Addressing Nigeria’s Forex Liquidity Challenge
Nigeria has a foreign exchange liquidity challenge crying for urgent, nuanced and sustainable solutions. To be sure, this liquidity problem long predated the President Bola Tinubu administration. But the foreign exchange reforms introduced by the administration, clearly necessary but obviously not well-sequenced, has triggered a rapid and seemingly unending depreciation in the value of the Naira against the US dollar and other major currencies.
At the close of business on Friday, the US dollar exchanged for N902.45 at the NAFEM window and N1, 350 in the parallel market. By contrast, the dollar rates were N471 and N765 at the Investors and Exports FX window and in the parallel market respectively on 13th June 2023, a day before the foreign exchange reforms commenced. The direct effect of the sharp and continuous depreciation in the value of the Naira is the constant hike in prices of goods and services, a development inflicting unceasing pains on most Nigerians.
The consensus among economists and financial analysts is that the Naira is currently undervalued. But the sad reality is that the value of the Naira keeps falling, and there seems no end in sight to the free-fall, despite some ad-hoc moves by and continuous reassurances from the government. Given the welfare and the regime/ national security implications of constantly rising prices, the present administration has to treat this problem as its most pressing challenge and it needs to evolve a coordinated, pragmatic and sustainable solution to it, especially because it removed the lid.
The Central Bank of Nigeria (CBN) surely has a key role to play here. But due to the many ramifications of the challenge, this is beyond what can be left to the CBN alone and beyond what can be approached in the current piece-meal, uncoordinated way. President Tinubu has to be in the lead, and has to take some difficult decisions. He needs to expand his toolkit and keep all the options on the table, weighing their pros and cons, and arriving at optimal decisions for the country.
Having a proper diagnosis is the starting point. There are possibly as many explanations for the depreciating value of the Naira as there are commentators in Nigeria. But one point that most analysts seem to agree on is that the Naira continues to depreciate because there is more demand for than the supply of foreign exchange. What is driving the demand for forex in the country can sometimes be a matter of ideological debate or pet theories. But what is not disputable is that the value of the US dollar will continue to be high (and conversely the value of the Naira will continue to tumble) as long as the demand for dollars in the country outstrips supply. It is basically a demand and supply thing, and the exchange rate can be seen as the price of the US dollar.
What government has been trying to do overtime is to manage the demand for US dollars. The demand management approach has not worked, and government’s attempts at rationing foreign exchange or picking who got FX at subsidised rates created opportunities for arbitrage, patronage and other sharp practices. A corollary of this approach was to defend the Naira with our foreign reserves. But reduced forex flows have shrunk the space for that. We cannot escape the tyranny of a forex supply crunch in an economy whose forex demand cannot immediately be suppressed except you want many sectors of the economy to grind to a halt.
So, what are the options Nigeria has for boosting forex supply and how quickly and sustainably can these options provide the needed relief?
The first option is to diversify and increase our export base. The oil and gas sector still accounts for more than 80% of our exports. This necessarily exposes us to the volatility of the oil market and other issues we will come to shortly. But clearly, we need to sell more things to the world to improve our balance of payments, expand our reserves and increase forex flows. The challenge, however, is that increasing exports is not like a switch that you can just flick on. It takes time. And here and now, there is a forex supply challenge to address.
The second option is to attract foreign investments, both direct and portfolio investments. The administration has introduced some reforms (including forex reforms) and the president and his team have been on the road to market Nigeria as a desirable and safe investment destination. All these moves are necessary and commendable.
But there is usually a time-lag between commitments and actual investments for direct investors. Portfolio investors have a global view and are constantly looking for where they can maximise returns. So even when you provide them the most favourable terms, there is no guarantee that they will come or that they will stay if they come. My hunch is that the devaluation of the Naira was premised on the assumption that forex would flood in. This has not happened yet or in the quantum desired, and understandably