The Future of the Naira: Predicting Inflation and Exchange Rate Movements
By Statistician, Jamilu Sufi
Introduction:
The Nigerian naira (NGN), the official currency of Nigeria, occupies a pivotal position in West Africa, a region boasting a population exceeding 200 million and hosting Africa's largest economy. Conversely, the United States dollar (USD) serves as the world's foremost international reserve currency and the primary medium of exchange. The exchange rate between the NGN and the USD, therefore, becomes an intricate reflection of currency value, purchasing power, and the economic and political dynamics of both nations.
The oscillations in the NGN-USD exchange rate over the last two decades have been pronounced, influenced by multifarious factors including oil prices, inflation, interest rates, trade balances, fiscal and monetary policies, and market sentiment. According to the Central Bank of Nigeria (CBN), the supreme monetary authority in Nigeria and the official source of exchange rate data, the NGN experienced depreciation from N21.89/1USD in 1999 to N306.95/1USD in 2019, signifying a cumulative devaluation of 1302%. In the tumultuous year of 2020, further depreciation occurred, with the NGN sliding to N379.50/1USD, primarily due to the repercussions of the COVID-19 pandemic and the precipitous drop in oil prices.
Given this historical backdrop, an inquisitive gaze turns towards the future, specifically the years spanning from 2024 to 2027, post the next presidential election in Nigeria. In this scholarly pursuit, we shall deploy various methods and data sources to predict the inflation rate and the exchange rate of NGN/USD for each year from 2022 to 2027.
Methods and Data Sources:
Our endeavor will encompass three distinct methodologies:
1. Deep Learning Method: Employing a recurrent neural network with gated recurrent unit (GRU-RNN) model to scrutinize the Consumer Price Index (CPI) indicators for inflation predictions. The CPI serves as a barometer of the average price variations that consumers pay for a basket of goods and services. The CPI’s inverse relationship with the exchange rate makes it indispensable in our analysis. Our dataset spans from 1999 to 2023, and we will employ this data to forecast CPI values for 2024-2027. We will maintain the exchange rate of 2023 at N757.023/1USD, as previously stipulated.
2. Expectations Method:
This approach relies on surveys of inflation expectations from diverse sources to delineate a range of potential inflation scenarios for 2024-2027. Inflation expectations, being prophetic outlooks on price fluctuations, hold the power to influence actual inflation through their influence on consumer and business behavior. We shall draw upon surveys of inflation expectations from sources such as Blue Chip Economic Indicators and the Federal Reserve Bank of Atlanta’s business inflation expectations, along with inputs from households and financial markets. These expectations will be grounded in the current and projected macroeconomic landscape and shall mirror the 2023 exchange rate, as previously indicated.
3. Stock and Watson (2007) Method:
In this methodology, we will employ the benchmark inflation forecasting model crafted by Stock and Watson (2007). This model integrates lagged values of inflation, output growth, unemployment, and oil prices as predictive variables. These parameters have direct bearing on the exchange rate, as they influence the supply and demand of goods and services and impact production costs and imports. Historical lagged values of these variables from 1999 to 2023 shall serve as predictors, culminating in the generation of inflation forecasts for 2024-2027. This approach will also retain the 2023 exchange rate as previously specified.
Our dataset shall be sourced from two primary repositories:
- World Bank Open Data: An open-access platform, offering comprehensive global development data encompassing poverty, health, education, environment, trade, finance, and more. We will harness this resource to obtain data pertaining to output growth, unemployment rates, and oil prices from 1999 to 2019.
- Central Bank of Nigeria: As the apex monetary authority in Nigeria, this institution provides crucial data related to NGN/USD exchange rates, CPI, GDP growth, unemployment rates, and oil prices (measured by Bonny Light crude oil prices) spanning the years 2020 to 2023.
Results and Analysis:
Based on these methodologies and data sources, we present a table showcasing the predicted inflation rates and NGN/USD exchange rates for the years 2022 to 2027:
| Year | Inflation Rate (%) | Exchange Rate (N/USD) |
|------|--------------------|-----------------------|
| 2022 | 15.3 | 873.32 |
| 2023 | 16.3 | 1015.18 |
| 2024 | 17.3 | 1190.97 |
| 2025 | 18.4 | 1409.75 |
| 2026 | 19.5 | 1684.16 |
| 2027 | 20.7 | 2031.86 |
The table unequivocally points to the continued depreciation of the NGN against the USD in the ensuing five years, culminating in an exchange rate of N2031.86/1USD by 2027. This signifies a substantial cumulative decline of 168% from the prevailing rate of N757.023/1USD in 2023.
Simultaneously, the data illustrates a progressive ascent in the inflation rate, projecting an increment from 15.3% in 2022 to 20.7% in 2027, signifying a persistent uptick in general price levels and a commensurate erosion of NGN's purchasing power.
However, it is vital to underscore that these results remain contingent upon certain assumptions and inherent uncertainties. Each method possesses its strengths, limitations, and reliance on specific assumptions and parameters, rendering variance in outcomes a possibility. Factors such as data quality, model specifications, external shocks, and structural changes may significantly impact the accuracy and reliability of these predictions.
Conclusion:
In this scholarly pursuit, we have endeavored to forecast the inflation rate and the exchange rate of NGN/USD for the years 2022 to 2027. Employing diverse methodologies and leveraging primary data sources, our results indicate a foreseen depreciation of the NGN against the USD, coupled with an inflationary trajectory.
However, it is imperative to approach these projections with judiciousness, recognizing the inherent uncertainties and the potential for deviations from the expected path. As the future is perpetually enigmatic, contingent upon multifaceted and dynamic factors, a vigilant and adaptable stance is advised when interpreting these forecasts for insights into the trajectory of the Nigerian economy and its currency. This article aspires to equip readers with essential perspectives for navigating the intricate domain of NGN/USD inflation and exchange rate dynamics.
Jamilu Sufi
Member, Professional Statistician Society of Nigeria (PSSN)
