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What’s going on with Nigeria’s floating exchange rate?



You people were shouting that we should float the naira. You said once we float, the dollar scarcity will go away. Now we have floated and the scarcity is worse! Explain this to me!
Yes, it is true some of us said floating will solve the problem of dollar scarcity. The problem is that CBN did not really float the naira. The best way to describe what it did is to call it ‘kiting’. While it appears to be floating in the air, someone in CBN is still controlling the rope to ensure the kite does not fly beyond a certain point.

When you float the currency, the only referee in the market is the price. The price determines who gets dollars and who doesn’t. It also determines whether or not you should be doing certain activities or not. In other words, when price is the only determinant of dollar demand and supply, its usage ought to become more efficient. Maybe that trip to New York for a party can wait till next year? Maybe importing raw materials to manufacture things for export is the most viable thing you can do with dollars? When the market works and price rules, we will be able to answer these questions.

But the naira has depreciated a lot since June. Why are investors not coming to help us? What is holding them back from entering Nigeria with their dollars and buying cheap naira?
They are looking at the kite and seeing that someone is holding it down. The problem is that when the breeze starts to blow very hard, the rope can cut and we don’t know where the kite will end up. The reason why the naira had to be floated in June was that after holding it down at N199 to $1 for 18 months, the rope finally cut when the CBN could no longer sustain it.

This is the risk with controlling rates – pressure starts to build up to the point where a sharp change is inevitable. And for investors, they are always scared of those sharp changes. What if you enter today and the rope cuts tomorrow? You can suffer a 30% loss overnight. They prefer a system where the market adjusts quickly instead of one big change after months of uncertainty.

Look at the black market as an example. The price changes every day but in small amounts. So if you study the black market for some weeks or months, you can see trends as to where the rate is going. Any news or event that occurs is actually reflected in the black market rate and everyone can see it.

But why is CBN doing all this? Why are they so afraid of letting go of the rope sef?
The biggest reason they are doing it is because of petrol prices. Because the government has fixed the price of petrol at N145 per litre using an exchange rate of around N280 to $1, any increase in the exchange rate will affect the price of petrol. This is the challenge with fixing prices – when you fix it in one place; you have to fix it in other places. Before you know it, you are running around trying to put off several fires at the same time.

So what the CBN has done is to take the biggest supply of dollars into the Nigerian economy and send it to petrol importers directly. All the international oil companies who earn dollars can only sell their dollars to petrol marketers at rates determined by CBN. This is how CBN and NNPC have managed to keep petrol prices at N145. But the cost of this strategy is that they have made petrol the most important thing to use dollars for in the economy. Every other type of demand for dollars must form a long queue behind petrol marketers.

But what happened when the price of petrol went up to N145 per litre? According to NNPC itself, the demand for petrol dropped by 47%! All that fake petrol demand that was collecting subsidy and then crossing the border into Cameroun and Chad completely disappeared. People have also reduced their petrol usage by cutting down unnecessary trips and becoming generally more efficient with their petrol usage. Is this really a bad thing? In an economy, there are many things you can import with dollars but we will only find out the best dollar usage when we let price determine the interaction between demand and supply.

Na wa o. But don’t we have other dollar supplies apart from oil companies? What of all those Nigerian’s abroad washing plate in London? What happens to all the money they send home every week?
Good question. They are still washing their plates so they are still sending money home. However, CBN has also taken control of their dollars and allocated it to Bureau de Change operators. The banks did not like this arrangement and refused to comply with CBN’s directive that they should supply BDC’s with $15,000 each per week. So the CBN banned all of them from that market and left only First Bank.

CBN’s gamble is that if it increases the supply of dollars to BDCs, rates will come down. So all the companies that handle money transfer to Nigeria have to agree to exchange rates determined by CBN for them to be able to operate in Nigeria. Some of them were banned some months ago and were only able to resume operations after they complied with CBN. Now, all the money from plate- washing Nigerians abroad goes to First Bank and from there goes to BDC’s and Travelex who sell it to Nigerians who are travelling abroad. In short, the money comes in from the diaspora and goes back out through middle class Nigerians who are travelling to London and New York. If you go to the International airport today, you will see the rowdy queue of Nigerians trying to get cheap dollars to travel.

So, this source of dollar supply is also spoken for.

This thing don tire me. What is now left for people like me who want to import raw materials or pay for services abroad using my naira bank card? Am I not a human being again? Is dollar not my human right too?
Well, after petrol marketers, BDC’s and foreign travellers have collected their dollars, we can consider your rights with anything that is left. The CBN has told banks to allocate 60% of their dollars to people like you who want to import raw materials and machines. The problem is that the banks don’t have enough dollars anyway.

So many people like you are going to the black market to look for dollars. And the more people go to the black market, the higher the rates will go as the black market is still a relatively small market. Ideally, we should have all the supply and demand in one place like the Interbank market and let anyone who wants dollars buy it there at the market price. But what we have today is the same thing as what we had before the naira was floated. In fact, in some cases this is worse than before the float.

This Nigeria sha. Reuben Abati recently wrote that there are demons and evil spirits in Aso Rock. Are we really sure the demons are not in CBN or the dollar market?
I am sorry, I cannot comment on spiritual matters.

  • tope fasua

    but Femi you are a free market advocate and you guys promised unequivocally that once the Naira is floated foreign investors will tumble over themselves to come here. we cautioned then that it doesn’t necessarily follow. now you guys have shifted the argument

    • Tosin

      May I refer you to Question 1.

  • 100%Iboguy

    The problem with textbook economics is that it has never worked in any underdeveloped economy that rely massively on imported goods, is a monolith economy, has no control over the price of its natural resources export and has a huge cadre of rent seeking individuals that have enough free money to lap up the available forex at whatever rate.

    What will always happen with free floating exchange rate is that the prices of imported raw materials and capital equipment will shoot up to the extent that the manufacturing sector will simply collapse and the rent seekers will continue to buy the available forex to meet their expensive taste at whatever price.

    The self correction by the market may not happen at our life time.

  • real

    This is exactly the problem that the central bank has created in our economy. price regulation in an open economy doesn’t work and create more problem. our solution to our problem is the complete and total price deregulation of every sector. Let the true demand and supply emerge due to market forces. our lack of local production continues to increase our massive demand for import. There is no reason why Nigeria should be importing any fuel. we need to put every force toward increasing local refining of oil, even those illegal refineries needs to be brought online to help increase the local supply of fuel. We need to celebrate that ability of Nigeria to refine fuel in such crude manner. There should absolutely be no importation of any food that is grown in Nigeria and we should increase our processing ability. This are the only things that would solve our problems.

  • ayo

    The question is what government will completely hands off its currency i. e completely float it’s currency? Economists propose solution without factoring in the political and social implication of what they are proposing. Can the writer just imagine the immediate effect of leaving the Naira to float completely and at the same time let fuel price loss, I am yet to see the government no matter it’s political capital that can deal with the back lash of the social upheaval that will Herald that decision. When you are on the outside it is very easy to lay claim to monopoly of knowledge since you don’t have to navigate other political and social reasons needed to take an economic decision. One can easily get carried away with such a fluid position thinking all the government have to do is float and completely deregulate and every other thing will just work. If you believe that then Utopia is next door

  • Prince Jude Onuchima

    The reason in the general context to float a currency is basically to allow market forces take precedent. This market forces are not in any ways controlled.
    The problem in the Nigerian situation is wholly political.

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