What does the Unification of exchange rate mean for you?

Nigeria has officially floated its naira currency, as recently announced by the Central Bank of Nigeria (CBN). This significant development indicates a shift in the country’s exchange rate policy, where the naira’s value against the U.S. dollar will now be determined by market forces of supply and demand rather than being solely controlled by the central bank.

What does this mean?

Over the years, Nigeria, as a leading African economy, has long grappled with the challenge of multiple exchange rates. This means that different rates are used to convert the Nigerian Naira into foreign currencies like the US dollar or the British pound.

Multiple exchange rates have had several adverse effects on Nigeria’s economy. Firstly, it has created economic distortions. Individuals and businesses have been incentivised to engage in arbitrage with different rates available, taking advantage of the rate differentials to make profits.

This has led to speculative activities, where individuals buy foreign currency at lower rates and sell at higher rates rather than using the currency for productive investments. Such activities have resulted in an inefficient allocation of resources and hindered economic growth.

Moreover, multiple exchange rates havehindered investment inflows into the country. Investors are wary of the uncertainties associated with the exchange rate regime. Due to restrictions and inconsistencies in the rates, they face challenges in converting their earnings or repatriating profits.

This lack of clarity and transparency has discouraged foreign direct investment, crucial for job creation, technology transfer, and overall economic development.

Furthermore, multiple exchange rates have created uncertainties for businesses and individuals alike. Businesses require stable and predictable exchange rates to plan operations, make investment decisions, and manage risks.

However, multiple rates have made it difficult for them to accurately forecast costs, price their goods and services, and manage their foreign currency exposures. This uncertainty undermines business confidence and hampers long-term economic planning.

Understanding Nigeria’s current Multiple exchange rate

Exchange rates refer to the value of one currency in relation to another. In the case of Nigeria, the country operates multiple exchange rates, with the official exchange rate and various parallel market rates operating concurrently. These multiple rates have resulted in discrepancies, market distortions, and limited transparency in foreign exchange operations.

1. Nafex rate: This is the rate set by the Central Bank of Nigeria (CBN) and was typically lower than the rates in the parallel market. The official rate was used for government transactions, official foreign reserves, and some priority sectors.
2. Interbank Exchange Rate: The interbank rate was the rate at which commercial banks traded foreign currencies among themselves. It was influenced by market forces but often had some level of intervention by the central bank.
3. Retail secondary intervention market: The parallel market, also known as the black market or the street market, operated outside the official banking channels. It involved the exchange of foreign currencies through informal channels and often had higher rates compared to the official and interbank rates. The parallel market rates were commonly used by individuals and businesses for various transactions.
4. Investors and Exporters (I&E) Window Rate: Introduced in 2017, the I&E window was created to attract foreign investors and encourage export earnings. It allowed investors and exporters to buy and sell foreign currencies at market-determined rates. The I&E window rate was relatively more flexible compared to the official rate.
5. Bureau De Change (BDC) or black-market Rates: The black market is mostly made up of BDCs who get their forex from the CBN and individuals who simply have foreign currency and want to trade. The black-market rate is usually unstructured and reflective of the demand and supply for foreign currency. Since there is no restriction in the black market, the rate is usually much higher than the other windows.

What does Unifying the exchange rate mean?

Unifying the exchange rate in Nigeria entails the convergence of multiple rates into a single rate determined by market forces rather than government intervention. The objective is to establish a rate that accurately reflects the true value of the Nigerian currency, the Naira, relative to other major currencies like the US dollar, Euro, or British pound.

By unifying the exchange rate, Nigeria aims to eliminate distortions arising from multiple rates. The varying rates had created opportunities for arbitrage, speculative activities, and rent-seeking behaviour, resulting in an inefficient allocation of resources within the economy. Unification seeks to remove these distortions and establish a level playing field for all market participants.

Moreover, unifying the exchange rate promotes transparency in the foreign exchange market. With a single market-driven rate, businesses and individuals can clearly understand the value of the Naira and make informed decisions regarding investments, imports, exports, and foreign currency transactions. Transparent and predictable exchange rates foster business confidence and attract domestic and foreign investments.

By allowing market forces to determine the exchange rate, unification reduces the reliance on government interventions in the foreign exchange market. This approach aligns with international best practices and provides a more efficient mechanism for price discovery. It enables the exchange rate to adjust to supply and demand dynamics changes, ensuring that the currency’s value accurately reflects economic fundamentals.

