Nigeria: another unconvincing devaluation - Capital Economics
Africa Economics

Nigeria: another unconvincing devaluation

Africa Economics Update
Written by Virag Forizs

The reported (but unconfirmed) devaluation of one of Nigeria’s exchange rates would help to improve the public finances, but it would keep already strong price pressures elevated. We doubt that the latest tweak in Nigeria’s FX market will culminate in a fully flexible, unified naira any time soon.

  • The reported (but unconfirmed) devaluation of one of Nigeria’s exchange rates would help to improve the public finances, but it would keep already strong price pressures elevated. We doubt that the latest tweak in Nigeria’s FX market will culminate in a fully flexible, unified naira any time soon.
  • Godwin Emefiele, the governor of the Central Bank of Nigeria (CBN), suggested in a conference speech on Friday that the official naira exchange rate has been devalued by 7% against the dollar, from 381/$ to 410/$. This would close the gap between the official rate (used for government transactions) and the Nafex rate (used by commercial entities including investors and exporters). But it would still leave both rates about 17% stronger compared to the latest parallel market quotes of 480/$. (See Chart 1.)
  • If confirmed, the move would simplify Nigeria’s multiple exchange rate system by essentially merging the official and Nafex rates, although we suspect some degree of fragmentation would remain. It is worth noting that the devaluation has not been confirmed at the time of writing. For example, the website of the CBN continues to quote the official exchange rate at 379/$ as of yesterday. And so far at least, there is no anecdotal evidence of the CBN’s FX sales rate to confirm or deny the move.
  • At face value, it seems unusual that the central bank is undertaking the devaluation given the rise in oil prices. The key, however, is that the official and Nafex rates are far stronger than our estimate of the fair value of the naira, which is closer to the parallel market rate.
  • One explanation for the move is pressure from multilateral institutions, which have urged Nigeria to take steps towards a freely-floating, unified naira for some time. Insufficient progress on currency reforms appears to be holding up a $1.5bn loan from the World Bank, which Nigerian policymakers may be hoping that the latest FX tweaks will help to get over the line.
  • Other explanations could be at play too. Devaluing the official rate would improve the public finances. A weaker official exchange rate would push up the local currency value of key oil exports, and with it, the government’s oil revenues. Indeed, we estimate that, all else equal, a 7% devaluation of the naira would increase government revenues by around 0.2%-pts of GDP. This would make Finance Minister Zainab Ahmed’s job of preparing a supplementary budget to finance the country’s vaccine roll-out easier.
  • Positive implications for the country’s balance of payments position may not be as large. Non-oil exports that would benefit from a weaker currency make up less than a third of Nigeria’s total exports (with oil, which is priced in US dollars, accounting for the remainder).
  • Meanwhile, a weaker exchange rate would probably do little to encourage import substitution, as various exchange rate windows are used by importers – including the Nafex and the parallel rates that have not fallen as much as the official exchange rate.
  • Even so, prices of imported goods are likely to rise, keeping inflation elevated. (See Chart 2.) Headline inflation stood at a nearly four-year high of 16.4% y/y in January and we expect it to stay around this level until the tail end of this year.
  • Taking a step back, we doubt that the latest devaluation of the naira will mark a meaningful shift in Nigeria’s exchange rate policy. We’ve flagged before that Nigerian policymakers appear reluctant to loosen their grip on the currency. In its latest Article IV report, released last month, the IMF noted that “the [Nigerian] authorities did not agree with the need for additional exchange rate adjustment”.
  • A lack of official confirmation of the devaluation hardly inspires confidence. Worse still, Governor Emefiele reportedly outlined plans to strengthen the currency just a day after his comments about the weakening of the official exchange rate. A multitude of FX restrictions aimed at defending the currency’s value remain in place, including prohibiting exporters who fail to repatriate proceeds from banking services.
  • The upshot is that Nigeria’s heavily managed exchange rate regime is here to stay. We remain comfortable with our view that policymakers will continue with their piecemeal approach to the currency, only letting the naira weaken when pressure mounts. Our end-2021 forecast for the Nafex rate remains at 425/$, and we have now revised our official exchange rate forecast to 425/$ as well (from 400/$).
  • Evidence is growing that this FX policy has failed to keep inflation stable, which policymakers pin their support on. Nigeria will probably be stuck with high inflation for the foreseeable future. And, so long as the threat of further devaluations is present, investors will be wary of putting their money into Nigeria. As a result, the authorities will continue to rely on capital controls and import restrictions to sustain the balance of payments position at the expense of disruptions to activity and weak economic growth.

Chart 1: Nigerian Naira (vs. $, Inverted)

Chart 2: Consumer Prices (% y/y)

Sources: AbokiFX, Refinitiv, Capital Economics

Sources: NBS, Refinitiv, Capital Economics


Virág Fórizs, Africa Economist, virag.forizs@capitaleconomics.com