5 reasons the Naira is depreciating in the parallel market

The issue on the minds of Nigerians today is why the Naira is falling or why the dollar's exchange rate is swiftly rising.

Given the steep and sustained depreciation of the Naira since June 14, when the Central Bank of Nigeria, CBN, announced new operating measures in the foreign currency market, this is a reasonable issue.

Since then, the Naira has devalued by 21% on the parallel market to N930 per dollar, and by 66% in the official market, namely the Investors and Exporters, I&E window.

This is especially concerning since this tendency would lead to greater increases in the prices of products and services, as well as higher inflation rates, given that the majority of what Nigerians consume is imported or has large import components. Petroleum products, wheat, raw materials, and so forth are examples.

There are two key reasons why the exchange rate has been quickly increasing, particularly after June 14.

1. Declining Forex Supply

The first reason, and the root cause of the naira's depreciation, is that the supply of dollars into the economy has been declining while demand for dollars has remained relatively unchanged, owing to the country's massive demand for dollars, which is fueled by the country's reliance on imported goods for many economic activities.

This is shown in the country's continual decline in external reserves, which indicate the quantity of dollars and foreign currency available for imports and dealings with other countries.

According to CBN data, the country's external reserves declined by $3.23 billion, or 8.5%, to $33.92 billion on July 9 from $37.15 billion on December 31, 2022.

overseas exchange inflows into external reserves, which represent supply, originate from export revenues, diaspora remittances, overseas investment, foreign aid, external loans, and so forth.

Foreign exchange outflows, which indicate demand from reserves, occur through import funding, foreign debt servicing, payment for services, travel, and so forth.

When the inflow is more than the outflow the external reserves rises. But when outflow is more than inflow, the external reserves falls..

2. Net Forex inflow

A very critical measure of forex inflow and outflow into the economy is Net Forex Inflow, NFI. When inflow is more than outflow, NFI rises. When outflow surpasses inflow, NFI falls. Data from the CBN shows that Net Forex Inflow into Nigeria has been falling since 2019.

According to the CBN, NFI stood at $76.38 billion in 2019. It fell by 6.6 percent to $70.65 billion in 2020, it fell again by 25.4 percent to $52.72 billion in 2021, and again by 28.3 percent to $37.94 billion in 2022. Thus Net Forex Inflow into the country fell by half (49.5 percent) within four years.

A major factor responsible for this persistent decline in NFI, is the fall in foreign investment inflow into the economy. According to the National Bureau of Statistics, NBS, Capital Importation (Foreign Investment) into Nigeria fell from $23.99 billion in 2019 to $5.33 billion in 2022. This represents a huge 77.8 percent decline in a major dollar supply source into the country.

The fact that the external reserves fell by $3.23 billion or 8.5 percent this year indicates that the above trend in Net Forex Inflow and foreign investment inflow, has not changed.

That is confirmed by the sharp decline in the volume of dollars traded (turnover) in the official forex market, represented by the Investors and Exporters, I&E window.

In the first six months of this year, H1’23, turnover in the I&E window fell to $13.11 billion. This represents a 35 percent fall when compared with a turnover of $20.23 billion recorded in the first half of 2022, H1’22.

The above trend explains the acute dollar scarcity in the economy.

And like other commodities when demand is higher than the supply, the price will rise, all things being equal. Hence the continuous rise in the exchange rate, which is the price of exchanging Naira for dollars.

3. New Forex Market Measure

The second reason behind the sharp depreciation of the naira in recent times is the new operational measures for the forex market announced by the CBN on June 14.

These measures include the elimination of multiple exchange rates in the official market, the introduction of the willing buyer willing seller model for the determination of exchange rate in the I&E window.

Prior to these measures, the CBN maintained different exchange rates for its various interventions or forex sales in the official forex market. Also, the official exchange rate was kept at a level determined by the CBN.

Meanwhile, due to the decline in external reserves, the CBN could not meet all genuine demand for forex, a situation that pushed many organizations to rely on the parallel market for their forex needs.

Thus while the exchange rate in the official market was relatively stable, the exchange rate in the parallel market rose steadily. Hence on June 13, the parallel market exchange rate stood at N768 per dollar while the official exchange rate stood at N471.67 per dollar, leading to a gap of N296.33 per dollar.

4. Tinubu’s Promise

The multiple exchange rates in the official market, wide gap between the official and parallel market exchange rates implied forex subsidy and opportunity for round tripping and other malpractice.

This anomaly, which was severely criticised by investment analysts, the World Bank, IMF and global rating agencies, discouraged foreign investment inflow into the country. It also discouraged repatriation of export proceeds through the banks, as well as Diaspora remittances into the country.

Thus President Bola Tinubu in his inauguration speech promised to correct this anomaly, saying that the CBN will work to achieve a single exchange rate.

The measures announced by the CBN on June 19 were in line with the promise of the President.

Consequently, on June 14, the CBN eliminated multiple exchange rates in the I&E window, allowing demand and supply to determine the exchange rate via the ‘willing buyer willing seller model’. Also transactions in the I&E window must be trade-backed, while government forex transactions were priced at the weighted average of exchange rate of transactions in the I&E window.

Furthermore, the CBN has banned selling currency to banks for resale to end customers such as SME, PTA, and BTA. All currency requirements, and hence demand, must be met through the I&E window, which operates on a 'willing buyer willing seller' basis.

5. The New Forex Measures' Goals

The goal of these reforms, however, is to increase openness and confidence in the forex market in order to boost forex inflows into the economy, particularly foreign investment inflows, which have decreased by 77% in the last four years, as previously stated.