Unifying the exchange rate also enhances the effectiveness of monetary policy. The Central Bank of Nigeria (CBN) can better manage the economy’s inflation, interest rates, and liquidity with a single rate. The CBN can implement more targeted policies to stabilise the economy and respond to macroeconomic challenges, as it no longer needs to manage multiple rates simultaneously.

Are there Benefits of Exchange Rate Unification

1. Economic Stability: Unifying the exchange rate creates a more stable economic environment. It reduces uncertainties for businesses, both domestic and foreign, by providing a clear and consistent exchange rate for transactions. This stability enhances investor confidence, encourages foreign direct investment, and stimulates economic growth.
2. Attracting Foreign Investment: Nigeria possesses vast economic potential, attracting foreign investors seeking opportunities in oil and gas, agriculture, manufacturing, and services. A unified exchange rate eliminates the risk of exchange rate volatility and reduces the challenges associated with currency conversions, making the country a more attractive investment destination.
3. Enhanced Monetary Policy Effectiveness: Multiple exchange rates can hinder the effectiveness of monetary policy. Unifying the exchange rate enables the Central Bank of Nigeria (CBN) to manage better the economy’s inflation, interest rates, and liquidity. It provides a clearer basis for implementing and adjusting monetary policies to achieve desired macroeconomic objectives.
4. Improved Balance of Payments: By unifying the exchange rate, Nigeria can better manage its balance of payments position. It reduces the pressure on foreign reserves, as a single rate helps to align the country’s imports and exports by accurately reflecting the true cost of foreign goods and services.

What about Benefits for Businesses?

Unifying the exchange rate in Nigeria has significant implications for businesses operating within the country. Here’s what it means for businesses:

1. Increased Transparency and Predictability: With a unified exchange rate, businesses will benefit from enhanced transparency and predictability in the foreign exchange market. They will have a clearer understanding of the value of the Naira and can make more informed decisions regarding pricing, budgeting, and financial planning. This increased transparency reduces uncertainties and improves the overall business environment.
2. Improved Planning and Risk Management: Businesses require stable and predictable exchange rates to plan their operations effectively. A unified exchange rate allows businesses to forecast costs, determine pricing strategies, and manage foreign currency exposures more accurately. This stability enables better risk management and reduces the potential for unexpected financial losses due to exchange rate fluctuations.
3. Simplified Transactions: Dealing with multiple exchange rates can be complex and time-consuming for businesses. Unifying the exchange rate simplifies foreign currency transactions by eliminating the need to navigate through various rates and associated complications. Businesses can engage in straightforward conversions and transactions at a single market-driven rate, streamlining their operations.
4. Enhanced Competitiveness: A unified exchange rate promotes a level playing field for businesses, as it eliminates the distortions and preferential treatment associated with multiple rates. This creates a fairer business environment, where companies can compete based on their core competencies rather than on their ability to exploit exchange rate differentials. It fosters healthy competition, which, in turn, can drive innovation, productivity, and overall business growth.
5. Access to Foreign Investment: Unifying the exchange rate makes Nigeria more attractive to foreign investors. The elimination of exchange rate uncertainties and the creation of a transparent and market-driven rate instill greater confidence in investors. This, in turn, can lead to increased foreign direct investment, technology transfer, job creation, and overall economic development.

What are the challenges with the implementation?

While the unification of the exchange rate in Nigeria holds the potential for significant benefits, it also presents certain challenges that need to be carefully managed. Some of these considerations include:

1. Managing Inflation: Unifying the exchange rate can have an initial impact on inflation. If the unified rate results in a depreciation of the Naira, it may lead to an increase in the prices of imported goods, which can contribute to inflationary pressures. The government and the central bank need to implement appropriate monetary policies to mitigate any potential inflationary effects and ensure price stability.
2. Addressing Exchange Rate Volatility: In the short term, the unification of exchange rates may lead to increased volatility as the market adjusts to the new unified rate. This volatility can pose challenges for businesses and individuals in planning and managing their foreign exchange exposures. It is crucial for the government and regulatory authorities to closely monitor and manage any excessive exchange rate fluctuations to maintain stability in the market.
3. Adequate Foreign Reserves: To support the unified exchange rate, it is essential to ensure the availability of sufficient foreign reserves. Foreign reserves act as a cushion to manage fluctuations in the exchange rate and provide confidence to investors. The government needs to implement policies to attract foreign capital inflows, such as through exports, foreign direct investment, and borrowing, to bolster foreign reserves and maintain the stability of the unified rate.
4. Structural Reforms: Unifying the exchange rate should be accompanied by broader structural reforms to enhance the economy’s resilience and reduce dependence on oil exports. Nigeria has traditionally relied heavily on revenue from oil exports, making it vulnerable to fluctuations in global oil prices. Diversification of the economy into non-oil sectors, such as agriculture, manufacturing, services, and technology, can help reduce this vulnerability and promote sustainable economic growth.
5. Strengthening Institutions: Effective implementation of exchange rate unification requires strong institutional frameworks and governance mechanisms. This includes robust regulation, supervision, and transparency in the foreign exchange market. The government should focus on strengthening institutions, enhancing regulatory frameworks, and combating corruption to create an enabling environment for a unified exchange rate to function effectively.

