The central bank should allow the forces of demand and supply to determine the exchange rates
After almost defying the law of gravity, the naira seems to be finding its level in the foreign exchange market following the decision by the Central Bank of Nigeria (CBN) to counter-attack the currency speculators. But to the extent that we cannot say that the naira has finally settled at its true value, we call on the apex bank to take a long-term view of the foreign exchange problem in the bid to finding a lasting solution, especially now that it appears to be winning the battle against the speculators.
The problem started with the massive drop in the price of crude oil towards the end of 2014, when it became clear that as a largely mono product economy in terms of foreign exchange earnings, Nigeria was going to be under pressure. The first action by the CBN in 2015 was to draw up a list of 41 items which it took out of the official foreign exchange market. This was done to control the demand for foreign exchange and conserve our foreign reserves. Unfortunately, that was the point at which the exchange rate started going up. The reason for this is simple: these items needed to be funded through unofficial sources.
As the naira continued its free fall, there were strident calls by critical stakeholders within the economy for the CBN to devalue the currency. The logic for these calls included that since the apex bank didn’t have limitless supply of the foreign currency, it could not forever control the price. The second reason is that an overvalued currency serves to encourage imports and discourage exports. It is also argued that an overvalued currency tends to discourage foreign capital investments. Besides, it is inefficient to insist on artificial low rates for the foreign currency as the government literally cheats itself of the opportunity to raise commensurate local currency from its sales of the scarce foreign currency. If it sold at market determined rates, it would be able to raise more naira with which to settle local debts to creditors, including contractors. Most important, selling foreign currency at subsidised rates creates a strong incentive for speculation and round tripping.
However, the CBN decided that it would continue to hold the naira/dollar exchange rates at pre-determined levels. But there is a problem with that. The official rate of N305/dollar does not have any scientific basis. To make matters worse, the CBN came up with several other rates for different kinds of transactions. The basis for these rates is also at best opaque.
At some point, the CBN publicly challenged speculators that it would continue to flood the market with dollars to ensure they face sustained losses. In less than two weeks, the CBN pumped over $1.5b into the market to take care of unsatisfied invisible transactions of school fees, medical bills and other remittances that had been lingering on in the market for several weeks. The black market rate had been pummelled to about N395 as at the time of going to press.
While we sympathise with the CBN that has had to make difficult choices in recent months, we nonetheless believe that this is the time for it to play its role as regulator in the market while allowing the forces of demand and supply to determine the exchange rates. There is no doubt that there may be an initial spike in the exchange rates but it is bound to settle at the equilibrium while other actions that will follow will stabilise the market at more realistic levels. From our understanding of the market, the present actions may give some temporary relief, but they are definitely unsustainable.
