News broke on Wednesday that the Central Bank of Nigeria (CBN) had issued a directive to commercial banks, instructing them to freely sell forex at rates determined by the market.
This signifies that Nigeria has relaxed its control over the naira, allowing the local currency to float. The government’s decision to float the naira had been a subject of debate among experts.
When the International Monetary Fund (IMF) first proposed the idea to Nigeria in 2022, many financial experts argued that such a move would be counterproductive.
To clarify, the free float of the naira means that the exchange rate is no longer determined by the government or the CBN, but by the interaction of market forces, namely the supply and demand for foreign exchange.
In simple terms, the exchange rate for the naira against any foreign currency will be determined by the mutually agreed price between buyers and sellers, without any interference from CBN regulations or policies.
When the idea was initially suggested in 2022, experts expressed concerns that floating the naira could ultimately lead to a complete collapse of the currency.
This measure could also result in a continuous depreciation of the currency’s value against all other currencies, rendering it practically worthless and triggering a currency crisis in Nigeria.
Furthermore, experts warned that it could have adverse effects on production costs in sectors reliant on exchange rates, such as manufacturing, by causing a negative supply shock for Nigeria.
It’s important to note that a supply shock refers to an unforeseen event that alters the supply of a product or commodity, leading to a sudden price change.
A negative supply shock, in particular, reduces output and causes prices to rise at an alarming rate.