BIG READ: Difference between a fixed, free float crawling peg and managed float exchange rate system; which is better for Nigeria?

In a landmark move on June 16th, 2023, the Central Bank of Nigeria unveiled sweeping reforms to its foreign exchange operations, consolidating multiple rate windows into a singular, unified system: the Investor and Exporter Window, commonly referred to as the I&E Window.

This shift has ignited spirited debates, with analysts and experts deliberating over the exact nature of Nigeria’s newly adopted foreign exchange rate policy.

While many contend that the country has embraced a free float, the central bank has categorically emphasized that Nigeria is navigating a managed float regime.

Yet, amid these discussions, there’s a vocal cohort of critics lobbying for a fixed float, asserting that the nation’s economic climate isn’t ripe for either a free or managed float approach.

In this explainer article, Nairametrics delves deep into this discourse, examining the spectrum of foreign exchange rate policies and evaluating their fit for Nigeria’s current economic landscape.”

1. Definitions

Fixed Exchange Rate System – Under a fixed exchange rate system, Nigeria’s currency’s value is pegged to another currency, a basket of currencies, or a commodity like gold.

The central bank intervenes in the currency market to maintain this peg, buying or selling its currency as necessary.

Crawling Peg – This is an exchange rate regime that allows for periodic adjustments in the peg or fixed rate of the national currency in relation to another currency (or a basket of currencies).

The adjustments are usually pre-announced and can be based on specific parameters, such as inflation differentials between the home country and its major trading partners.

Nigeria tried this during the Soludo era.

Managed Float – This is an exchange rate system in which a country’s currency’s value is largely determined by market forces (supply and demand), but the central bank or monetary authority intervenes periodically in the foreign exchange market to stabilize or influence its currency’s value.

According to the central bank, this is what Nigeria is currently practising.

Free float – refers to an exchange rate system in which the value of a country’s currency is determined solely by market forces, namely supply and demand, without any government or central bank intervention. Nigeria has never practised this role

2. Characteristics of each exchange rate system 

 Fixed Exchange Rate System 

Pegged Value: The currency is anchored or pegged to another major currency, a basket of currencies, or a commodity such as gold. This fixed rate provides a standard of value.

For example, the exchange rate was pegged at N460/$1 for most of 2022 as the central bank preferred capital controls.

Central Bank Intervention: To uphold the pegged value, the central bank commits to buy or sell its currency in the forex markets, intervening as needed to ensure the currency does not deviate from its pegged rate.

The central bank often intervened but preferred to sell forex to industries they thought are critical to the economy.

Currency Reserves: Central banks must maintain substantial reserves of the currency (or commodities) to which they’re pegged. These reserves are utilized to intervene in the forex market to sustain the peg.

While Nigeria’s central bank did maintain over $35 billion in reserves, most of it was encumbered.

Monetary Policy Constraints: The commitment to a fixed rate often limits the central bank’s ability to enact independent monetary policies. Instead, the policy must often be designed around maintaining the peg, even at the expense of other domestic economic objectives.

Unfortunately, the central bank did not have effective control of monetary policies.