Dollarisation will further wreck naira as market holds dollars amid rising inflation
By Jeph Ajobaju, Chief Copy Editor
Nigeria’s economy may go under with dollarisation, which is hard to revert once it takes hold, as being precipitated by crashing naira and rising inflation, according to the International Monetary Fund (IMF).
A report by the IMF titled, “Digital Money and Central Banks Balance Sheet”, said market participants tend to protect themselves by holding dollars under high and persistent inflation environments.
It acknowledged most economies operate with a dollar bias for international trade and finance invoicing, but stressed dollarisation poses a threat to the Nigerian economy with the rising pace of dollar scarcity and high inflation.
“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,” the IMF said.
“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.
“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 domestic currency vs FX will depend on the monetary framework and the benefits each may offer as they co-exist as two currencies.
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Currency mismatches and liquidity risks
“The most common type of dollarization is financial dollarization (FD), or asset substitution, caused by the poor performance of the local currency, the IMF added, per Nairametrics.
“The local currency is used more for payment transactions but is replaced by the dollar as saving asset or store of value, in line with Gresham’s law.”
“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.”
Nigeria’s inflation rate
Nigeria’s inflation rate surged to 20.77 per cent in September, up from 20.52 per cent in August. Food inflation rate was 23.34 per cent, an uptick on 23.12 per cent in August.
The National Bureau of Statistics (NBS) attributes rising inflation to the disruption in the supply of food products, rise in import cost due to depreciating currency, and the general increase in the price of production.
Exchange rate has crashed to N800/$1 on the black market, and depreciated to N441.13/$1 at the importer and exporter window (I&E) official window.