Worries are beginning to mount up in the minds of a lot of Nigerians as the naira tumbles again, exchanging for about N696/$1 on the black market. This plunge, coming after a major decline, where the naira reached a record low of about N710 to a dollar may be on its way to reaching a historic low, as the naira pivoted downward for over three weeks following its recovery from the N710/$1 currency quagmire.
This raises an important question about why the naira is Falling. In understanding why the naira has been falling relative to the dollar, it is imperative that we first understand what makes a domestic currency depreciate against a “strong” foreign currency.
The exchange rate is essentially a pricing mechanism Just like inflation. As such, largely affected by the forces of demand and supply. In foreign exchange, market forces fix an equilibrium exchange rate for a currency pair through the interaction of demand and supply of the currencies. Consequently, a currency becomes strong if it has a high demand relative to other currencies it is paired with. This is particularly true when an apex bank practices a flexible exchange rate regime. That is, a floating system where a currency adopts a market fixed rate.
In the case of naira and dollar, it is obvious that the CBN is trying to peg the naira to the dollar. But the relatively high demand for the dollar combined with the country’s inability to earn enough foreign exchange has led to the constant swindling in the value of the naira. This has therefore led to a wide gap between the official market and the parallel market exchange rate. In other words, Nigeria is battling with a two-edged sword. One side is a shortage in forex earnings, while the other is the high demand for the dollar due to the country’s import dependency.
The CBN is Not Earning Enough Forex
About 70 to 80 percent of the foreign exchange Nigeria earns comes through crude oil forex remittance. This exposes the country’s forex base to external shocks arising from the volatility in the prices of oil.
A Macroeconomic Policy Analyst, Professor Ken Ife, in an interview with AIT stated that the CBN has not been getting enough forex from NNPC as it used to. He said, “the CBN usually receives up to 3.4 billion dollars monthly from the NNPC as of 2014, but since that period, what we only heard was that up to 1.8 billion was remitted to the CBN, translating to about an average of $300 million for the first six months of this year.”
According to him, the crash in the forex remittance to the CBN was a result of the direct swap the NNPC was carrying out, where it exchanged crude for refined petroleum products.
The CBN has been left with sourcing dollars through diaspora remittance that has once peaked at over 26billion but is now a staggering $100 million to $5 billion a week. Also, FDI and portfolio investment have fallen. FDI has dropped significantly from over $8 billion to about $200 million. Portfolio investment has also significantly dropped.
This clamp down in forex inflow is because a lot of investors are pulling out from Nigeria to the US as they seek safety in USD-denominated assets amid the strengthening dollar and hawkish interest rate hikes by the US Federal Reserve. This has further strengthened the dollar.
The dollar strengthened year-to-date
The currencies of other major economies are also dropping against the dollar. For the first time in two decades, the dollar reached parity with the euro. Rate Captain also reported how the pounds sterling fell against the dollar, reaching a two-year low at the beginning of this week.
The USD index which measures the value of the dollar against a basket of six foreign currencies was about 94.5USD by the beginning of this year but has shut up to about 108.5USD as of this writing, and analysts believe it has the potential of hitting 115USD. What this means is that the USD has strengthened significantly against the currencies of other countries of the world, appreciating by about 12 percent and having a knock-on effect on economies of the world.
Nigeria’s Import Dependency a Major Issue
Apart from essential raw materials, Nigeria has an extraordinarily high level of importation. Every dollar Nigerians expend on the importation of frivolous items contributes to the depletion of the foreign reserve, thereby increasing the pressure on the naira. This high level of importation places the country at the front of global supply chain shocks. That is, global economic shocks are easily transmitted into the economy of the country.
Demand side effects are also a serious challenge. In Nigeria, there is a heavy demand pool on the dollar as a result of the high level of importation. The political terrain is a significant factor. With politicians seeking dollars to move less bulky money. The activities of speculators on the naira also have a dampening impact on the naira. Everybody wants to buy dollars at the I&E window rate but no one wants to sell at that rate. For instance, someone can speculate the naira dropping by say N70, the person buys and keeps the dollar, and sells for a profit at a later time.
The Way Out
Nigeria should reduce the patronage of imported goods and services. We cannot spend the dollar we do not have. While the CBN is implementing strategies that can jack up foreign earnings, Nigerians’ appetite for imported products should be controlled. The CBN is progressively cutting down rice importation but a lot of other import items still have to be looked into.
