By Michael Chibuzo
On May 29, 2023, President Bola Tinubu stood on the presidential podium at Eagle Square and signalled his administration’s intention to carry out major and audacious shake-up in Nigeria’s monetary environment. He affirmed that in line with his campaign promise, the CBN would receive his blessing to harmonise the foreign exchange market and do away with the multiple exchange rates the CBN pegged the Naira to in various FX windows.
Just like with the deregulation of PMS, President Bola Tinubu knew that the liberalisation of the foreign exchange market to allow demand and supply to determine rates was bound to be disruptive to the economy. However, the attempt by the CBN to regulate supply of FX and control the exchange rate since 2017 due to grossly inadequate dollar liquidity was already suffocating the economy and was even severely hampering the ability of the CBN to meet legitimate FX obligations.
The Situation Tinubu Inherited:
Upon assumption of office, President Bola Tinubu inherited a foreign reserve of $34 billion, an FX backlog of over $6 billion, an external debt of $43.16 billion, an official exchange rate of around N460/1$, a parallel market rate of N780/1$, and a restriction on 43 items from accessing FX from the CBN’s I&E window.
The CBN under Godwin Emefiele between 2014 and early 2023 experimented with different monetary policy options to manage FX demand and supply. It maintained an official exchange rate for the Naira, which is below the open market value of the Naira with the intention to maintain price stability due to the over reliance of Nigeria on imported goods, including foods. Due to inadequate FX reserves to satisfy FX demands of importers at the various pegged official exchange rates, CBN had to restrict importers of 43 items that are or can be produced in Nigeria from accessing FX from its reserves.
This move artificially reduced FX demands from these categories of importers on the CBN reserve but it increased pressure on the parallel market. Despite the restrictions, CBN was struggling to meet up with the legitimate FX requests from eligible customers. The gap between the parallel market rates and the official rate widened, creating room for round tripping. Those who had access to get the subsidised CBN dollars, did so and then turn around to channel the FX through the parallel market to make almost 100% profit without doing anything!
Also, CBN under Emefiele took up some direct fiscal roles to stimulate production of some of the items on its FX restriction list such as rice, tomatoes, milk, maize, etc. With the hope of reducing the need for their importation. These interventions had varying degrees of short-term success but it did not erase the importation appetite for these items and invariably demand for FX through the black market. So, Tinubu’s government inherited a very unsustainable monetary situation, and a reset was the only way out.
CBN’s monetary policy reset under Cardoso
The new CBN leadership headed by Dr. Yemi Cardoso came on board a year ago and decided to reset Nigeria’s monetary landscape by returning to the basics especially in the area of forex management and achieving price stability. The CBN allowed the value of the Naira to be determined by the dynamics of demand and supply based on the principle of “willing buyer, willing seller”. In effect, market participants began to determine exchange rates without fixed rates imposed by the CBN. The most significant impact of this policy was that it achieve a rate convergence between the official market and the parallel market, thereby eliminating any incentive for round tripping.
This bold decision to float the Naira was basically to lift the crushing monetary yoke that fixed exchange rate had placed around the neck of Nigeria’s economy, which had seen the CBN struggle to meet FX obligations to importers and foreign investors trying to repatriate their profit. Like I pointed out before, the monetary reset came with so much pains for Nigerians, but it was the only way out. It was time to face our demons and accept our stark realities, which would enable us gradually stand on our feet.
Our reality was that we don’t have abundant FX reserves to peg the Naira to a rate that would lower cost of imports, so there is little we can do in the interim other than to allow the market determine the rate. To be able to have a fixed exchange rate determined by the CBN, we need to first have a sizable foreign reserve to provide enough liquidity in the FX market. Pegging the exchange rate with a foreign reserve of less than $34 billion and outstanding FX obligations of over $6 billion is simply suicidal.
Reserves climb to $40.2 billion: evidence of progress
The CBN did not just float the Naira and went to sleep, the apex bank made it a priority to shore up Nigeria’s foreign reserves, which would help the Naira strengthen in the long run as FX liquidity improves in market. In the past one year, the CBN has done an impressive job with our foreign reserves. From a reserve of $34 billion in May 2023, the CBN has overseen an accretion of our foreign reserves to around $40.2 billion.
The increase is even more remarkable when you consider the fact that the CBN within this period had to clear over $6 billion in unmet FX obligations, provide forex for importers and also service our external debts. In fact, in the first seven months of 2024, the CBN has expended $2.78 billion in servicing Nigeria’s external debts. Between July 2023 to December 2023, the CBN spent $2.33 billion in external debt service (note that Nigeria’s debt service for the entire 2022 is $2.41 billion).
So, when you analyse the debt service figures closely, would realise that between July 2023 and July 2024, the CBN expended a whooping $5.11 billion out of our foreign reserves to service our external debts. Despite all these, the apex bank was able to grow our foreign reserves to $40.2 billion earlier this month – the highest level since January 2021.
What the above data simply point to is that CBN’s monetary policy tools are yielding results. The CBN over the past nine months put in place measures to increase inflows of FX from many sources including diaspora remittances. As a result of the CBN’s engagement with the International Money Transfer Operators (IMTOs), remittance through the official channels of the CBN has steadily increased to an average of $600 million monthly (last year, the highest remittance in a month was $350 million). The CBN is targeting a monthly diaspora inflow of $1 billion. This alone is enough to significantly clear the domestic market demand for dollars.
Impact of rising foreign reserves on Nigeria’s economy
The floating of the Naira led to a significant devaluation of the currency with the negative impact it had on prices of goods and services across the country. Inflation has been high, with food inflation the worst hit. The long term outlook for exchange rate and price stability is very promising if our foreign reserves sustain its present pace of accretion. As our reserves rise, it will strengthen the capacity of the CBN to provide enough liquidity in the foreign exchange market.
Once the market is saturated with enough FX, the Naira will appreciate significantly. A stronger Naira means cheaper imports and that would definitely help curb inflation. The interesting part of it is that, this time around, the strength of the Naira would not be artificially pegged instead, it would be a product of interaction of the market forces of demand and supply. There is great optimism that we will eventually grow our reserves to over $50 billion in the next two years especially with the happenings in the oil and gas industry where importation of petroleum products are drying up and exportation picking up to yield forex for Nigeria thanks to the Dangote Refinery.
Nigeria has seen the worst in terms of the initial shock that followed the monetary policy reset. We have turned the corner and we are currently on a sustainable march upwards. That is progress and more of it is coming. Let us trust the process and the man driving it!