standard was abolished under the Bretton Woods System, several foreign exchange rate management regimes were pursued in Nigeria and other parts of the world. These include the independently adjustable peg, crawling peg, independent peg, collective exchange arrangement, dual exchange and floating regimes. IMF member countries practice six (6) other exchange rate regimes, which were later compressed into three (3) regimes to include pegs, limited flexibility, and great flexibility. These were later decomposed into fifteen (15) regimes, mainly from 1975 to 1998 (see Mishkin, 2007).
All those regimes were adopted unevenly by the IMF countries. This means they practice one or more of the regimes based on their choices and persuasions. By 1999, the IMF proposed eight (8) different exchange rate regimes. They include separate legal tender, currency boards, conventional fixed (pegged against a single currency or basket of currencies or other commodities like gold), pegged within horizontal bands, crawling pegs, crawling bands, managed floating and independent floating (see Mishkin, 2007).
Still, these interchanging regimes continued in Nigeria depending on the available foreign reserves, capital inflows and current account balances. Nigeria’s forex crisis worsened in the 1980s when the US economy pursued Nigeria to devalue its currency by 10% and other scenarios. However, some attention will be given to the last ten years or so, particularly the administration of President Muhammadu Buhari or the reign of Godwin Emefiele as the CBN Governor (2014 – 2023). Some reflections would also be made on earlier antecedents before the Buhari’s and current administrations.
Nigeria has pursued two dominant exchange rate regimes: the Retail Dutch Auction System (RDAS) and the Wholesale Dutch Auction System (WDAS). The RDAS is an exchange rate regime introduced in Nigeria in 1987. It focuses on buyers (end-users or customers) of Forex (USD) to bid for the prices, and the marginal bidder is supplied with the quantities by the CBN through authorized dealers. Under the RDAS, the inept dealers are supplied less, while the highest bidders are penalized for rent-seeking and invitation for depreciation.
The WDAS, on the other hand, is an exchange rate regime targeted at maintaining the gains of the RDAS and the continued liberalization of the forex market. The WDAS came into operation in Nigeria in February 2006 and allows authorized dealers to buy forex on their accounts rather than on behalf of end-users. Also, the authorized dealers are carefully watched by the CBN, and the dealers are also allowed to trade in the interbank forex market. During that time, the CBN pursued other special interventions of forex sales to Deposit Money Banks (DMBs) and direct sales to licensed Bureau de Change (BDCs). The CBN further mandated that DMBs increase Business Travel Allowance (BTA) and Personal Travel Allowance (PTA) from $2,500 and $2,000 to $5,000 and $4,000 per quarter, respectively. All these policies were sustained in positive directions as the naira continued to appreciate by 2.6%, 8.7% and 5.8% for 2006, 2007 and 2008, respectively.
However, at the beginning of 2009, there was an observed forex policy reversal and the reintroduction of RDAS to reduce capital outflows and depletion of foreign reserves. The interbank trading segment was suspended. This was followed by sales restriction of forex to oil companies and government agencies and sales of forex to BDCs. But towards the end of 2009, the CBN called for recapitalization of BDCs in what they call ‘Class A’, while those that did not recapitalize are called ‘Class B’ BDCs. Both ‘Class A’ and ‘Class B’ BDCs can bid a maximum of $1 million and $250,000 respectively.
Similarly, by 2016, Nigeria’s forex market was further liberalized. During the period, the average naira-dollar exchange rate was N197/$ at the interbank window, representing a depreciation of 18.7% (as the exchange rate was N160/$ before 2016). However, one worrying thing remains: the premium between the interbank and BDC sections was about 41.5%. After this, some other forex regimes were still embraced under the administration of President Buhari and Godwin Emefiele. For instance, forex primary dealers (FXPDS) and non-FXPDS were introduced into the forex market in 2017.
In addition, longer-term derivatives like forwards trading from 1 to 3 months tenor and up to 2 years were introduced. The exchange rate was relatively stabilized at averages of N231.76/$ and N351.82/$ at interbank and BDCs, respectively. This has created many arbitrage opportunities for those with access to the interbank rates to continue to worsen the forex market. Such a trend continued for 2020, 2021, 2022 and until 2023. For instance, as of March 2023, the official rate was N462/$, while in the black market, it was an average of N750/$.
The sacking of Emefiele as the CBN Governor and the appointment of the acting CBN Governor, Mr Shunobi, in June 2023, where the latter tried to close the gap and arbitrage opportunities, moved the official rate from N474/$ to N664/$. With the appointment of substantive CBN Governor in September 2023, Mr Cardoso, the apex Bank, moved on with complete deregulation of the forex market, and this has led to incessant depreciation of the naira to a historic level of N1,300/$. However, it now appreciates an average rate of N1,000/$ and other rates depending on information and locations.
The next thing to talk about is the proposed solutions to the lingering naira-dollar crisis. However, it is important to note that the CBN’s recent and previous exchange rate policies are floating in nature or simply deregulating the forex market, and this is counterproductive as it has not provided the desired results, especially recently. This is because floating regimes are usually for export-dominant countries such as China, the United States, Japan, Germany, India, Russia and Saudi Arabia, among others, as argued by the Mundell-Fleming model. Nigeria is a predominantly import-dependent economy. As such, depreciations affect inflationary levels in the first round (exchange rate pass-through to inflation) and at the ‘second-round’, popularly known in the current literature as the ‘second-round effect’.
To end this submission, the CBN needs to do one or two things to exit from the naira-dollar crisis, and these include:
(1) Invite a small but huge ‘Conference of the Parties’ (COP) to deliberate and take appropriate decisions for implementation immediately;
(2) Under the COP, dollarization with its components; official dollarization, unofficial dollarization, partial dollarization, etc should be reviewed;
(3) Hard-peg exchange rate regime should be deliberated;
(4) Managed-floating regime should be discussed;
(5) Most importantly, sources of the forex demand pressures must be exposed.
Baffa Kabiru Gwadabe wrote from Bayero University, Kano, via bkabirugwadabe@gmail.com.
