Naira Under A Freely Floating Rate System

Naira Under A Freely Floating Rate System

The Naira has been the legal tender in the Nigeria’s economic system for over three decades now, the naira just like the dollar as well as other currency has undergone different stages of transformation and modification, in the case of naira, it has not only been redesigned and re-modified, it has been devalued. However, on this article we will be discussing the free floating rate system under the naira, now let us appraise both the merits and demerits of the above conditions.

Merits Of freely Floating Rate

The free floating rate was adopted following Nigeria’s disenchantment with import licensing system and this goes to explain the credulousness of many Nigeria business men who accepted the following as the merits of the new exchange rate;

1. A market determined rate is more reliable and less risk to over all interest of the economy since no authority need decide allowing or promoting deflation or inflation.
2. A market determined rate will result in phasing out import licence requirement.
3. The rate adjust itself under impersonal measures, in essence it will move upward for a country that would otherwise have had an external surplus just as it readily moves downward for a country otherwise in external deficit.
4. The inflationary bias of the adjustable peg is absence.

Demerit Of Free Floating Rate

Some economists who objected to the new system argued that exporters and importers need to be reasonably certain (if not for some limited period of time ahead) of exchange rate levels in order that they price their products sensibly since variations in exchange rates of one or two percent over a short period can disrupt pricing policies either cause export to suffer losses or receive windfall gains.

This group of economists concluded that foreign trade benefits from having a greater decree of certainty about the future level of exchange rate than is likely within a general floating system which breeds frequent exchange rate fluctuations based on these arguments the following are said to be demerits;

1. Exchange rate fluctuations complicates accounting.
2. In selling or buying goods on credit at a price specified in foreign currency, businessman runs the risk that the exchange rate may have moved to his disadvantage by the time he receives or makes payments.
3. A decline in the price of foreign exchange subject to an inflation of goods for resale either with or without further fabrication will reduce the naira value of the inventories by cheap new import of such goods.
4. Exchange rate fluctuations may also cause the nuisance of requiring frequent changes in the markets and sources of supply or even inputs and products.
5. Since market resistance can lead to business failure businessmen would try to hedge against exchange rate fluctuations by adding larger mark ups to their selling prices than stable exchange.
6. Businessmen might refrain from some otherwise profitable international transactions due to various risk and nuisance of exchange rate fluctuations.
7. More so floating exchange rate system is very susceptibility to exchange rate fluctuations due to temporary seasonal cyclical and speculative factors in supply while demand is constantly high relative to supply.

Supply Of Foreign Exchange Into The Nigerian Economy Is Expected From the following;

1. Oil Earnings – Oil earning is a constant source leakages not ordinarily expected, but the amount of supply cannot be predicted with very high degree of probability because Nigeria sells to an exposed market, Nigeria is there a price taker.
2. Non oil Export Earnings – The amount as far as supply is concerned is not predictable because of complete reasons;

• Nigeria’s export market is an exposed market as noted above hence she is a price taker she has no control over anything price.
• Supply of export is price inelastic there is physical limitation on Nigeria’s export capacity in the short run.

3. Foreign Exchange Domiciliary Account – Judging from the performance of foreign exchange domiciliary account up till date nobody will believe that this source would amount so much. The problem is that none of those who are reputed to have substantial foreign exchange are known to have come forward to patronise the market.
4. International Finance Institutions – Apart from world bank and IMF no other international finance institutions has found it credit worthy to invest in Nigeria recognising the fact that exchange rate is regarded as an assets price therefore the relative price at which the stock of money, bonds and some other financial and real assets of a country will be willingly held by domestic and foreign assets holders.
5. World Bank – This source is predictable but does not constitute a fountain to the market however it is assumed that the intention is not to borrow from IMF, but that world banks makes available some loan to support the market at the initial stages.
6. Precautionary and Speculative Motives – These are approved transactions, and so long as there would be people with such motives, the Second Tier Foreign Exchange Market (SFEM) decree can never eradicate the tendency for over invoicing of imports, invoicing or not invoicing at all of exports. So long as there are limits to how much one can acquire in respect of travels and so on it stands to reason that unsatisfied demand would be met by the black market.

Decision On What Next?

Based on the characteristics of Nigeria’s economy and the tendency for exchange rate to fluctuate, Nigeria is therefore not yet ripe for a freely floating exchange rate system. The success of modified form of Second Tier Foreign Exchange Market (SFEM) will depend to a very large extent on an adequate and regular supply of foreign exchange, the lack of which might produce high exchange rate that might tend to fluctuate.

While attempt to bring the exchange rate down measures that might produce results such as high corporate costs, tight monetary conditions, difficult investment, business failures high rate of unemployment etc.

Conclusively, when the above begins to happen, economists will be will be forced to abandon Second Tier Foreign Exchange Market (SFEM) like some countries with such predicaments have done in the past by returning to a modified form of managed exchange rate system. This conclusion, which is in agreement with S.O is the birth of third tier.