Will Nigeria Maintain the Peg or Allow the Naira to float?
Since 2017 there has been a constant tussle between the Nigeria Central Bank and the other stakeholders in the financial markets about floating the Naira.
What does it actually mean to float a currency?
When floating a currency, you make the exchange rate become the instrument with which the currency value is determined, with no government intervention or immediate decision by the central bank on pegging the value.
How does this affect Nigeria?
The Government's take on the issue
In 2018 Nigeria's Vice President, Professor Yemi Osinbajo said that the federal government would not allow the Naira to float. Still, he emphasized that despite their stance the Central Bank of Nigeria (CBN) if it wished could decide to float the local currency.
He revealed that the government is negotiating with CBN to fully implement the "floating" exchange rate policy, but the "logical conclusion" of the negotiations would not be a quick fix, nor would the implementation be fast.
An Egyptian Success Story
After letting the currency float for nearly four years, Egypt's stable economic situation clearly reminds Nigeria that Egypt made the right decision.
Comparing the two countries today, Egypt's economy is steadily improving while Nigeria continues to take the brunt of the recent falling oil prices.
According to statistics from the International Monetary Fund (IMF), Nigeria's annual inflation rate has risen from 13.22% to 13.71% in September 2020 for 13 consecutive months. Simultaneously, Egypt's annual inflation rate jumped from 3.7% to 4.5% during the same period leading up to October 2020.
Proponents of the currency float point to these two economies, with Nigeria being first and Egypt being the third most significant economies in Africa. Similarly with Nigeria's inflation being in the double digits while Egypt’s being in the single digits.
The belief is that floating Naira will undoubtedly stimulate the Nigerian economy through capital inflows from portfolio investors searching for yield, and foreign direct investment on the hunt for cheaper assets.
The long-term floating Naira could have a positive impact on the Nigerian economy. Still, the real question is whether the country is strong enough to withstand the first storm caused by uncontrollable inflation and weak currencies when a herto fixed currency is allowed to float unfettered.
Like many of its peer economies dependent on oil prices, Nigeria's economy has been battered in 2020 as the global coronavirus pandemic lays waste to travel, & manufacturing causing global oil demand to plummet.
Brent crude oil prices made a good start in 2020, with an average price of $64 per barrel in January. However, they fell in the second quarter, when the cost of West Texas Intermediate (WTI) from Cushing in the United States failed to an unprecedented negative price of approximately US$9 per barrel in April.
Even as the year’s midpoint came, the average price of Brent crude oil barely exceeded US$40 per barrel and continued an anemic rise through the 2nd and 3rd quarters of the year.
The average price of Brent crude oil in November was US$43 per barrel, an increase of US$3 from the average price in October. According to the short-term energy outlook released by the U.S. Energy Information Administration (EIA) in December 2020, the price is expected to remain until the fourth quarter of 2020, with an average of US$49 per barrel by 2021.
The U.S. Dollar
It is worth noting that all successful first-world economies successfully keep floating exchange rates. Conversely, countries subject to exchange rate control usually have poor, dysfunctional economies and often have multiple exchange rates. Therefore, with a regulated exchange rate mechanism, Nigeria’s economy is constrained by the invisible subsidy of a pegged exchange rate. Can the country afford to keep subsidizing it’s elites and import dependent constituents by maintaining this exchange rate regime?
Over time, it is undeniable that CBN's interest rate strategy has failed seriously to protect the Naira. It would behoove the CBN to float the Naira simply because it is the right thing to do, and this might help stimulate an economy battered by the pandemic, and a slump in oil prices, which is a significant driver of the country's economy.
Similarly, CBN's refusal to adopt a variable Naira exchange rate only shows that they cannot significantly reduce the currency's current account deficit, leading to inflation, rising borrowing costs, and ultimately limiting demand.
Yes. It hinders the growth of personal consumption, industrial expansion, and employment opportunities. One popular and well researched reason for the lower than desired exchange rate of the Naira (despite Central Bank manipulation) is that whenever the CBN replaces its oil receipt quota with monthly distributable dollar-denominated income, the excess liquidity issued by Naira has increased the inflation spiral. Conversely the country gets poorer as consumer’s real income becomes less and less each month with the increase in inflation.
Nigeria should float their currency but it is unlikely that they will due to intransigence on the part of the government.