The Nigerian National Petroleum Company Limited (NNPCL) has recently secured a $3 billion facility from AfreximBank in a bid to stabilize the exchange rate. The persistent dollar shortage in the I&E window and the naira’s depreciation in both the I&E window and the parallel market necessitated the loan.
The fund would provide the necessary dollar liquidity to counteract the fall of the naira. Future revenue streams tied to crude oil production were used to secure this dollar-based financing.
Evidently, there has been a significant appreciation of the naira as a result of the loan. This notwithstanding, the gains associated with the improvement in dollar-based liquidity might be short-lived and play only a transitory role in the exchange rate markets.
This article highlights the underlying factors contributing to the sustained depreciation of the naira, emphasizes the temporary nature of the loan's impact, and outlines a potential pathway to secure the enduring stability of the naira in the long term.
Why is the naira depreciating?
The depreciation of the naira stems from a persistent demand for the dollar coupled with its scarcity. To provide a deeper understanding, the demand for dollars has been steadily rising to facilitate imports and international transactions. However, Nigeria's inability to boost exports and attract substantial foreign investments has strained available dollar reserves.
In essence, Nigeria is confronted with a substantial domestic aggregate supply gap, resulting in consistent import reliance and limited export volumes, leading to a shortage of foreign exchange earnings. These challenges are the underlying factors that feed into the naira's depreciation.
Inflation also contributes to the naira's depreciation in two significant ways. Firstly, mounting inflation in Nigeria diminishes export competitiveness, especially for non-oil exports, as it escalates the cost of exports, thereby dampening their demand. Secondly, inflation leads to a reduction in productivity, subsequently resulting in decreased export volumes.
Data from the Central Bank of Nigeria (CBN) further showed that total import volumes rose from $35.73 billion in 2020 to $53.61 billion in 2022. This statistical revelation underscores Nigeria’s prevailing state of low productivity and overreliance on imports, putting consistent pressure on the naira-dollar exchange rate.
$3 billion naira loan, transitory or permanent?
The loan facility's impact is constrained to the short term, providing a temporary means to stabilize the naira. This raises the question: What will unfold once the facility is exhausted? The enduring resolution to the naira's challenges hinges on bolstering overall productivity.
It's important to highlight that Nigeria has yet to attain its OPEC-mandated crude oil quota, as present oil production falls below the 1.8 million barrel threshold. This contributes to the non-availability of the dollar.
The loan facility's effect will be of limited duration, and there will be renewed pressure on the naira if the underlying factors responsible for its consistent depreciation are left unattended.
A way forward?
Increasing aggregate supply is the primary solution to a long-run appreciation of the naira, and this involves enhancing productivity. An increase in aggregate supply can effectively cut imports, leading to lesser demand for the dollar, and increase exports, leading to an increase in the supply and availability of the dollar.
The government plays a crucial role in ensuring an increase in aggregate supply by implementing pro-business policies that improve the ease of doing business. It is also equally important to invest in critical infrastructure that reduces the cost of doing business. This enhances both domestic and foreign investment. Reliable infrastructure not only lowers operational costs but also helps to augment productivity.
Moreover, more efforts must be made to diversify the Nigerian economy and encourage the growth of the non-oil sector. The overdependence on crude oil exports has made the economy vulnerable to fluctuations in global oil prices that feed into exchange rate depreciation. The government must make intentional efforts to encourage the growth of the non-oil sector to reduce the overreliance on oil for foreign earnings.
It is also imperative for Nigeria to prioritize the augmentation and maintenance of its external reserves to provide a buffer against external shocks. The fluctuations in Nigeria's external reserve have been notably pronounced in recent periods, presently at $33.8 billion compared to the $40.5 billion recorded in January 2023.
Ensuring the adequacy of our reserves assumes significance, as it serves as a protective cushion against the impact of global economic fluctuations and trade imbalances. This is, however, tied to improving the trade balance and productivity.
In conclusion, it is imperative for the government to focus on increasing productivity and enhancing exports, along with implementing import substitution policies. These steps are crucial to enhancing the competitiveness of the naira.