The CBN wants you to be able to buy more chocolate

What is the new

Unless you produce everything that you consume in your country, at some point you are going to need foreign currency to buy things. Nobody outside of Nigeria will accept Naira as payment.

So if you want to buy a chocolate, for example, you go to the market and buy it. But the person who originally brought that chocolate into the country, had to buy that chocolate with US dollars (perhaps) somewhere outside of Nigeria.

Now how does that chocolate seller get the foreign currency to buy that chocolate? Well they could go to the bank and trade some Naira for the dollars. But the problem is that the CBN has artificially held the dollar to Naira exchange rate, or the price they charge to buy dollars, to somewhere around N198 to the Dollar.

So the chocolate seller could give the bank N198 and get $1 to buy chocolate. But this won't happen because the value of the Naira is artificially held up by the CBN. In reality, the value of the Naira to the dollar is about N360 to the dollar. So the bank won't sell the dollars, they just can't afford to at the CBN rate.

So the chocolate seller goes to the black market sellers and gives them N360 and gets $1 and uses that to buy the chocolate.

The policy announced yesterday, hints that the CBN will allow 10 sellers to determine a fair rate for the Naira and the CBN will set their rate to be the same as those seller's rates, effectively eliminating the difference between the official rate and the black market rate. The currency will be allowed to "float" so to speak.

So who cares, why does this matter?

So how does this affect the chocolate seller or buyer? Well, now, the chocolate seller can go to the bank instead of the black market to get dollars. Slightly easier perhaps but really no big short-term change.

What about the company making the chocolate overseas? For them, not much difference in the short term because they were getting paid in USD anyway. But, if the value of the Naira continues to fall, it becomes more difficult for the person buying the chocolate from them to get enough Naira to buy the dollars to get the chocolate. In short, it makes Nigeria a less attractive place for foreign companies to open businesses or make investments.

But, what could happen in the medium term? In the medium term, now that Dollars can be easily bought from banks or on the black market, they should eventually not be scarce anymore. If they are not scarce, then the price of buying a Dollar should go down, meaning the value, or buying power, of the Naira has gone up. This is good for almost everyone. Now the chocolate seller can buy more chocolate with the same amount of Naira and thus make more profit, expand his business, etc.

What the CBN is hoping is that removing the artificial price of the Naira will, in the long term, prevent the currency from tumbling further. It's a painful step because now they have to admit that things are messed up, but admitting you have a problem is the first step to fixing it. The rest of the world watching knows this also. Sound policies and difficult decisions by central banks give investors confidence in a country, so eventually there should be a benefit to the float.