The gap between the naira’s official and black market exchange rate has widened, reaching a N268.5 premium in the parallel (black) market and raising the opportunity for arbitrage in the foreign exchange market.
While the official I&E Window rate which has been managed around N420 – N431 per dollar broke into a historic low of N436 a few days ago, the black market rate has declined incredibly, plunging 26 percent year-to-date to reach N705/$1 as of this writing.
This widening gap between the official and parallel market exchange rates is suggestive of the CBN’s inability to sell the dollar at its (CBN) fixed rate to all those who want to buy, thereby fueling speculation and arbitrage bazaar.
Generally, the activities of arbitragers tend to resolve market price variation but this will not be the case for the Nigerian foreign exchange market as the CBN continues to maintain an unrealistic rate of about N430.
What experts are saying
Bode Agusto, a former member of the Monetary Policy Committee of the CBN said Nigeria is unable to successfully peg the naira to the dollar because the naira has a higher long-term annual rate of inflation relative to the dollar. He asserted that pegging a domestic currency to another currency will be successful only when the annual inflation rates of both are not significantly different.
He recommended a crawling peg exchange management where a country starts at a near market exchange rate and then allows its currency to depreciate (or appreciate) against the USD by close to the difference in annual inflation (which in the NGN/USD case is 10%). He said “this means starting at an NGN/USD exchange rate of around 600/1 and then allowing the currency to depreciate by around 10% per year. It also means allowing knowledgeable willing buyers to do business with knowledgeable willing sellers at contracted rates. The CBN may intervene in the market when rates are significantly higher or lower than its target.”
According to the June 2022 Nigeria Development Update (NDU) by the World Bank, Nigeria’s exchange rate policy should be such that reflects market dynamics. The bank said, “the benefits of a more effective exchange rate management, with a view towards a unified and market-reflective exchange rate, are more significant than in previous years.”
“Allowing further gradual adjustment in the IEFX rate, where the CBN manages the price, would help eliminate misalignment and alleviate persistent FX pressures.”
What you should know
Nigeria has been recording an improved trade balance from 2021 up to 2022, however, the impact of this improved trade balance on Foreign Exchange (FX) strains in the country will be limited due to the large exchange rate premium in the parallel market which is now staying around 61 percent.
Favorable external conditions; improving trade balance; elevated oil prices, provide enough ground for Nigeria to adjust its exchange rate to mirror market-determined price with the CBN’s intervention only when rate deviates significantly from target. This will ultimately help to ease the pressure on the naira.