There has been a progressive depreciation in the value of the Naira since 1999 while the nation’s external reserves have followed a somewhat positive trajectory within the past 20 years. An interesting observation is the decline of reserves between 2008 and 2014 at a time when the Naira was trading around N150. While it may seem like there is no correlation between the Naira exchange rate and foreign exchange reserves, the missing piece of the equation is Oil prices.

It must be kept in mind that Oil exports still account for a handsome chunk of Nigeria’s foreign exchange earnings, so when oil prices started to fall in 2008 amid the financial crisis, the nation’s reserves took a hit. This same scenario occurred in mid-2014 as demand from Asia cooled and US Shale production increased. Although Nigeria initially allowed the Naira to depreciate, the central bank decided to peg the Naira around 198 in March 2015 to prevent inflation from rising.

Naira

Unfortunately, this did not ease inflationary pressures as the parallel exchange rate skyrocketed. The sharp drop in reserves during 2015 was based around the Central Bank of Nigeria defending the Naira in an effort to prevent economic instability. When the nation descended into a recession in the first quarter of 2016, the central bank unexpectedly floated the Naira in summer of that year. This move resulted in the Naira weakening towards 300 on the official exchange and foreign exchange reserves rebounding towards $40 billion by the end of 2016.

Although the recent resurgence in oil prices has boosted Nigeria’s external reserves towards $45 billion, it does not change the fact that the nation remains heavily exposed to external risks. Should oil prices depreciate, this will complicate the Central Bank of Nigeria’s efforts to defend the Naira against domestic and external headwinds.

For the Naira to appreciate and external reserves to remain at healthy levels, Nigeria must diversify away from oil reliance and source growth from other sustainable sources such as agriculture. While the multiple exchanges have provided short-term stability, this is unsustainable in the longer term, with the CBN at the mercy of external risks. Although the idea of a single exchange rate may be warmly welcomed by foreign investors, it may lead to heightened inflationary pressures in Nigeria.

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Secondly, what needs to change to get a better performance in the next 20 years with regards to Nigeria’s external sector?

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The rise in Crude Oil markets in recent months may continue to improve Nigeria’s external position, which may lead to stability in the foreign exchange market. However, weak infrastructure and over-reliance on one major source of income have exposed other sectors to downside risks. A major push in diversification in certain sectors such as agriculture and even tourism, may improve the performance in the next 20 years.

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