Nigerians are thought to be accumulating foreign currencies which they believe will protect their wealth from the nairaâ€™s volatility as well as the surging inflation. Further, as a research paper in a journal published by the Central Bank of Nigeria (CBN) found, Nigeriansâ€™ use of dollars exceeds IMFâ€™s 30% threshold.
Exchange Rate Volatility and Currency Substitution
According to a report, this preference for foreign currencies (or currency substitution as CBN economists call it) however, needs to be contained in order to maintain the effectiveness of the central bankâ€™s monetary policy. Remarking on the importance of curbing this currency substitution phenomenon, three CBN economists said:
Meanwhile, the report also quotes the economists explaining how one measure of currency substitution, â€œthe ratio of foreign cash deposits to naira deposits on-demand in the banks exceeded the IMFâ€™s 30% threshold from 2009 following the global financial crisis.â€ According to the researchers, this ratio only â€œhit a peak of 98.2% in 2014 before declining to 83% in 2018.â€
Nevertheless, the broader measure of foreign currency in banks to naira savings, demand and term deposits â€œstayed largely within the IMF limit over the study period from 1995 to 2018.â€ On the other hand, Nigeriaâ€™s inflation rate quickened â€œto the highest level in four years in March and is now more than double the 9% limit of the central bankâ€™s target range.â€
In the meantime, as part of its response to the currency substitution phenomenon, the CBN has previously asked: â€œmerchants to stop offering local goods in foreign currency.â€ The central bank also â€œbanned the practice of accessing the foreign-exchange market for settling domestic transactions.â€ However, in early February of 2021, the CBNâ€™s war against currency substitution was broadened to include cryptocurrencies. Just like foreign currencies, cryptos also act as a hedge against inflation and currency depreciation.
Meanwhile, the three Nigerian economists believe that diversifying the economy â€œshould be of paramount interest to boost the base for foreign-exchange earnings.â€
What are the other reasons why Nigerians prefer holding US dollars? Tell us what you think in the comments section below.