Five Ways Naira Flotation Will Affect Nigeria

Nigeria is allowing its struggling currency, the naira, to trade freely in a move to tackle the financial crisis in Africa’s most populous nation. Financial blogger, Feyi Fawehinmi looks at how it will affect people’s lives.

1. Petrol prices will remain stable

Refined petrol is Nigeria’s single biggest import. The story of how an oil exporting nation has to import almost all of its refined products is well told.

According to the National Bureau of Statistics, refined petrol imports in the first three months of 2016 amounted to 226bn naira ($1.1bn, £791m) or 15.6% of the total imports.

Last month, petrol subsidies were removed and a new price band of 130 naira to 145 naira per litre was recommended by the government.

Petrol was in short supply this year until the petrol subsidy was removed last month
This new price assumed an exchange rate of 285 naira to $1, compared to the official rate of 199 naira to $1. Remarkably, Nigerians took this price rise with no more than a shrug and the attempt by labour unions to force a price reversal with strikes flopped spectacularly.

In the short term, the Central Bank of Nigeria (CBN) is likely to continue to be the main supplier of dollars to the market until foreign investors return.

With one eye on the petrol price, it is likely to kick start the market at a rate that keeps petrol prices stable i.e. somewhere below 285 naira to $1.

2. Still no imported tomatoes, rice – or tooth picks

In June last year, the CBN came up with a now infamous list of 41 items that would no longer be eligible for foreign exchange from official sources.

A tomato pest has wiped out much of the local crop and prices have rocketed. Items on the list ranged from Indian incense to private jets. Importing those items were not actually banned so since the list came into effect, anyone who wanted to import them had to source foreign exchange from the black market.

The CBN said last week that those 41 items remain ineligible to access forex at the new interbank market. You can still import toothpicks but you will have to source dollars from the black market to do so. Based on this, prices of those items are unlikely to be affected. This is a shame because Nigeria could do with some tomato imports right now after the tuta absoluta pest devastated harvests in northern Nigeria.

Nigerian palm oil producers have benefitted from the importation restrictions. Allowing rice imports wouldn’t be a bad idea either given how rice prices have spiked in recent times. Rice importation has always worked on a quota system – those with political connections usually getting the right to import it. The current policy restricting the imports is tied to goals of national pride in achieving self-sufficiency. Given this, it is unlikely to be lifted.

Not everyone is unhappy about this list, though. The Nigerian palm oil producing company, Okomu Oil, posted a 98% increase in profits for 2015. Palm is of course on the list of 41 ineligible items.

3. Inflation should eventually fall

Latest figures from the National Bureau of Statistics show that inflation is rising steadily in Nigeria. Given how Nigeria is dependent on imports for a lot of basic items, a floating currency is likely to further increase prices, at least in the short-term.

In reality, however, the policy of rationing foreign exchange in the last one year meant that those who needed it the most hardly ever got it. President Muhammadu Buhari took office last year with a promise to boost employment. As such, even as the official rate remained stable at 199 naira to $1, prices of imported everyday goods have been reflecting black market exchange rates for a while now.

Nigerians have already endured the equivalent of a gut punch from soaring prices and are unlikely to be in the mood for any more. Further price increases might just force consumers to eliminate demand for some products altogether. A more stable and open foreign exchange regime should also eliminate a lot of the uncertainty that has been pushing up prices.

Given what has already happened in the last year, a floating naira, somewhat counter-intuitively, can be expected to start bringing down inflation.

4. Bad news for banks and businesses with forex loans

The CBN says that 10.1% of all the loans in Nigeria’s banking system have gone bad. A lot of these loans are foreign currency loans extended to local oil and gas companies when crude oil prices were $100 per barrel. Between 2012 and 2014, an estimated $10bn was lent to local oil companies to purchase assets from foreign oil majors.

The oil and gas industry is Nigeria’s main foreign exchange earner. Once the naira starts to float, banks will have to adjust the value of these loans on their books. In turn, the increased burden on the borrowers is likely to push more of them into bad loan territory. A couple of weeks ago, the Nigerian government bizarrely asked banks to stop sacking workers. More bad loans will almost certainly trigger more sackings.

It remains to be seen how the government will react to more sackings if and when they happen. Or perhaps the banks will use it as a bargaining tool to extract another round of bailouts from the government.

5. Foreign airlines will be back in business

Another effect of rationing foreign currency in the past year is that it has allowed a backlog of unmet demand for forex to steadily build up.
The CBN says this backlog is now at $4bn and will take four weeks to clear. Others say the backlog is at least double that amount.

Nigeria’s elite has been forced to travel less because it has been difficult to get forex. Included in that backlog is the $600m owed to foreign airlines which has caused a number of them to either stop serving Nigeria entirely or put the route under review. If nothing else, this has been embarrassing for Nigeria and has drawn unflattering comparisons with Venezuela. Once that backlog is cleared, foreign airlines should continue their business as normal.

Of course, trapped funds are not their only worry – the economic situation has done its bit to dampen demand for foreign travel by Nigerians. Still, solving one of two problems is not a bad deal.

The verdict?

Ultimately, Nigerians have reason to hope that the worst of the last year is now over.
With a floating exchange rate, foreign investors can have more confidence in the country and Nigeria should see an uptick in the foreign investments it so desperately needs.

BBC