Unification Of Exchange Rate And Its Ripple Effects On Nigerian Economy

The unification of the Nigerian exchange rate around the NAFEX rate clouded the space of news headlines that were confirmed by the Central Bank Governor, Godwin Emefiele. The NAFEX rate is the foreign exchange window where Investors and Exporters transact US dollars on market-determined prices. The pursuit of this unification has been confirmed to have been initiated based on the recommendation of the World Bank as Nigeria seeks a loan of $3 billion.

Following the aforementioned issue, data reported by FMDQ on 7th July showed that the official exchange rate has been technically devalued from N360/$ to N381/$, (an equivalent of 6 percent devaluation), despite the rate reported on the CBN official website as at the time of the report.

The CBN Governor further made it clear that the exchange rate unification will only revolve around the official exchange rate using the NAFEX rate as the benchmark, after making it clear that the parallel market rate is an unofficial and illegal means of transaction. The implication of this statement could indicate that the monetary authorities are insensitive to the prevailing peril that is expected to infiltrate the economy through the market (parallel market).

Going forward, Statistics showed that there has been a strong relationship between the movement of the official exchange rate and the parallel market rate, as arbitrager seeks to maximize the differences in the prices. In other words, the movement’s official exchange rate and the parallel market rate follow the picture of the movement of the snail and its shell. For clarity sake, Figure 1 shows the co-movement of the official exchange rate and the parallel market rate between January 2006 and June 2020.

Figure 1: The Official Exchange Rate (EXR) and the Parallel Market Rate (BDC)

Source: CBN 2020

                                                                            

As expected, the recent 6 percent naira devaluation by the CBN has agitated the movement of the parallel market rate, as arbitrager ceases to maximize the opportunities therein. Figure 2 shows the recent behavior of the parallel market rate in July, following the devaluation process.

Figure 2: Parallel Market Rate movement in July (using the benchmarked Lagos market rate)


Source: AbokiFx.com

A quick teaser, the effect of the 6% devaluation on parallel market rates is not an end in itself, but a means to an end. Nigeria’s economy is largely characterized by an informal sector, of which most of the foreign exchange transaction is been carried out in the parallel market. An average Nigerian due to the following reasons prefers to transact at the parallel market, relative to the official market; technicalities in procedures at the official market, fear of formalities, accessibilities, and information asymmetry, to mention a few.

To this end, it is expected that the pressure in the parallel market will further command a spike in the general price level of the economy due to the coverage of the informal sector of the economy; speculations; and the ongoing pandemic. For example, the 55% devaluation of the official exchange rate from N197/$ to N305/$ in May 2016, further resulted into a consistent increase in the parallel market rate which had its peak at N495/$ in February 2017, was also marked by an inflation figure of 18.72, year-on-year (YoY), while food inflation records an average of 20.3, YoY, between July and November 2017. Thus, given the current pressure on the general price level, as a result of the pandemic; alongside the devaluation, it is expected the basket of goods sold in the economy will yield a persistent and sustained rise in the months to come. In a simple term, an increase in the parallel market will further induce an increase in the general price level of the economy, following the 2016/2017 experience. See Figure 3 below;

Figure 3: Parallel Market Rate (BDC), Food Inflation and Inflation, Jan. 2016 – Dec. 2017


Source: CBN, 2019

Using a Forecast Error Variance Decomposition, FEVD (an econometric analytical technique), it is expected that the official exchange rate devaluation will increase the food inflation and the import price index through the parallel market rate by 3.29% and 39% within the space of 10 months, while other factors are being held constant.

As the domestic price level and the import bills increases; the purchasing power of naira falls (both in the domestic and international trade), the cost of living, poverty rate, and anti-social behavior rises, as the case may be.

In the medium term, the implication of the devaluation is expected to pose a threat to the lenders in the money market when the inflation rate rises above the monetary policy rate, following the present rate of 12.82 and 12.5 percent, respectively.

Also, the technical adjustment of the exchange rate in the medium term will have a deleterious effect on the country’s debt profile. Thus, the additional cost is incurred for payback following the reduction in the worth of the currency.

In a bid to address the aforementioned issues, the CBN needs to address the following issues as the key reasons why the parallel market is being flooded; technicalities in procedures at the official market, fear of formalities, accessibilities, and information asymmetry, to mention a few.

With no sense of bias towards the unification, the economic advantage of the unification includes; an increase in oil revenue for the governments, create more arbitrage opportunities, and curtail the cloud of uncertainty over the exchange rate movement.

Olumide Onitekun is currently undertaking his Master’s in Economics in Nigeria’s premier varsity, University of Ibadan. He is an economic analyst and can be reached via onitekunolumidedamilola@gmail.com

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