THE ABC OF POTENTIAL IMPACTS OF THE NEW NAIRA EXCHANGE RATE POLICY ON BUSINESSES AND INDIVIDUALS IN NIGERIA

1.0 The Meaning and Importance of Naira Exchange Rate

The Naira exchange rate is the amount of money (Naira) that you need to pay for every foreign currency like say US Dollar (USD), British Pound (GBP), and Euro (EUR) that you want to buy. You may wonder what you or a business needs foreign currency (USD and GBP) for since they are based in Nigeria. You and your business may need to use USD and GBP when you want to send your children to study abroad; the Universities in the UK and the US will not accept your naira as money so you need to use your naira to buy USD and GBP which they accept and pay the school fees. Your company may wish to buy a machine or raw materials which are not manufactured in Nigeria. So the seller of this machine or raw material will certainly not accept Naira from you as money, you would have to use your Naira to buy USD or GBP which the foreign seller accepts and pay them.

?From the above, you can see that the exchange rate plays an important role in our daily lives as both individuals and businesses. So you could see that the exchange rate is such a big issue in every country including Nigeria. And because the exchange rate is important, a government bank called the Central Bank of Nigeria(CBN) has been given the duty to help Nigeria as a country to make sure that the exchange rates of Naira against USD and GBP and EUR are determined fairly and easily in a way that will not cause problems for you, your family, and businesses that need to use Naira to buy USD, GBP, and EUR to pay for foreign school fees, buy a machine, pay foreign medical bills, buy raw materials, etc.

?2.0 Types of Exchange Rates

There are mainly two types of exchange rates from which a country’s central Bank can choose one to help determine the exchange rate of its currency( in this case Naira) against foreign currencies(USD, GBP, EUR).

Fixed or pegged exchange rate: this is where the Central bank of a country is allowed and given the power to determine/fix the amount of local currency (i.e Naira) you or a business will pay to get 1 USD or 1 GBP. The Central Bank can intervene i.e supply more or less ?USD and GBP in the currency market to make sure that the fixed exchange rate remains constant-does not change.

Flexible or Floating Exchange rate: this type of exchange rate is determined by the market forces of demand and supply in the foreign currency market. If the demand for USD or GBP is higher than its supply in Nigeria, you would have to pay more amount of Naira to get 1 USD or 1 GBP. And if the supply is more, you would pay less amount of Naira to get 1 USD or 1 GBP. The Central Bank allows the amount of local currency that you pay to buy 1 USD or GBP to be determined by agreement between a willing buyer- you and a willing seller.

Managed or Dirty Float Exchange Rate: This is a type of exchange rate system where the exchange rate is primarily determined by the market forces of demand and supply but the Central Bank occasionally intervenes to influence the amount of exchange rate. The intervention by the Central Bank is aimed at reducing fluctuations in the amount of exchange rate.

3.0 Central Bank of Nigeria Exchange Rate Policy Before and Now

I know you are trying to figure out what type of exchange rate the CBN anchored its exchange rate policy on before the new exchange rate policy. While it is difficult to say what exactly the CBN was doing with the exchange rate before now, there are indications that they were using the managed or dirty float exchange rate system to drive the exchange rate between Naira and foreign currencies like the USD and GBP. In fact, the CBN governor claimed so on several occasions. But we are in doubt of this claim as the managed float exchange rate is usually not operated with multiple exchange rates.

But if you look very well at the type of exchange rate they were using to manage the Naira exchange rate before, you would find that they were neither here nor there. Because they operated multiple exchange rates at the same time. The exchange rate that individuals and most small businesses bought USD and GBP at was different and mostly higher. The rate at which government agencies were buying USD and GBP at was different. And the exchange rate at which big companies like Dangote Cement, Fly Emirate Airlines, etc bought USD and GBP at was also different. So there was no clarity about the exact type of exchange rate system the Central Bank was using to manage the Naira exchange rate.

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This lack of transparency by the CBN discouraged foreigners who wanted to come and do business in Nigeria, and many of them refused to come to Nigeria. In fact, some foreign investors who were already doing business in Nigeria were disappointed and frustrated by this bad policy by the CBN and closed down their businesses and left the country.

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Presently, the new government of President Bola Tinubu has pushed the CBN to eliminate those multiple exchange rates by harmonizing them into a single unified exchange rate. And the CBN is now likely using a flexible or floating exchange rate system where the market forces of demand and supply are allowed to determine the exchange rate between Naira and USD or GBP or EUR. This means the CBN will no longer force any exchange rate on any body but it will be agreed upon by a willing buyer of USD or GBP and a willing seller. This exchange rate agreement between willing buyer and willing seller will be influenced by the amount of supply and demand for the USD and GBP in Nigeria. If the amount of supply is higher than amount of demand, the willing buyer will pay lower amount of Naira to buy 1 USD or GBP. But if the amount of supply is lower than the amount of demand for USD or GBP, the willing buyer would have to pay more amount of Naira to buy 1 USD or GBP.

