The Central Bank of Nigeria (CBN) had, during its last Monetary Policy Committee (MPC) meeting held on the 23rd and 24th of May 2016, announced an imminent departure from the current fixed exchange rate regime. Explaining the shift, the CBN confirmed that the move has become necessary in order to reduce the pressure, and introduce greater transparency in the foreign exchange market. In light of this policy shift, it has become imperative to analyse the flexible model to appreciate the implications for businesses as well as ordinary Nigerians.
In simple terms, a flexible forex market is one that allows the exchange rate to float freely and to find its equilibrium without any form of intervention from government. Indeed, globally, governments rarely operate a clearly defined exchange rate regime. What you would have is a situation where the market operates a model that hovers between the polar opposites (fixed or floating) depending on the level of government intervention. Thus, a regime that witnesses a lot of government intervention is considered relatively fixed while one which witnesses minimal interventions would be defined as flexible. Also, the extent of such intervention is limited by the size of the government's foreign reserves.
Consequently, due to the current mismatch in the demand and supply of foreign exchange, we anticipate that there would be an increase in the official exchange rate with the introduction of the flexible regime. However, the immediate effects may not be such that would drastically affect the behaviour of key market participants. Thus, while it is expected that there would be a general increase in the price of commodities/products which are exchange rate sensitive, such increase may be modest rather than sharp. This is because the current state of the market has compelled many companies to look to the parallel market for their dollar requirements.
However, if, in the long run, we are still not able to maintain sufficient export earnings such as would allow a healthy balance of payments surplus, the negative effects of the consequent general price increase might cause more strains on the already tight economy. Indeed, the probabilities of this scenario is more realistic when we consider that Nigeria recorded its first trade deficit in 7 years in the 1st quarter of this year. Also, whilst the model has been applauded to be more reflective of the state of the market, the proviso for the application of a CBN determined fixed rate for "a small window [of] critical transactions" raises some questions about the nature of the flexibility being proposed.
Finally, in spite of the negative implication of this model due to the import-dependent nature of the Nigerian Economy, there are still some positives. One quick win might be a renewed confidence in the market such that foreign investments begin to trickle in once again. Second, government may also be able to reduce rent-seeking and price arbitrage by some major players in the official foreign exchange market. In any event, we expect that the market reaction will be mixed and the full implication will be better appreciated when the modalities for its implementation are made public.
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