Freed’ but bound: Why liberalising exchange rate is bad for the naira

In recent years, the naira-dollar market in Nigeria has so far been liberalised twice. The first, in June 2016 and the second, in June 2023. Both moves have significantly contributed to the rapid decline in the value of the naira. If the monetary authority firmly embraces and continues to stick to this option, the strength of the currency will yet again continue to shrink at an accelerating pace.

The fall of the naira is fast diminishing the international (purchasing power of the currency and consequently) buying strength of Nigerian residents. For instance, as recently as 10 years ago, Nigerians schooling or buying foreign education services abroad in the United Kingdom needed roughly two million naira to pay a tuition of £10,000. Today, they will need close to 20 million naira to pay the same school fees. A tenfold increase.

To liberalise a currency is to let the forces of demand and supply of the currency solely determine the value of the currency. The technical term for this in economics is called “floating”. For instance, if Nigerians rush to buy the dollar more than Americans are rushing to buy the naira, the value of the dollar will go up at the expense of the value of the naira. In other words, the value of the naira will fall. Similarly, if there is more demand for the naira by Americans and less demand for the dollar by Nigerians, the value of the naira will rise. It will become stronger.

In this opinion piece, I share my perspectives – grounded in data-driven evidence – on why liberalising the Nigerian forex market (was and still is) a policy error. I also argue that the premise (“to attract foreign direct investment”) motivating the most recent liberalisation is not a compelling one for many observers. Finally, I offer suggestions – short-term, medium-term, and long-term – solutions in dealing with Nigeria’s currency crisis.

✓ When the ‘float’ cleans out the naira

On 17 June 2016, the naira was ‘freed’ by the central bank. But the ‘freedom’ set the currency on a freefall such that within a few months, by the end of that year, it had fallen in value by 60 per cent against the US dollar (see the chart below). Before this, the naira was pegged at 197 to the dollar. The sharp drop in the value prompted the apex bank to rescind its initial forex policy, thus intervening in the market to save the naira.

✓ The forces behind the fall of the naira

The increasing scarcity of the dollar and its growing demand in Nigeria are at the root of the collapse of the naira. Why is the dollar scarce in Nigeria? I have identified four contributing factors.

First, falling oil revenues. In eight years, between 2007 and 2014, Nigeria earned over US$340 billion in oil revenues. This figure has fallen to US$110 billion (more than three times) in the recent eight years between 2015 and 2012, thus, shrinking the nation’s capacity to pull in more dollars into its economic system.

Second, in late 2015, the then government through the central bank activated capital control measures such as shutting out access to foreign currency withdrawals and imposing limits on how much cash Nigerians can withdraw using foreign ATMs. These interventions did not pay off as the currency further depreciated. As a result, factories that could not obtain dollars to import raw materials and capital goods shut down and eliminated tens of thousands of jobs. By mid-2016, the economy had fallen into a recession.