Explainer: How would a stronger dollar affect Nigeria’s economy?

The US dollar index, which is a measure of the strength of the US dollar compared to a basket of other major currencies was trading at 104.55 at the time of writing, up 10.84% in six months and 4.31% in a month, taking the greenback to a 2-decade high.

This surge in the strength of the dollar to a 20 year high may be good news for savers with USD holdings. However, the continued strengthening of the dollar poses a great risk for emerging economies including Nigeria.

Most analysts have attributed the recent surge in the dollar’s strength to a number of factors, specifically global inflation whereby the value of other countries’ currencies depreciate, rising interest rates in the US with room for more interest rate adjustments and ever spiking threats of slower growth and even recessions in Europe due to the ongoing Russia-Ukraine dispute.

  • Consequently, the safe-haven perception of the dollar has meant a huge inflow of savers and investors to USD based low-risk-assets such as treasury bills and gold.
  • Notably, from an interest rate perspective, the Federal Reserve Bank of the United States hiked key interest rates by 25 basis points in March 2022 and another 50 basis points in May. It also hinted that it might hike rates more times in 2022 alone, as it tries to keep inflation under control in the United States.

The interest rate hikes come at a particularly poor moment for Nigeria, as the US’ hawkish stance has had the consequence of further weakening the Naira, raising export costs, making debt more expensive, and escalating inflation.

Nairametrics took a cursory look at how the surging dollar could impact Nigeria’s economic prospects.

Capital Outflows

Nigeria, which historically has been reliant on foreign investment from the United States and other developed countries, may continue to face a severe shortage of direct investment from overseas.

This is due to the fact that higher rates in the US would entice investors to return to the US capital markets, due to the widely held views about the relative safety of investments held in the United States, thereby accelerating capital flows out of emerging nations and making the cost of sourcing USD more expensive via exchange rate depreciation.

This issue of reducing capital inflows aggravates the already existing problem as Nigeria’s capital inflows hit a four-year low of $9.66 billion in 2020, before dropping to $6.7 billion in 2021.

Higher cost of debt

Another outcome of the surging dollar strength is that emerging markets economies will need to pay a higher rate interest to attract folks to buy dollar-denominated bonds issued by EM sovereigns and corporates

This is particularly concerning because an anticipated fall of the local currency as a result of a reversal of capital flows could make servicing the dollar loan more difficult. Corporations and institutions that borrowed in dollars may be put under extra strain if their earnings do not rise in lockstep.

Nigeria’s external debt has increased by $5.04 billion to $38.39 billion as at Q3 2021. Multilateral institutions account for 48.6% of the country’s foreign debt, with $3.46 billion payable to the International Monetary Fund (IMF), $11.97 billion owed to the World Bank’s Internal Development Association, and $1.55 billion owed to the African Development Bank, among other sources.

Pressure on the Naira

Due to the US Fed’s hawkish approach, a higher dollar may spell bad news for the Naira, as it is likely to push above N600/$.

If Nigeria’s exports do not improve, the country’s currency may suffer a double blow as demand for risky assets declines. However, current data indicates that Nigeria has experienced a historic trade deficit.

Nigeria’s international trade deficit for 2021 has reached a new high of N1.94 trillion. Nigeria’s exports climbed by 51% to N18.91 trillion in 2021, up from N12.52 trillion the year before.

The increase in export revenues, however, was not enough to offset a 64.1% increase in import expenses, which totalled N20.84 trillion.

What experts are saying

Samuel Oyekanmi, Research Analyst at Nairametrics stated that the impact of a rising dollar would lead to an uptick in Nigeria’s inflation.

He said, “If the naira continues to grow weaker against the US dollar, it means that Nigeria will have to spend more on import bills, considering we still depend largely on importation to even meet up domestic agricultural demands amongst other things, logically causing an uptick in inflationary pressure in the country.”

He added,“This will also have a ripple effect on Nigeria’s balance of payment, which only managed to print a positive net balance in 2021.”

Oyekanmi raised concerns about the impact of a stronger dollar on debt. He said, “Also, with the aggressive move by the US fed in raising interest rates, it means that the interest paid on Nigeria’s external loans will rise. Already, the federal government is spending as high as 96% of its retained revenue on debt servicing, this could surge significantly in 2022, which would open the government to more borrowings and hinder its ability to fund capital projects.”

Dr. Oladipo Olabisi, Lecturer of Economics at  Landmark University said the problems start with Nigeria’s key macroeconomic indicators. She said, “Further depreciation should be expected as long as our policies do not have the capacity to enable effective macroeconomic indicators. As long as Nigeria’s macroeconomic indicators are weak, naira value will keep depreciating”

She added that “The ineffective macroeconomic tools is causing frictions in the labour market. Nigeria’s economy is facing serious labour supply shock (unemployment) and wage shock (wage reduction).”

Omotoso Oluwaseyi, Forex Analyst at WestbellisyFx stated that the hawkish stance of the US Fed is expected to depreciate the Naira further.

He said, “an increase in the dollar rate would push the dollar/naira exchange to N600 – N620 per dollar as compared to N580 – N585 it was before.”

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