Explaining Nigeria’s rising FX rate and its opportunities

Exchange rate is a very important economic indicator in an economy. It is the rate at which a country’s currency is exchanged for another currency. In Nigeria, we have Naira (N)/US Dollar ($) exchange rate, N/Pounds Sterling (£) exchange rate, N/Yen (Y) exchange rate, N/ CEFA exchange rate etc. A country’s exchange rate will depreciate (lose value) when there is a higher demand for a foreign currency in that country than its supply. Assume $1= N20. If people in Nigeria demand for $ to pay their children’s foreign school fees, foreign medical bills, or to import goods, and they cannot get it, the Naira will depreciate (this basically follows law of demand and supply) and $1 may become N200. When a currency is depreciating against a currency, the residents of a country are basically paying more Naira to get the same value of the currency.

Basically, the reaction of the exchange rate is a combination of several factors such as the demand for foreign goods and services (which is also demand for $), sales of goods to other countries (exports), inflow of foreign investments into Nigeria, inflow of money from Diaspora Nigerians, etc. It is a game of inflow versus outflow and how the Central Bank of Nigeria manages the market. Now, there are different markets for the sale of foreign currency. As no one is allowed to spend foreign currency in Nigeria, a foreigner coming to Nigeria will take his foreign currency to the market, exchange them for Naira and then spend the Naira in Nigeria. Officially, there are two main foreign exchange markets in Nigeria – one is the official market (managed by the Central Bank of Nigeria – CBN) and the other is the black market.

When individuals, businesses, students, importers go to the official market to get $ to pay for foreign healthcare, school fees, or imported goods, many of them do not often get it. Most times, they will have to wait for months to get it and this can be frustrating. Part of why they do not get $ is because the dollar inflow into the official market is small relative to their demand. Say, their demand is $200 million in a month, only a fraction of this (say $10 million) is often met. When they do not get it, they go to the black market. Now, because many people keep going to the black market as a result of scarcity in the official market, the Naira in the black market keeps depreciating. As at March 2023, the rate in the official market was N462 to $1 while in the black market it was around N750 to $1. This gives a margin of N288. It was not that bad in March 2013, when the rate was N157 in the official market and N172 in the black market.

This wide margin between official and black market rates creates a lot of problems. One is hoarding, while two is round-tripping. There are people that can get $ in the official market and sell it in the black market to make massive gains. This happens at the expense of those who need $ legitimately. It also erodes confidence of foreign investors. It shows that CBN cannot effectively manage its own currency vis-a-vis other currencies. Thirdly, the black market has (almost) become the go-to market because you will find $ there more than in the official market. The players in the black market have easy access to USD because of their higher prices of USD than those in the official market. This is called round-tripping, an indication of corruption and nothing other than that!

In the past, although USD ($) demand is not often met in the official market as at when due (scarcity), the Naira does not depreciate that much in the black market. This is because the CBN does not want it to depreciate rapidly. So, it holds the rate in the market. But this comes at a cost. Our foreign reserve is often used to “hold” the Naira so that it does not depreciate much in that market. In other words, our reserve is not growing as it should. Below is how Nigeria’s foreign reserve in 2023 compares with that of selected countries:

*Nigeria : USD($) 33.00 million;

*United Kingdom : USD($) 190,489.85 million

*USA : USD($) 37,300.00 million

*Saudi Arabia : USD($) 411.90 million;

*Taiwan : USD($) 570.60 million;
*Brazil : USD($) 341 million.

When a country’s reserve is large and increasing, foreign investors have relatively more confidence in that country and in the ability of the Central Bank of that country to meet its US Dollar ($) obligations as at when due. On the other hand, when USD ($) is rising steadily, prices of imported goods will be increasing and it will also affect the prices of local goods. In a country with high efficiency of people, high prices will tend to motivate producers to go into production of products with higher prices, especially those that can yield foreign exchange. The functions of price are rationing, signalling and incentive. Rationing helps allocate products efficiently among customers when supply is scarce. Consumers’ wants are infinite; no matter what people have, they always want more. This is a problem because the resources to satisfy these infinite wants are limited (scarce).

The price of cocoa, a major ingredient in chocolates, beverages, and cosmetics, has been on the rise in the last three years. According to the International Cocoa Organisation (ICCO), as of February 13, 2024, the price of cocoa reached $5,794.18 per tonne, a substantial year-to-date increase of 34.5 percent. This surge in cocoa prices can be attributed, in part, to adverse weather conditions such as droughts and floods in key cocoa-producing nations like Ivory Coast and Ghana. These environmental challenges have adversely impacted crop yields. Additionally, the proliferation of a cocoa pod disease known as “Black Pod” in some major producing countries has exacerbated the situation. This disease has particularly affected ageing cocoa trees, hastening the end of their productive years and subsequently diminishing the overall cocoa output.

Furthermore, political instability in certain cocoa-producing nations has disrupted the smooth flow of the cocoa supply chain. Locally, the rapid rise of cocoa prices, denominated in foreign currency, should stand as a significant economic boon for cocoa farmers in Nigeria. The devaluation of the Naira coupled with the elevated dollar price translates into enhanced earnings for these farmers. The heightened income presents an opportunity for increased investments in cocoa production on a broader scale. This positive trajectory may, in turn, stimulate higher levels of exports, a development which may be beneficial for a nation in need of foreign currency. However, it may also result in a decrease in the availability of the commodity for local manufacturers who rely on cocoa for production. Cocoa Research Institute of Nigeria (CRIN) should encourage farmers to produce more cocoa, earn more foreign currency and balance the export and local supply to cocoa-based manufacturers.

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