Nigeria’s foreign exchange reforms have restored the effectiveness of monetary policy after years of distortions under a multiple exchange rate regime, while making currency movements a more important driver of inflation, according to the International Monetary Fund (IMF).
In a Selected Issues Paper accompanying its latest Article IV consultation on Nigeria, the IMF said the June 2023 unification of the foreign exchange market and the subsequent transition to a floating exchange rate regime marked a fundamental shift in the country’s economic policy framework.
The reforms ended a decades-long system characterised by multiple exchange rates, administrative controls and persistent gaps between official and parallel market rates, allowing the naira to trade more freely and strengthening the transmission of monetary policy decisions through the financial system.
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“The June 2023 unification reform marked a fundamental shift in the exchange rate framework, culminating in the transition toward a floating arrangement by 2024,” the IMF said.
According to the Fund, the exchange rate overhaul significantly reduced distortions in the foreign exchange market. Before the reforms, the premium between official and parallel market exchange rates averaged about 30 percent and exceeded 70 percent during periods of acute stress between 2016 and 2017 and again from 2020 to 2022.
Following the unification of exchange rate windows in June 2023, the premium narrowed sharply to an average of about 9 percent, while the exchange rate became more responsive to market forces.
The IMF noted that the increase in naira volatility following the reforms reflects a transition from infrequent and often abrupt devaluations to a system of more frequent two-way market adjustments.
“Since then, the exchange rate has adjusted continuously, with volatility rising to around 11.6 percent, reflecting the shift from infrequent, stepwise adjustments to more frequent two-sided fluctuations under a market-determined regime,” the report said.
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The Fund said the reform package was accompanied by a major tightening of monetary policy aimed at restoring price stability and anchoring inflation expectations.
Since the exchange rate unification, the Central Bank of Nigeria has raised the Monetary Policy Rate to 27.5 percent, while money market rates and Treasury bill yields have adjusted significantly higher.
According to the IMF, one of the most significant outcomes of the reforms is the restoration of monetary policy transmission, which had weakened considerably under the previous exchange rate regime.
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The report showed that under the managed exchange rate arrangement that existed before 2016, policy rate changes were transmitted only partially to market rates. During the period of multiple exchange rates and administrative controls between 2016 and 2023, however, transmission effectively broke down.
“During the stabilised arrangement (2016–2023), transmission broke down entirely,” the IMF said, noting that efforts by the Central Bank to defend the exchange rate through liquidity injections often offset the intended impact of policy rate changes.
Following exchange rate unification, the pass-through of policy rate changes to wholesale market rates surged, indicating that monetary policy signals are once again influencing financial conditions.
The report found that the interbank call rate now exhibits near one-for-one pass-through with changes in the MPR, while Treasury bill yields also respond significantly to policy adjustments.