We all know that the Central Bank of Nigeria needs to float the Naira.
Hopes that this had been done in mid-2016 when the CBN announced the introduction of the ‘automatic adjustment mechanism of the exchange rate’ in a flexible foreign exchange regime were soon dashed when it became obvious that there was no real float. What essentially had been done was a veiled devaluation of the naira. The controls were still firmly in place and the foreign exchange market is currently anything but flexible.
At last count, there were about ten different naira/dollar exchange rates operating in Nigeria. The variance between the lowest and the highest rates is about N303. The implications of this regarding creating opportunities for arbitrage are dire. Find a way to access forex at the interbank rate legitimately or not, and you can make a spread of between 60% and 100% by selling back to the parallel market.
No serious investor will bring in foreign exchange in large quantities to an environment where he knows the rate of exchange at entry but cannot estimate which of the ten exchange rates will apply when he wants to repatriate his profits. This, in addition to policy inconsistencies and the fundamental issue of significantly reduced foreign exchange earnings due to the plunge in global crude prices could be the reason why from National Bureau of Statistics (NBS) figures, Nigeria suffered a 46% decline in capital importation between 2015 and 2016.
There have been renewed calls from experts and analysts for the CBN to let go of the reins and free the Naira to find its market value in a free float. It appears that floating the Naira is the silver bullet that will solve all our problems, bring back the billions of dollars in foreign direct and portfolio investments and revive our economy. So why is the CBN not doing this?!
I have considered two reasons why the CBN cannot truly float the naira just yet:
This all-important product is currently priced based on the Petroleum Products Pricing Regulatory Agency (PPPRA) pricing template which assumes an exchange rate of N285 to $1, a figure that is obviously lower than the current inter-bank rate. A full float of the naira will imply essentially a full deregulation of the PMS portion of the downstream petroleum industry. If analysts are right and the naira finds its floating value at around N400 to $1, we can expect the pump price of petrol to increase from N145 to no less than N200 per litre, all other price template elements remaining unchanged. Accounting for the fact that current DPK and AGO prices are based on (sometimes) accessing forex at the inter-bank rate, we will see increases in these prices too. The effect of these price increases on living costs for Nigerians who are already reeling under current harsh economic conditions will provoke a public outcry that can potentially lead to political unrest of worrying proportions.
If you took a foreign-denominated loan of $1m from a Nigerian bank with the current exchange rate of N305 to $1, and the new floating rate becomes say N400 to $1, you would now be owing the bank N400m instead of N305m. If your revenue is in naira, as is most likely the case, this represents a 30% increase in loan exposure. Multiply this by the hundreds of cases that are like this, and you will have a situation where the already troubling number of non-performing loans reach a scale that endangers the entire Nigerian banking sector.
My take is that Nigeria in its current state is like a patient who requires surgery but is also suffering from a pre-existing condition e.g. high blood pressure. Medical professionals will agree that you cannot operate on such a patient without first stabilizing him/her to a certain safe extent. The CBN is faced with what can be called a wicked problem. Float the naira now and you risk political and financial sector chaos that will prevent the very foreign capital inflows you want to attract. Retain the controls and foreign investors will stay away, putting further pressure on the naira and making life harder for Nigerians. In the short term, damned if you do, damned if you don’t.
However, if the new refineries come on stream in the next two years, if we sell or divest equity in the existing refineries and get them to operate optimally, then we can reduce our forex demand by at least the 16–20% of our total imports which, according to the NBS is comprised of petroleum products. Perhaps, success with this, as well as with increasing local production/capacity in other major industries will create more stable conditions for us to conduct the surgery on this patient and eventually float the naira.