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As the naira falls and inflation rises; IMF warns Nigeria of the risks of dollarization
The International Monetary Fund (IMF) has issued a warning that Nigeria’s dollarization is difficult to reverse as the country struggles…
- IMF warns Nigeria of the risks of dollarization
- The Washington-based multilateral lender’s report
- Problems with the naira and excessive inflation in Nigeria
The International Monetary Fund (IMF) has issued a warning that Nigeria’s dollarization is difficult to reverse as the country struggles with a collapsing native currency and soaring inflation.
In a recently published paper titled “Digital Money and Central Banks Balance Sheet,” the IMF issued the warnings.
The IMF observed in the report that in times of high and ongoing inflation, market players often choose to hold dollars as a form of self-protection.
The IMF also stated that most economies operate with a dollar bias for international trade and finance invoicing, which is concerning for Nigeria. However, Nigeria’s dollarization levels offer cause for concern due to the rapid rate of dollar scarcity and rising inflation.
The Washington-based multilateral lender’s report contained the following, in part:
“Most economies operate with a foreign exchange (FX) (e.g., the dollar) bias for international trade and finance invoicing. Additionally, banking systems in many developing economies are bi-monetary.
“A bi-monetary system embodies the failure to conduct monetary policy effectively, i.e., secure price stability, efficient payment systems, and well-functioning financial markets (including long-run financial contracts at comparatively low nominal interest rates). Particularly, under high and persistent inflation, market participants defend themselves by shifting to FX.”
Changing a bi-monetary system is challenging: The IMF issued a warning that dollarization is challenging to stop. According to the report:
READ MORE: Dollarization Of The Economy Will Rise As A Result Of Naira Note Change-Expert
“Once a country gets used to a bi-monetary system, the process is not easy to reverse, even when the initial trigger (e.g., high inflation) subsides, a phenomenon known in the literature as hysteresis. The optimal choice between the domestic currency and FX will depend on the monetary framework and the benefits each may offer as they co-exist as two currencies.
“The most common type of dollarization is financial dollarization (FD), or asset substitution, caused by the poor performance of the local currency. The local currency is used more for payment transactions but is replaced by the dollar as a saving asset or store of value, in line with Gresham’s law.”
Additionally, it restricts the role of the exchange rate as a shock absorber because real dollarization implies a substantial pass-through from exchange rate depreciation to inflation, according to the IMF analysis.
“Financial dollarization creates currency mismatches and liquidity risks for the financial system and the economy as a whole. Therefore, the exchange rate amplifies negative external shocks rather than absorbing them.
“Both financial dollarization and real dollarisation jeopardize monetary transmission mechanisms, as inflation expectations are difficult to anchor with a weak interest rate channel. Financial dollarisation-related financial instability would need to be addressed via policy responses such as a central bank forex reserve buildup and associated regulation.”
READ MORE: Naira hit rock bottom, N815 per dollar at the black market
Problems with the naira and excessive inflation in Nigeria
Nigeria’s currency problems and high inflation rate: In September 2022, Nigeria’s inflation rate increased to 20.77% from the previous month’s figure of 20.52%. The annual food inflation rate in September 2022 increased from the 23.12% noted the previous month to 23.34%.
The National Bureau of Statistics states that the interruption in the country’s food supply, the rise in import costs as a result of the sinking currency, and the general increase in production costs may be to blame for the country’s rising inflation rate.
On the black market, the exchange rate between the naira and the US dollar has fallen to N800/$1 while it has appreciated to N441.13/$1 at the importer and exporter window (I&E) official window.