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How change of naira notes could depreciate the exchange rate

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The latest decision by the Central Bank of Nigeria to change the N200, N500, and N1000 notes could negatively affect the exchange rate.

Recall that the apex bank Governor, Godwin Emefiele, announced on Wednesday, October 26th that they had obtained approval from President Buhari to change the naira notes.

According to the CBN Governor, the move is aimed at curbing counterfeiting of the naira whilst also reigning in on currency in circulation that is outside the banking system.

Although addressing currency in circulation is an important tool for monetary policy, Nairametrics opines that the move will trigger a response that could further heap pressure on the exchange rate and depreciate the naira as cash hoarders rush to exchange their stashed naira for dollars.

As we already explained, the CBN policy move is targeted at corrupt money, politicians, and currency hoarders. Several crime reports over the years suggest that criminals and currency hoarders typically stash their money in articulated safe houses to evade authorities.

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To ensure that their stash is not rendered illegal by next year following the introduction of the new naira notes, most criminals and currency hoarders will be forced to convert the naira in their safe houses to dollars which could impact the exchange rate. The same goes for politicians and anyone evading the EFCC’s oversight. Converting the money into dollars is a possible way of laundering the cash without getting caught.

Mr Emefiele mentioned that about N2.7 trillion is out of circulation which translates to about $3.6 billion assuming the average black market rate of N750/$1. Nairametrics’ tracker indicates the exchange rate at the parallel market already raced to N770/$1 on Wednesday as traders anticipated the announcement by the CBN. There could be more pressure if traders continue to face increased demand exacerbated by this decision.

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But while this may cause short-term pressure on the exchange rate, we also opine that currency traders will be circumspect about collecting cash in exchange for huge sums of foreign exchange. This could trigger a premium for cash-based forex trading, a price usually reserved for electronic transfers. If traders receive cash in exchange for dollars, they will also need to deposit it in a bank which could expose them to EFCC oversight. In addition, they might also need to exchange cash naira for cash dollars which might not be easily available.

The immediate economic benefit of this policy is largely limited for most Nigerians even though it aids the operations of the central bank in general. However, we do believe the growth and dominance of electronic money in Nigeria will be exponential in the short to medium term. More Nigerians will gravitate towards mobile money and handle less cash due to its growing inconvenience.

On the flip side, the central bank through its eNaira will technology will have better insights into the velocity of the money and how the money supply is impacting the economy. It will also expose several illicit flows of cash, especially towards terrorist activities. But for the central bank to also track dollar inflows and outflows, it will need to make market forces determine the exchange rate which gives it better insight into the largely opaque black market.

It will still need to deal with the short-term effect of this decision on the exchange rate before any benefit can be extracted.