The exchange rate, which is a price
of the domestic currency in terms of other currencies, is usually determined in
principle by the interplay of supply and demand in a free market environment.
In practice, however, no currency is allowed to float freely by the monetary
authorities. Between the fixed and floating systems exchange rate management
and other regimes such as the managed and dual exchange rate regimes. In
Nigeria, past exchange rate policies have been designed with a bias towards
demand management, as the supply side has always been limited by the monoculture
base of the economy, where foreign exchange inflow is
dominated by oil export
proceeds. The main objective of exchange rate policy in Nigeria are to preserve
the international value of the domestic currency; maintain a favourable
external reserve position; and ensure external balance without compromising the
need for internal balance and the overall goal of sustainable output growth and
employment in determining the daily exchange rate, the CBN is generally guided
by the developments in the market on the one hand, and the movement in the
nominal exchange rate.
Since the introduction of SAP in
1986, the central bank has implemented different techniques in the management
of the exchange rate of the naira. Firstly, the dual exchange rate regime was
adopted between 1986 and 1987 in which one rate was reserved for official
transactions and pegged at N1.5567 to
U.S $1.00, and other rate was largely market driven. However, due to
imperfections in the market and operational problems, which hampered the
attainment of a stable exchange rate, the dual system was discontinued, with
the merger of the official and market rates under the inter-bank foreign
exchange market (IFEM) in January 1989.
Exchange rate management under IFEM
also witnessed a number of changes aimed at improving its operational
efficiency. Thus, various methods of arriving at the realistic exchange rate
were adopted at different times, such as the “managerial rate” pricing system,
the ‘average of successful bids” system and he “Dutch auction” system. In march
1992, the exchange rate pricing system was completely deregulated, with the
administrative adjustment of the effective rate upwards to N18.00=U.S $1.00 from N10.6564=U.S
$1.00 the previous day. The aim of this de-factor devaluation was to narrow the parallel market
premium and enhance the operational and allocative under the supply structure
of foreign exchange, the central bank of Nigeria (CBN) has remained the major
source of foreign exchange supply in the IFEM, in contrast to the objective of
establishing it. Other independent sources, such as oil companies banks non-oil
exporters prastatals, bureaux de change and private companies who were expected
to broaden and deep the supply side of the IFEM and get to make such impact on
the contrary, the banks have depended almost entirely on the CBN to source
foreign exchange for their customers while other potential sources of supply
only engage in speculative and rent-seeking activities in the market.
In speculative, it is an integral
component of trading in the foreign exchange market and can have a stabilizing
or destabilizing effect on the exchange rate. The destabilizing effect occurs
when traders buy and hoard foreign exchange, with the that expectation its
price will continue to rise. The CBN’S on site investigations have revealed
that foreign exchange transactions are designed along this line in Nigeria,
with massive round tripping of funds to take advantage of the widening
arbitrage premium between the official and parallel market rates. This has the
tendency of increasing speculative buying, including additional pressure on the
market, leading of further depreciation of the naira exchange rate. It was
against this background that the CBN stopped the transferability of IFEM funds
amongst the bank.
In spite of the huge amount of
foreign exchange which, the bank injected into the market, the impact has not
been felt in the real sector of the economy. Random surveys have been revealed
that an appreciatable proportion of total foreign exchange demand is for the
procurement of finished goods and payments for invisible often a code for
capital flight. In effect a number of the authorized dealers are not
transparent in the their foreign exchange dealings.
In low domestic output and high
importer levels, the pressure in the foreign exchange market has been the
inability of the manufacturing sector to increase its level of output. The
sub-sector has failed to produce enough import-substitutes that would have
helped to switch demand away from the foreign products to the domestic
substitutes. Also, the sub-sector has failed to expand exports to earn foreign
exchange which would have increased the supply base thus, enhance the economy’s
external balance. It is acknowledge however that this failure by the local
manufacturing industry is the direct result of the lack of a conducive
environment and many structural deficiencies in the economy. Including
infrastructural deficiencies in critical areas of power and energy,
telecommunications, road and other infrastructural, etc.