Nigerian foreign exchange market : possibilities for convergence in exchange rates

The extended model, which was used to survey 10 banks in Ibadan that were authorized forex dealers and 20 such banks in Lagos, shows that exchange rate convergence is frustrated by (a) institutional barriers and the costs they generate and (b) the monopoly powers of the Central Bank of Nigeria (CBN) in the official market and its exercise of such powers in an unpredictable and uncompetitive manner. The theoretical conclusion was that the necessary condition for exchange rate convergence is that the sum of the institutional costs should approach zero over time while the sufficient condition is that the official forex market should approach a competitive market where no participant exerts market powers in unpredictable ways and there is no collusion. Study results show that there was no tendency towards exchange rate convergence in December 1993. The study concludes that convergence in the future may not be possible unless (a) the institutional barriers segmenting the forex market are removed and (b) the official market operates competitively. The study also analyzed the links between the macroeconomic and external environment and exchange rate stability. The analysis leads to the conclusion that (a) post-reform macroeconomic and external shocks exerted downward pressures on the supply of forex but upward pressures on demand for forex, and (b) the differential effect on supply is causal to the decline in the nominal exchange rate in the 1986-1993 period. The study proposes that reduction in federal deficit and inflationary finance would reduce the pressure on the existing supply of foreign exchange and, by extension, halt the fall in the value of the naira. Similarly, reduction in external debt (and hence external debt service), rise in external revenue (oil and non-oil), reduction in diversions from the federation account and so on, would have a negative impact on the nominal exchange rate by increasing the supply of forex. The paper concludes that the realism of any forex management policy, and any other policies for that matter, must be determined through objective and comprehensive evaluations of their effects on domestic incentive structures, investment, employment, national income, fiscal balance, and external balance. Includes references. (Author abstract, modified)