Addressing Nigeria’s Forex Liquidity Challenge

Postscript by Waziri Adio

Nigeria has a foreign exchange liquidity challenge crying for urgent, nuanced and sustainable solutions. To be sure, this liquidity problem long predated the President Bola Tinubu administration. But the foreign exchange reforms introduced by the administration, clearly necessary but obviously not well-sequenced, has triggered a rapid and seemingly unending depreciation in the value of the Naira against the US dollar and other major currencies.

At the close of business on Friday, the US dollar exchanged for N902.45 at the NAFEM window and N1, 350 in the parallel market. By contrast, the dollar rates were N471 and N765 at the Investors and Exports FX window and in the parallel market respectively on 13^th June 2023, a day before the foreign exchange reforms commenced. The direct effect of the sharp and continuous depreciation in the value of the Naira is the constant hike in prices of goods and services, a development inflicting unceasing pains on most Nigerians.

The consensus among economists and financial analysts is that the Naira is currently undervalued. But the sad reality is that the value of the Naira keeps falling, and there seems no end in sight to the free-fall, despite some ad-hoc moves by and continuous reassurances from the government. Given the welfare and the regime/national security implications of constantly rising prices, the present administration has to treat this problem as its most pressing challenge and it needs to evolve a coordinated, pragmatic and sustainable solution to it, especially because it removed the lid.

The Central Bank of Nigeria (CBN) surely has a key role to play here. But due to the many ramifications of the challenge, this is beyond what can be left to the CBN alone and beyond what can be approached in the current piece-meal, uncoordinated way. President Tinubu has to be in the lead, and has to take some difficult decisions. He needs to expand his toolkit and keep all the options on the table, weighing their pros and cons, and arriving at optimal decisions for the country.

Having a proper diagnosis is the starting point. There are possibly as many explanations for the depreciating value of the Naira as there are commentators in Nigeria. But one point that most analysts seem to agree on is that the Naira continues to depreciate because there is more demand for than the supply of foreign exchange. What is driving the demand for forex in the country can sometimes be a matter of ideological debate or pet theories. But what is not disputable is that the value of the US dollar will continue to be high (and conversely the value of the Naira will continue to tumble) as long as the demand for dollars in the country outstrips supply. It is basically a demand and supply thing, and the exchange rate can be seen as the price of the US dollar.

What government has been trying to do overtime is to manage the demand for US dollars. The demand management approach has not worked, and government’s attempts at rationing foreign exchange or picking who got FX at subsidised rates created opportunities for arbitrage, patronage and other sharp practices. A corollary of this approach was to defend the Naira with our foreign reserves. But reduced forex flows have shrunk the space for that. We cannot escape the tyranny of a forex supply crunch in an economy whose forex demand cannot immediately be suppressed except you want many sectors of the economy to grind to a halt.

So, what are the options Nigeria has for boosting forex supply and how quickly and sustainably can these options provide the needed relief?

The first option is to diversify and increase our export base. The oil and gas sector still accounts for more than 80% of our exports. This necessarily exposes us to the volatility of the oil market and other issues we will come to shortly. But clearly, we need to sell more things to the world to improve our balance of payments, expand our reserves and increase forex flows. The challenge, however, is that increasing exports is not like a switch that you can just flick on. It takes time. And here and now, there is a forex supply challenge to address.

The second option is to attract foreign investments, both direct and portfolio investments. The administration has introduced some reforms (including forex reforms) and the president and his team have been on the road to market Nigeria as a desirable and safe investment destination. All these moves are necessary and commendable.

But there is usually a time-lag between commitments and actual investments for direct investors. Portfolio investors have a global view and are constantly looking for where they can maximise returns. So even when you provide them the most favourable terms, there is no guarantee that they will come or that they will stay if they come. My hunch is that the devaluation of the Naira was premised on the assumption that forex would flood in. This has not happened yet or in the quantum desired, and understandably because investors are adopting a wait-and-see posture and constantly scanning competing investment domains. We need to continue to remove the constraints to domestic and foreign investments, but we should have no illusions.    

The third option is to take some foreign loans at commercial or concessionary rates. One example of a commercial loan is Eurobonds, which we binged on at a point. Another is the recent $3.3 billion Afrexim Bank loan facilitated by NNPCL. When stripped of all the financial and legal jargons, this is a commodity-backed loan, a tribe of loans renowned for opacity. Besides, at 11.85%, it is expensive. We can get longer-term loans for under 3% interest rate from the World Bank and the International Monetary Fund (IMF).