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But I suspect that the CBN might have to intervene in the exchange rate market from time to time when they find that the Naira exchange rate is fluctuating too much. This intervention will be in the form of supplying more foreign currencies in the market if they fill there is a supply shortage. Or, creating demand by buying foreign currencies if they feel there is a shortage of demand. And if this is going to be the situation, then we can argue that the CBN is actually using Managed or Dirty Float Exchange rate system as the model for the new Naira exchange rate policy.

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4.0 The Role of the CBN under the Flexible or Floating Exchange Rate System

?The CBN has collapsed all the exchange rate selling and buying markets (multiple exchange rates) into a single unified exchange rate market called the Investors and Exporters Window (I&E window). The I&E window is the ONLY market where you can sell and buy foreign currencies (USD, GBP, and EUR) now in Nigeria.

Apart from the I&E window, there is the black market that continues to thrive now because it is more convenient for individuals and small businesses that need a small amount of foreign currencies (USD and GBP) to quickly buy from it. Another reason why this black market continues to thrive is because the amount of Naira you pay to buy 1 USD or 1 GBP here is more so it gives more profit to the seller who is selling in the black market than the seller selling in the I&E Window. However, we predict that the exchange rate at the I&E Window will increase and become the same as the exchange rate in the black market, so sellers will not have any reason to leave the more secure I&E Window to go to the black market to sell their USD and GBP, provided the CBN is willing to allow the importers of the 43 items banned from using the I & E window to access USD or GBP through the I&E Window.

?Based on these reasons, we expect the black market to decrease and go to the near end. But it will not end completely because of the convenience yields/benefits it offers to individuals and small businesses- no documents required, and no delays in getting the USD or GBP.

?The CBN’s major role now is to register and appoint market dealers in the I&E Window and to set the rules and guidelines that will guide the activities of the appointed market dealers, buyers, and sellers in the I&E Window. The CBN may also intervene in the market from time to time if they finally decide to use managed or dirty float exchange rate system to guide their new Naira exchange rate policy, as I have mentioned earlier.

?5.0 How the Investors and Exporters Window (I& E) Works

It is important to state again that the I & E Window is now the only foreign currency market in Nigeria. Although the black market still operates side-by-side with it, we expect that the attractiveness of buying USD or GBP from the black market will diminish significantly as both rates in the I&E and black market become the same.

To use the I & E window to buy and sell USD, GBP, and EUR, you have to deposit enough Naira in your Naira bank account, go to your bank, and make an application. You can use the I&E window if you want to buy raw materials from abroad, pay foreign school fees, travel abroad, pay medical bills abroad, buy a machine for your company abroad, pay foreign debts and interest, pay to import approved finished products, etc. Note that you are not approved to use the I&E Window to pay for their importation of 43 items- rice, cement, vegetable oil, furniture, tissues, etc

?When making your application to buy USD or GBP in the I&E window you would be asked to state the amount of Naira – the exchange rate you are willing to pay to buy 1 USD or 1 GBP. Your bank will use this your willing exchange rate to submit your request on the I&E webpage. The I&E webpage will look for a willing seller who has USD or GBP and has submitted a request to sell at the same selling price you have stated that you are willing to pay and match your order with it. The trade is closed and the Naira amount is taken from your bank account and sent to the seller while the USD or GBP is taken from the seller’s bank account and paid into your USD or GBP bank account. Or the USD or GBP will be paid to the bank account of the foreign recipient you requested your bank to pay.

?6.0 Impact of the Policy on Individuals

The new Naira exchange rate policy will have the following effects on individuals and families.

?More Expensive Foreign Tuition Fees: For families who have children currently studying or planning to send children abroad to study, the tuition fees and maintenance allowance they will pay will be higher and more expensive now. ?Before you used to apply to one of those CBN Multiple exchange rate windows to get GBP or USD at rate of N579 per 1 GBP of N425 per 1 USD, however, this window has been closed so you can only buy from the I&E Window to pay these tuition fees at the rate of N945 per 1 GBP or N754 per 1 USD.

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?Because of this, we expect that the number of Nigeria students going abroad to study would decline as many families and self-sponsored students may no longer be able to afford these expensive foreign tuition fees again. However, this is for the short-run: in the long-run, the economy would adjust and families and individual’s wages and salaries would rise so people could afford foreign fees again.

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More Expensive Foreign Medical Bills: In the same vein, since the cheap exchange rate from the CBN multiple exchange rate is no more, people in Nigeria seeking medical care abroad would have to buy GBP and USD from the I&E Window where exchange rate is more expensive. This will make the cost of seeking medical care abroad very expensive to Nigerians and likely reduce medical tourism.

?We expect that many Nigerians would switch from seeking medical care abroad to seeking it locally especially for health conditions that local medical experts and hospitals can manage and treat.

