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Rewane: Exchange Rate Unification Will Enhance FDI

Rewane: Exchange Rate Unification Will Enhance FDI

The Managing Director/Chief Executive Officer, Financial Derivatives Company Limited, Mr. Bismarck Rewane, in this interview says steps taken so far to reduce the divergence in exchange rates in the country will has helped to reduce market abuse and sharp practices. Peter Uzoho presents the excerpts:

In your opinion, what are the implications of the current exchange rate regime on Nigerian trade and businesses?

The exchange rate is the price of one currency expressed in terms of another. It is a price that establishes equilibrium between the domestic and external economies of any country. It is an extremely important factor price and is used by policymakers to facilitate and execute their macro-economic objectives. These may include export promotion, that is releasing a country’s exports in another country or in some cases to subsidise imports of essential commodities. The pricing of a commodity (currency) is usually determined by its market structure. Currently, Nigeria is practicing a managed floating exchange rate system. It is used to reinforce the monetary policy framework of explicit inflation targeting. The Central Bank of Nigeria (CBN) believes that imported inflation can be controlled by defending the value of the naira and ensuring exchange rate stability. Trading is the occupation of most Nigerians. The wholesale and retail trade sector employs approximately 25 per cent of the Nigerian labour force. The sector however grew by a meager 0.85 per cent in Q1 2019. Wholesale and retail trade’s profitability is largely dependent on the exchange rate value of the currency. Multiple exchange rate practices create room for speculative trading, arbitrage and abuse, resulting in extraordinary transaction gains and losses for companies that have dollar obligations and revenues. Consequently, the CBN has embarked on a convergence process of the multiple exchange rates. In other words, it has reduced the divergence between the highest and lowest exchange rates. This process has helped reduce market abuse and sharp practices.

 How will the unification of the exchange rate encourage trade agreements like the AfCFTA?

Most economies practice a unified exchange rate system. This means that the effective and nominal rates are the same and priced in-line with market fundamentals. An equilibrium exchange rate is an efficient price of currency that clears the market. A divergence between the nominal and effective exchange rate results in gaps and distortion to resource allocation. Trading is the occupation of most Africans and Nigerians. As previously stated, it employs close to 25 per cent of the Nigerian workforce. Typically, all trading transactions are settled with a currency payment. Thus, any change in payment and settlement system will have a profound effect on the income and living standards of most citizens. The value of the currency in which a trade is settled is a major determinant of the profit of the trader. A trader therefore will either increase his price to compensate for the difference between the nominal and effective exchange rates or smuggle his products out of the country to take advantage of higher value. For example, if the price of cocoa in Nigeria is N500,000 per ton and the global price is $2,000 (N720,000) per ton, cocoa traders would either increase price to N720,000 to make up for the divergence between the nominal and effective exchange rate or smuggle their product to take advantage of higher value in the global market. To reduce or eliminate such activities, a dynamic equilibrium (unified) exchange rate that reflects the true value of the currency must be in place. A unified exchange rate is more likely to lead to seamless transaction settlements, lower transaction costs, reduction in arbitrage and smuggling and promotion of transparency in the forex market. This would boost investor confidence and enhance trade relations.

 In what ways do you see the convergence of exchange rates impacting Nigeria on a global scale in terms of trade and investments?

It is important to differentiate between exchange rate convergence and exchange rate unification. Exchange rate convergence implies a reduction in the deviation between the highest and lowest exchange rates while a unified exchange rate means that the effective and nominal rates are the same and priced in line with market fundamentals. A unified exchange rate is more likely to enhance efficient resource allocation and aid transparency in the forex market. This would boost investor confidence, thus increasing trade and investment flows. However, in the event of external shocks, the currency could depreciate if the economy lacks adequate fiscal and external buffers.

 What are the possibilities for active government involvement in terms of unifying the exchange rate?

There are possibilities for active government involvement in unifying the exchange rate. These include: The CBN could exercise its autonomy and act independently to unify the exchange rate. This could involve: Retaining all the windows but ensuring that a single exchange rate is implemented across all; merge the entire windows and ensure that a market determined rate is used; and the federal government could instruct the CBN to unify the exchange rate.

 Can a unified exchange rate have an impact on foreign direct investment in Nigeria? 

Exchange rate unification will positively impact foreign direct investment in Nigeria. This is because a unified exchange rate increases the efficiency, transparency and stability in the forex market. These are basic requirements for appropriate investment decisions. Foreign investors are usually concerned about the ease of repatriating their funds.

 Nigeria was one of the last countries to sign the AfCFTA, do you think we are prepared for the agreement as a nation?

Being the last country to sign the trade pact suggests that the relevant authorities critically examined and evaluated the implications of signing such an important pan-national agreement. As a nation, more still needs to be done to adequately prepare for AfCFTA and benefit immensely from it. There is no doubt that Nigeria has the strong fundamentals needed to benefit from the trade agreement; its large market size and its natural resources. However, the underlying challenges such as poor investment climate, huge infrastructure deficit and opaque policies will have to be addressed.

In the event that Nigeria proceeds with the implementation of AfCFTA without a unified forex rate, what will be the effect on the economy and trade?

Proceeding with the implementation of AfCFTA without a unified exchange rate would limit both trade and investment gains for the country. This is because it could discourage or reduce foreign investments.

source:- https://www.thisdaylive.com/index.php/2019/09/06/rewane-exchange-rate-unification-will-enhance-fdi/