So, what does the future hold for foreign exchange in Nigeria?

It all boils down to two things: liquidity and volatility.

Liquidity means the amount of money (in this case, dollars) available at any given time. This is one of the main reasons for ongoing exchange rate issues. When there is low liquidity of exchange rates, we start to scramble for more foreign exchange.

And this is what we’ve seen recently. Two years ago, crude oil revenue (which makes up about 70% of our export revenue) was low because of the low crude oil price. But this year, the crude oil price is back to over $100, So, ideally, what should happen is that the exchange rate should appreciate because the supply of foreign exchange is higher, but that is not the case because of trade.

Our imports have been significantly higher than usual.

In the first quarter of this year, imports totalled ₦6.9 trillion — the highest quarterly figure in over a decade. It was a 16% increase compared to Q4 2020.

This is mainly because we have been importing a lot of machinery and transportation equipment. We imported ₦4.5 trillion worth of manufactured and transport goods — a 70% increase compared to Q1 2020.

This high level of imports explains the recent troubles with the exchange rate. Our relatively low dollar intake from oil is being spent on this boom in importing these goods. At this rate, if oil prices drop again then we will find ourselves in a lot of trouble. The exchange rate will worsen even further.

This is where volatility comes in. Because our foreign exchange is highly dependent on how much the federal government makes from crude oil sales, the exchange rate is quite volatile (mostly moving upwards). So till we have more steady sources of forex, we will continue to suffer from a foreign currency problem.

The volatility and liquidity cannot be improved by unifying the exchange rate. If the country is unable to earn more foreign currency, the short term effect will be painful. In the long term, a flexible and unified exchange rate will allow businesses to make better decisions, which will attract more businesses, provided other things fall in place for businesses to thrive

How to Navigate the Challenges with Liquidity and Volatility?

The challenges related to liquidity and volatility in Nigeria’s foreign exchange market have significant implications for businesses operating in the country. Businesses are directly affected by the availability of foreign currency and fluctuations in the exchange rate. In this context, utilizing an expense management platform like Bujeti can offer several advantages and help mitigate the impact of these challenges.

1. Expense Optimization and Cost Control: Managing expenses effectively is crucial in an environment characterized by liquidity challenges. Bujeti offers comprehensive expense management features, enabling businesses to track, categorize, and analyze their expenditures. By gaining insights into their spending patterns, businesses can identify areas of cost optimization, implement budgetary controls, and make informed decisions on resource allocation. This level of expense control is particularly valuable in times of currency scarcity, where every Naira spent needs to be maximized.
2. Risk Management and Compliance: Fluctuating exchange rates can introduce risks for businesses engaged in international trade or reliant on imported goods and services. Bujeti facilitates risk management by providing tools to monitor foreign currency expenses and assess their impact on overall financial performance. Additionally, the platform can help businesses comply with regulatory requirements and maintain accurate financial records, reducing the risk of penalties or audits related to currency transactions.
3. Efficiency and Automation: Bujeti streamlines expense management processes, automating tasks such as expense tracking, reporting, and reimbursement. This automation saves businesses valuable time and resources, allowing employees to focus on core activities. By digitizing expense management, Bujeti reduces the risk of errors, enhances efficiency, and ensures transparency in financial operations.
4. Business Insights and Decision-making: Bujeti generates detailed reports and analytics on expenses, providing businesses with valuable insights into their financial performance. These insights enable better decision-making, helping businesses adapt their strategies based on changing economic conditions, exchange rate fluctuations, and market dynamics. With accurate and timely information at their fingertips, businesses can make proactive decisions to navigate the challenges posed by Nigeria’s foreign exchange environment.

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In summary, the challenges associated with liquidity and volatility in Nigeria’s foreign exchange market emphasise the importance of effective expense management for businesses. An expense management platform like Bujeti can provide businesses with exchange rate visibility, expense optimization, risk management capabilities, automation, and valuable business insights. By leveraging Bujeti, businesses can navigate the complexities of the foreign exchange environment, enhance financial control, and make informed decisions for sustainable growth.