The pros and cons of floating the Naira

On Wednesday 14th June 2023, the Nigerian currency was sold for ₦755 against the dollar at the investors and exporters (I&E) window, following the news of the floating of the naira with a directive from the CBN

The implication is that the official rate of the naira fell from ₦471 for a  dollar on Tuesday to ₦755 on Wednesday. This move following the president’s decision to suspend the CBN governor could be the greatest game-changer for the Nigerian economy, most importantly the financial services industry.

This brief article will break down what this means for the individual and businesses, and what happens next to the Nigerian naira. Will it be favourable in the long run, will it be a disaster? These and more of what lies in-store for you as you read on

What does it mean to “float the naira”?

When we refer to the naira as floating, we mean that the Nigerian government has decided to let the foreign exchange market’s supply and demand determine the naira’s value. Now, market forces will determine how much the naira will change in value.

What does it signify when the naira “floats”? Nigeria has enabled market forces to determine the exchange rate of its currency by allowing the naira to float. Previously, the CBN controlled the so-called fixed rate rates. Buyers and sellers on the official Forex market can buy and sell at prices they feel comfortable with thanks to the floating exchange rate.

A recap from History

The naira was permitted to float as of May 2016 after being fixed at 197 Naira to 1 US dollar for a while. Godwin Emefiele made this declaration while participating at a press conference that followed the completion of the monetary policy committee meeting, a bimonthly gathering that decides the course of Nigeria’s financial policy.

By June 20, 2016, the float was formally announced, and one day later, the Naira naturally fell to 280 naira to a dollar. The black market reacts quickly at that point, dropping from 347 to 337 per dollar. However, the CBN was certain that the official and parallel markets would converge, and the Naira would stabilise at roughly 250 Naira to the 1 US dollar. However, when the differences between the parallel and official rates widened, it became a remote possibility.

The question now is: will floating the naira address the challenges facing the local forex market? Will the difference in the market continue to widen despite the floating? And most importantly, will bad actors and speculators make the market more volatile and create uncertainty? And finally, will the government be disciplined enough to watch without intervention when the naira is devalued more than maent because of demand and supply?

These and more are some of the questions that must be answered as we delve into the pros and cons of floating the Naira.

Advantages of floating the Naira

1. Foreign exchange  becomes unrestricted

Contrary to currencies with fixed exchange rates. trading in currencies with floating exchange rates is unrestricted, therefore, ongoing management processes are not necessary for governments or banks.

2. High market efficiency

A country’s total economy and domestic production can be strengthened when its currencies are based on a floating exchange, which also tends to make international investments more flexible and appealing.

3. Free entry and exit

Contrary to the fixed foreign exchange policy of the central bank of Nigeria, free-floating forex is the right step in the direction because the value of the Naira is currently over-stated, and a continuous fixing of the forex does harm to the economy .

In free-floating forex, everyone is given the opportunity to source for and sell dollars at a rate that is profitable to them, based on what the market is offering. So another benefit is that there are more sellers and more buyers, that is, a free entry and exit. Everyone can sell, and everyone can buy or decide not to buy at your rate.

4. CBN will require less foreign currency reserves:

The quantity of foreign exchange reserves held by central banks to maintain a stable exchange rate is not necessary while utilising a floating exchange rate. Reserves can be utilised to finance capital purchases that will help the economy grow.

5. Boost export competitiveness

The competitiveness of exports can also increase with naira floating. The value of the naira may decline if it is allowed to float freely, making Nigerian goods and services for foreign customers relatively less expensive.

This can encourage companies that are focused on exports, boost revenue from foreign exchange, and possibly lessen the nation’s dependency on oil exports. It would support economic diversification and contribute to the creation of a stronger, more durable economic system.

Disadvantages of floating the Naira

 1. Increase in Nigeria’s external debt

The external debt and financial stability of Nigeria could be impacted by the currency’s floating. The country’s international debt commitments in other currencies, including the US dollar, would rise when converted to naira if the naira fell in value.

This might make it harder for the government to pay its debts

2. Increase in some importation goods and services

The price of imported goods and services, which was 471 to the dollar, will increase. For instance, the cost of medications and drugs purchased from outside will increase. Additionally, the cost of IELTS and visas will increase.

Since imports are vital to Nigeria’s economy, rising import costs inevitably result in rising prices for related goods and services.

3. Bad non-state actors

Floating the naira allows speculators, those with corrupt funds, and those who inflate the economy’s bubbles to enter the market. These individuals put pressure and uncertainty on the Forex market, which leads to unhealthy speculation that may result in significant market volatility.

Conclusion

The naira float will have direct or indirect repercussions on every person residing in Nigeria as well as on foreign actors, depending on who you are, where you work, and the type of business you are in. This would refer, for the typical person, to the price of products and services.

The use of formal channels should draw more funds into the Nigerian economy as patronage of the black market declines. Remittance inflows, for instance, might begin to come in through authorised channels. Businesses and individuals now have to watch keenly to see if the Naira will balance at a certain rates or if market factors will devalue the Naira more than expected. And when this happened, we should always watch to see if the CBN will come to the rescue.

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