However, Nigeria seems to have maxed out its credit line with the World Bank and the IMF will not give loans without stringent conditions. Nigeria has never gone to IMF for a bailout, but the institution is roundly demonised in popular imagination in the country. This makes approaching the IMF a tough political choice. Interestingly, Nigeria is already implementing some of the conditions that IMF will stipulate, though IMF is likely to insist on more transparency and prudence. As politically unpalatable as it may be, this is an option the president may have to keep alive and figure out how to sell it to Nigerians.

The fourth option for boosting forex supply is related to the third. We can seek placements or deposits from countries awash with forex, such as the petrostates of the Gulf. This could come in different forms: currency swaps, direct deposits and strategic investments in state-owned companies. In July 2023, the United Arab Emirates signed deals worth $50.7b with Turkey. On its part, Egypt has attracted long-term deposits and short-term debts above $30 billion from Saudi Arabia, UAE, Qatar, Kuwait and even Libya.

The Federal Reserve of the US also provides dollar swap lines to central banks to boost dollar liquidity in other countries. This facility has been extended to central banks in Canada, Mexico, England, Australia, Japan, Brazil, Singapore and others. We should be realistic that Nigeria might not have the same strategic and systemic significance to the US as these other countries. We may stand a better chance with some of the Gulf states. My sense is that some of these discussions are ongoing with the recent visits by the president and his team to UAE and Saudi Arabia, but we need to offer reassurances and step up formal and informal contacts with those countries as well as prepare internally for potential charges of religious agenda in some quarters.

To make any difference on the forex market, we need loans and deposits in the region of $20 billion. This is the quantum that will calm the market and reassure players in the forex market about adequate liquidity. We actually don’t have to draw down on or use the forex loans/deposits. Their existence will serve as psychological boost and take the heat out of the forex market. But loans (whether commercial or concessional) have to be repaid, and at a cost. So, taking on loans in whatever guise has implications for our external debt, for the increasingly crushing revenue/debt-service ratio, and for the debt burden we are imposing on future generations. However, we may have little or no options but to seek some significant but reasonable loans/deposits.

The fifth and last option is to ensure that Nigeria returns to earning forex from its main export: oil and gas. In 2010, flows from the oil and gas sector accounted for 94% of total forex flows to the CBN but dwindled to 24% by June 2022 (and is probably much lower now). A ready explanation for this is the decline in oil production. But it is more than that.

Yes, there has been a precipitate decline in Nigeria’s oil production since 2020 as our production fell from an average of 2m barrels per day to between 1.2-1.4m barrels per day. The reason favoured by government officials for this major decline is oil theft (and it is a favoured line because the oil-theft narrative will involve spending money and awarding contracts). But other reasons for the decline include the stagnation of investment, the aging oil and gas assets, the divestments, and the failure to close new deals.

As said earlier, reduced oil production doesn’t fully explain why oil forex flows more or less dried up. Nigeria is still producing oil, prices of oil have remained consistently high since Russia invaded Ukraine about two years ago and oil still accounts for more than four-fifth of Nigeria’s export. The reason why the oil exports are not translating to commensurate forex flows is because of the effect of the policy that assigns a portion of the Federation share of oil to domestic consumption, called the Domestic Crude Allocation (DCA) and paid for in Naira.

As indicated in a recent policy memo by Agora Policy, crude oil apportioned for domestic consumption constituted only 8.57% of the Federation share of oil in 2004, meaning the remaining 91.43% went to Federation Export, which fetched the country dollars. Fast forward to 2023, DCA accounted for almost 100% of Federation share of oil because oil production declined and the Federation share as a percentage of total oil produced also declined on account of shift in oil production arrangements. The crude oil due to the Federation was still exported, but bartered for petrol for local consumption through the direct sale, direct purchase (DSDP) arrangement, and was paid for in Naira (note: the Naira payment itself is not guaranteed as NNPCL makes sundry upfront deductions from the DCA and this explains why the national oil company failed to make remittances to the Federation Account for a long time).

The DCA represents multiple whammies for Nigeria and has been overtaken in the context of deregulation. Agora Policy rightly called for the scrapping of this opaque and suboptimal policy, asking for the Federation’s share of oil to be sold in dollars whether it is on offer within or abroad. (For those interested, it can be accessed here: https://agorapolicy.org/cancelling-domestic-crude-oil-allocation-is-nigerias-surest-path-to-easing-forex-supply-crunch/).

Earning forex from all of Federation’s share of oil is Nigeria’s surest path for addressing its lingering forex supply challenge. While other options for unlocking forex supply should be pursued, cancelling the DCA or earning dollars from Federation’s oil is a necessary complement that will yield immediate and continuous result. It is fully within the control of the country, and it will provide constant flows that will guarantee liquidity in the forex markets. It is the way to go.