Nigerians are thought to be collecting foreign currency that they believe will protect their wealth from the volatility of the naira and rising inflation. Furthermore, a research article in a journal published by the Central Bank of Nigeria (CBN) shows that the use of dollars by Nigerians exceeds the IMF threshold of 30%.
Exchange rate volatility and currency substitution
However, according to a report, this preference for foreign exchange (or currency substitution as CBN economists call it) must be limited in order to maintain the effectiveness of the central bank’s monetary policy. Three CBN economists pointed out the importance of curbing this phenomenon of currency substitution:
Greater volatility in the real exchange rate is associated with a greater degree of currency substitution. (Therefore) it is necessary to “contain exchange rate volatility and inflation as a way of curbing the wave of currency substitution in the country.
Meanwhile, the report also quotes economists explaining how a measure of currency substitution, “the ratio of foreign cash deposits to on-demand naira deposits with banks, passed the IMF’s 30% threshold as of 2009 following the global financial crisis. ” According to the researchers, this ratio only peaked at 98.2% in 2014, before falling to 83% in 2018.
Nevertheless, the broader measure of foreign currency in banks to naira savings, demand deposits and term deposits “remained largely within the IMF limit during the study period from 1995 to 2018.” On the other hand, inflation in Nigeria “accelerated to its highest level in four years in March and is now more than double the 9% limit of the central bank’s target range”.
In the meantime, as part of its response to the currency substitution phenomenon, the CBN has previously asked, “traders should stop offering local goods in foreign currency.” The central bank “also banned the practice of accessing the foreign exchange market to settle domestic transactions.” However, in early February 2021, the CBN’s fight against currency substitution was expanded to include cryptocurrencies. Like foreign currencies, cryptos also act as a hedge against inflation and currency depreciation.
Meanwhile, the three Nigerian economists believe that diversifying the economy “should be of the utmost importance to strengthen the basis for foreign exchange earnings.”
What are the other reasons Nigerians prefer to hold US dollars? Tell us what you think in the comments section below.
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