?Food and Other Consumer Goods Prices: The prices of food and consumer goods will not rise much because these prices have already adjusted and reflected the higher exchange rate from the black market even before now. This is because most Small businesses and even bigger companies usually buy USD and GBP from the black market to pay for their imports so they have since transferred the higher cost of importing those goods to the customers by increasing prices for their products. Also, in an interesting research by the International Monetary Fund (IMF), they stated that any 25% increase in the exchange rate can only lead to a 0.25% increase in the prices of goods and services that are consumed by people in a country.

?Higher Cost of Travelling Abroad for Vacation: Because of the increase in the Naira exchange rate, which means the value of your Naira has fallen, the cost of going abroad alone or with family for vacation will be more expensive now. So many Nigerians who used to travel abroad for holidays with families or alone would not struggle to afford to pay these new higher costs.

?Accordingly, we expect that the number of Nigerians and their families traveling abroad would drop, at least in the short run until wages and family incomes adjust upward.

?New Jobs and Investment Opportunities: The good news is this: the increase in Naira exchange rate has made the Naira weaker, thus make Nigeria attractive to foreign investors. Two types of foreign investors would be coming to Nigeria with more USD and GBP to invest: Foreign Direct Investment (FDI) and Foreign Portfolio Investment( FPI). FDI are investors who would come to build new factories and produce in Nigeria while FPI are those investors who will come to buy the shares of Nigeria companies that are sold on the Nigeria Stock Exchange.

?When the FDI investors come to build factories or open offices to operate in Nigeria, they would employ Nigerians and provide more jobs and good incomes to families. And when the FPI investors come and begin to buy the shares of Nigeria companies like NEM Insurance Plc, BUA Cement, First Bank Holdings Plc, etc, the value of those shares will increase and individuals and families in Nigeria who invest in the capital market would have their wealth and incomes grow as well.

?7.0 Impact of the Policy on Businesses and Companies

The new Naira exchange rate is going to have both positive and negative effects on businesses and companies doing business in Nigeria. We have discussed these effects below.

?Increased Competitiveness: The increase in the Naira exchange rate means that the Naira becomes weaker compared to the USD, GBP, and other currencies. Because of the weaker Naira, the goods and services of Nigerian companies that export their products to foreign and neighboring countries will become cheaper and more attractive to foreign customers. This will increase the demand for Nigeria-made products like Cocoa beans, cement, sesame seeds, etc in foreign markets and make the companies that produce these products more profitable.

?Increased Cost of Foreign Debt: Some Nigerian companies like the banks have borrowed money from abroad in foreign currencies- USD, GBP, and EUR to do business. These companies are going to see their cost of servicing these loans (interest payments) increase very well, because of the increase in the Naira exchange rate. ?Most of these companies like banks and manufacturing companies make their money in Naira so they have to use more Naira now to buy USD or GBP to pay the interest and principal amount of their loans as the creditors will only accept USD or GBP from them.

?Increased Financial Risk: Generally, a risk is a chance that something bad might happen. Financial risk is a risk caused by changes in financial factors like interest rate, currency exchange rate, etc. Now that the CBN is using the flexible or floating exchange rate to drive the Naira exchange rate, the fluctuations in the value of the Naira against the USD and GBP are going to increase greatly. Therefore, companies are generally going to be facing a high level of financial risk that would negatively affect their cash flows, profits, and the value of their assets and liabilities.

?Companies need to sit up and actively manage the financial risk that is arising from this naira exchange rate fluctuations as failing to do so could result in falling profits, cash shortages, and failure to pay their debts.

?Increased Domestic Interest Rate: The interest rate is the amount that banks charge when they lend money to businesses. Since the Naira exchange rate has been freed to fluctuate and the exchange rate has increased, the CBN is expected to use its monetary policy to raise interest rates higher so as to attract foreign investors to bring more USD and GBP to Nigeria. This increase in interest will make the cost of borrowing money from the Nigerian banks more expensive and companies who currently hold bank loans would struggle to repay those loans plus interest on them.

8.0 ?Conclusion

Generally, there is positive sentiment about the new Naira exchange rate policy which has collapsed all the multiple exchange rate markets that were operated by the CBN into a single unified market called the I & E Window. Investors and the business community, both in Nigeria and abroad have admitted that this would create a level playing field for ALL participants in the foreign currency market and promote certainty, which is a required ingredient for investment and business decision-making. ?

The policy is going to affect both individuals and businesses disproportionately as it brings both positive and negative effects on both parties. Overall, we expect the markets and economic conditions in Nigeria to shift positively, and re-establish a new equilibrium that would unleash the full benefits of this policy, which are more than its cost.

Japheth Jev, ACMA, CGMA, ACA, M.Sc.(Finance)

Founder/CEO

GreenFinance Capital, United Kingdom

E-mail: [email protected]

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