The US dollar has been on the rise since the beginning of the year 2022, appreciating by about 11 percent year-to-date and reaching a par value with the Euro. Notably, major currencies like Euro, Chinese Yuan, and Korean Won have depreciated against the dollar and for developing economies like Nigeria, the effect is even more dampening.
Historic rates show that the US dollar index used to measure the value of the dollar against a basket of six foreign currencies: the euro, Swiss franc, Japanese yen, Canadian dollar, British pound, and Swedish krona, which stood at about 94.4USD in January now stands at 104.9990USD as at this writing, data from Bloomberg shows.
The value of the dollar is rising majorly because of the strong demand for the currency. A lot of international trade transactions are carried out using the greenback. Also, major global commodities like crude oil sold across borders are priced in dollars.
For an emerging market economy like Nigeria which is on the transmission line of global shocks, the economic outlook is suggesting a slowdown. The supply chain disruptions caused by the Russia-Ukraine war have led to a surge in the prices of global commodities, darkening the outlook of a major importer like Nigeria. Also, spiraling inflation has led most central banks to raise monetary policy rates, including the U.S.
How this phenomenon is affecting Nigeria
Given that the economic outlook for Nigeria is pointing majorly to a slowdown — IMF recently downgraded Nigeria’s 2023 growth projection in its July 2022 World Economic Outlook (WEO), titled, “Gloomy and More Uncertain” — astute investors will naturally want to move towards safety and may be prompted to look to other stable investment destinations as they fly their capital to safety, increasing the demand for dollar-denominated assets. Pointing to data from the Institute of International Finance, Financial Times reported that emerging markets faced record high withdrawals by foreign investors in the last five months. This suggests an increasing difficulty Nigeria may encounter in trying to attract and retain foreign investors.
Nigeria is an import economy and as the dollar strengthens, import becomes more expensive (in naira terms). Also, considering that foreign exchange is driven by the forces of demand and supply, excess demand for the dollar will cause the dollar to keep strengthening against the naira, thereby putting more pressure on Nigeria’s currency.
Following the above, Nigeria’s Fiscal Space may experience some stress. A stronger dollar requires more naira to import oil and with the petrol subsidy still in place, a large portion of fiscal expenditure will go into subsidizing imported petrol. Nigeria may also experience sovereign debt repayment stress because as the dollar becomes stronger relative to the naira, repayment of the 7-year Eurobond will become more expensive (in naira terms).
Notwithstanding, a strong dollar relative to the naira also means cheaper export and Nigeria can leverage this to increase its foreign exchange earnings. This will directly raise the nation’s foreign exchange reserve and can spill over to improving the value of the naira.