Nigeria’s foreign exchange policy is controversial – Razia Khan, Standard Chartered Bank
The optimal FX policy in Nigeria will likely be the subject of debate for some time. Over the years, many of the country’s resources have been utilised in order to achieve currency stability. While there would have been an obvious cost to higher inflation, it is not at all clear that the policy adopted by Nigeria has helped to bring about meaningfully lower inflation. The exchange rate has been stable for some time now, but inflation remains in double digits, pressured by higher food prices.
Nigeria’s FX reserves are at a healthy level now. But consideration must still be given to the cost of achieving a managed FX regime. Strictly speaking, in pegged regimes (which does not apply to Nigeria), FX reserves must always be adequate to cover the money in circulation, or confidence in the currency might go.
In Nigeria’s case, with its managed FX regime, this will necessarily put limits on the amount of credit growth when economic recovery begins. The amount of credit growth that can be ‘tolerated’ must always be a function of the level of FX reserves. Reserves need to be adequate to cover money supply – so there may almost be a conscious choice to achieve lower growth, which is more sustainable from an FX reserves perspective.
Resilience to economic shocks matter
After the 2014 collapse of the oil price, the more managed currency regime from February 2015 (after an initial depreciation), meant that the exchange rate could not fulfil its function as that nominal variable, able to absorb the external shock Nigeria had experienced, by acting as a buffer. Because the FX rate was fixed, the full burden of the external shock was transmitted to the Nigerian economy, bringing about a recession that may have been deeper than was strictly necessary.
It is always difficult to prove the counter-factual, but Nigeria’s various attempts to fix its FX regime have not necessarily lent themselves to economic diversification. There may have been significant episodes of currency over-valuation over past decades, making it cheaper to import goods and services, than to try to produce them domestically. This FX policy might have cost Nigeria a great deal in terms of domestic production, and diversification potential, that was ultimately forgone.