In recent months, developments in the Nigerian foreign exchange market have elicited reactions from stakeholders, some of which reflect understanding while others do not. This piece seeks to throw light on the issues relating to foreign exchange, external reserves and naira exchange rate instability.
Foreign exchange is relevant in the context of world trade, payments and capital flows into and out of a country. It is the monetary instrument for the settlement of international transactions and for financing imbalances in a country’s external payments position vis-à-vis other countries. Foreign exchange forms a major component of a country’s external reserves which according to the International Monetary Fund consists of “official public sector foreign assets that are readily available to, and controlled by the monetary authorities, for direct financing of payments imbalances, and directly regulating the magnitude of such imbalances, through intervention in the foreign exchange markets to affect the currency exchange rate and/or for other purposes”. In light of this, the Central Bank of Nigeria Act, 2007, Section 24, mandates the Bank to maintain external reserve assets in gold coin or bullion, balances in banks outside Nigeria, foreign short-term treasury bills and medium-term securities, Special Drawing Rights (SDR) of the IMF, etc.
These assets have the feature of liquidity and are represented by convertible currencies such as the US dollar, British pound sterling, Chinese Remnibi, Japanese Yen, etc. As of September 8, 2021, the US dollar assets accounted for the lion’s share (72.04%) of Nigeria’s external reserve stock of US$ 36.25 billion. The shares of the other components of the external reserves were as follows: British pound sterling (0.75%); Euro (0.33); Chinese Remnibi (11.81%); SDR (15.05%); and Japanese Yen (0.02%). The CBN Act 2007 enjoins the Bank to “use its best endeavour to maintain external reserves at levels considered by the Bank to be appropriate for the economy and the monetary system of Nigeria”. In light of this, the CBN has strived to carry out this mandate by using supply and demand management strategies, particularly, foreign exchange conservation and control measures as well as measures to ensure adequate supply of foreign exchange. This is particularly so because foreign exchange is a scarce resource that needs to be efficiently managed if the country is to achieve macroeconomic stability, and avoid chronic balance of payments and external reserve problems.
It must be stressed that it is only foreign exchange, in the form of convertible currencies or internationally acceptable currencies, and not naira, that can be used for international transactions. The main sources of foreign exchange supply to a country include foreign currency receipts from exports of goods and services, monetary gifts and inflows of capital from abroad such as loans and investments. It is from these earnings that the demand for foreign exchange is met to spend on foreign imports of goods and services (including foreign travel, education medical treatment abroad), monetary gifts to foreigners, and loans and investments abroad. What is the implication of this? It is that for Nigeria whose currency is not convertible or serve as international currency, she must necessarily earn foreign exchange through high productivity and export of goods and services, receipt of monetary gifts or receipt of foreign loans and investments in order to import needed goods and services aimed at the development of the economy and enhancing the welfare of the citizens. Also, high levels of foreign exchange earnings and external reserves are the backbone of the naira exchange rate. They ensure stability of the rate while low levels weaken the naira. But then, it must be noted that the CBN does not produce foreign exchange; it is what is earned by the country that the Bank strives to manage and use to stabilise the exchange rate.
And achieving adequate amount of foreign exchange earnings requires developed domestic production structures, diversified economy and export orientation, and a conducive macroeconomic environment, among others. For quite some time now, there have been issues about these which predate the present regime. The genuine efforts of the Federal Government to achieve headway on these have tended to be undermined by exogenous shocks in the past five years which pushed the economy into recession in 2016 and 2020. The shocks affected foreign exchange earnings, external reserves accumulation and exchange rate stability.
The first recession which lasted from the first quarter of 2017 to the first quarter of 2017, was triggered by the collapse of crude oil prices in the global market. The price of Nigeria’s Bonny Light crude oil declined continuously from US$ 62.22 in quarter 2 in 2015 to US$ 34.39 per barrel in Q1, 2016. As of the second quarter, 2017 when the country exited recession, crude oil price per barrel stood at just US$ 50.21 per barrel. Due to the heavy dependence of the Nigerian economy on the oil sector, the impact of the oil market crash was severe on export earnings, foreign exchange reserves, government revenue and other macroeconomic aggregates including economic growth. External reserves declined from US$ 28.28.33 billion in Q2, 2015 to US$ 23.8 in Q3, 2016. The other external sector indicators similarly deteriorated: balance of goods and services, balance of current account, financial account, overall balance of payments, and external debt stock and debt servicing. The net foreign exchange inflow became negative, implying that the country paid out more foreign exchange to the rest of the world for importation of goods and services than it received. This implied that the demand for foreign exchange was higher than receipt of foreign exchange, and the pressure on forex and the naira exchange rate was very high. This accounted for the devaluation/depreciation of the naira in relation to the US dollar at that time.
Secondly, the COVID-19 pandemic-induced economic crisis in 2020 resulted in recession in the third and fourth quarters of last year. The pandemic containment measures in the form of economic lockdowns and restrictions on international travels and business resulted in recessions for countries in various degrees. Again, the external sector aggregates of the Nigerian economy experienced serious deterioration due to the economy’s continued heavy dependence on the oil sector for export earnings and external reserves accumulation. Crude oil production reduced from 2.07 mbpd in Q1, 2020 to 1.61 mbpd in Q2, 2021. Reports even indicate further decline to 1.27 mbpd in August, lower than the 1.38 mbpd achieved in July 2021 caused by difficulties in some oil terminals. This decline in output partly explains why the observed increase in oil prices to about US$ 70+ per barrel has not impacted much on government revenue or foreign reserves accretion.This contrasts with US$50.43 per barrel on January 4, 2021 and a low of US$14.67 per barrel recorded on April 27, 2020. Although the price of the commodity is currently above the pre-pandemic level of US$67.20 per barrel recorded on January 1, 2020, its impact on government revenue and foreign exchange reserves is further limited by the continued heavy importation of refined petroleum products for nearly all the domestic consumption needs. For example, in July and August, the inflow of foreign exchange revenue from crude oil and gas was zero.
Thus, the nature of challenges that the authorities currently face in the management of foreign exchange and exchange rate must be understood: net inflow of foreign exchangebeing negative in Q1 and Q2, 2021; current account balance was negativefrom Q1 2020 to Q2 2021; overall balance of payments was negative in Q1 and Q2, 2021; external reserves declined from US$ 36.5 billion in Q4 2020 to US$ 32.9 billion in Q2 2021 due to heavy forex demand pressures and weak forex inflow. It however increased to US$ 36.03 billion as of September 13, 2021 due to a lifeline allocation in August of the SDR equivalent of US$ 3.35 billion to the country by the IMF. Foreign exchange required for external debt servicing has also increased, rising from US$ 289.45 million in Q4 2020 to US$ 1,003.41 million in Q1 2021.
To be concluded
- Obadan, a Professor of Economics, is a former Director-General, National Centre for Economic Management & Administration, Ibadan Tel: 08023250853; E-mail: [email protected]
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