Insight Digest: Tinubu's FX Unification Policy in Nigeria
Nigeria has abandoned its years-long currency peg and allowed the naira to trade freely, leading to the biggest single-day fall in its history. The move follows the removal of the central bank chief and is expected to bring significant changes to Nigeria's exchange rate system.
- Inflow of Investment: Abandoning the currency peg is likely to encourage an inflow of portfolio and direct investment into Nigeria. Foreign investors, who have been absent for many years, may return if the naira is allowed to float freely.
- End of Foreign Exchange Rationing: The policy change would end years of foreign exchange rationing, allowing businesses and individuals to access US currency at market rates. This could promote transparency and reduce the privileged access some well-connected individuals had to subsidized rates.
- Potential Disinflationary Effect: A free-floating currency may have a disinflationary effect, as most of Nigeria's economy already operates at the parallel rate. This could help control inflation and stabilize prices in the long run.
- Economic Orthodoxy: The shift towards a free-floating currency represents a departure from the interventionist economic policies of former President Muhammadu Buhari. It aligns with economic orthodoxy and could attract confidence from international investors.
- Enhanced Liquidity: The policy change is expected to enhance liquidity in the foreign exchange market, making it easier for businesses and individuals to access foreign currency.
- Transparency and Reduced Corruption: A unified exchange rate regime can reduce discretion in forex allocation, minimize corruption vulnerabilities, and reduce opportunities for round-tripping and other malpractices.
- Boost in Government Revenue: The liberalization of the forex market could lead to an increase in government revenue by approximately N4 trillion through additional remittance of exchange rate surplus to the federation account by the Central Bank of Nigeria (CBN).
- Potential Price Increases: The liberalization of the exchange rate may lead to higher prices of goods and services in the short term, especially if the exchange rate depreciates significantly.
- Increased Government Debt: The policy change could increase government debt by about N12 trillion to N90 trillion, potentially raising the cost of servicing the nation's debt and elevating the debt-to-GDP ratio.
- Market Volatility: The initial transition period may see volatility in the foreign exchange market as the demand backlog is addressed. The central bank may need to intervene periodically to stabilize the exchange rate.
Overall, the abandonment of the currency peg and the move towards a free-floating currency in Nigeria presents prospects for increased investment, improved liquidity, and reduced corruption. However, there may be short-term challenges such as potential price increases and market volatility that need to be carefully managed.
