US interest rate hike threatens naira as investors eye safer dollar assets

By Uche Usim

The latest increase in interest rates by the United States Federal Reserve could put fresh pressure on the naira as global investors reassess emerging-market assets and consider moving more money into dollar-denominated investments.

The Federal Reserve, America’s central bank, raised its benchmark interest rate by 0.25 percentage points to a range of 3.75 per cent to four per cent, its first rate increase since 2023.

The decision, announced on Wednesday, was aimed at tackling persistent inflation in the US, but its effects are expected to be felt beyond the American economy, particularly in emerging markets such as Nigeria.

The development is important to Nigeria because the United States controls the world’s most widely used reserve currency. Changes in US interest rates often influence where international investors choose to put their money.

When interest rates in the US rise, investments such as US Treasury securities can become more attractive because investors can earn higher returns while taking relatively low risk. This can make emerging-market investments, including Nigerian bonds and equities, less attractive by comparison, particularly where investors are concerned about currency and economic risks.

For Nigeria, the major concern is that some foreign investors could reduce their exposure to naira-denominated assets and move funds into dollar assets.

Such a move could increase demand for the dollar and, depending on the volume of capital leaving the country, put additional pressure on the naira in the foreign exchange market.

The effect is not automatic, however, as investors consider several factors before moving their money.

These include the returns available in Nigeria, the stability of the foreign exchange market, inflation, economic growth, government policies, the availability of dollars and the overall outlook for the Nigerian economy.

But the US rate increase could make the competition for foreign capital more difficult for emerging economies.

For instance, an international investor holding a Nigerian government bond may compare the return from that investment with what could be earned from a US Treasury security. If the return on the US asset becomes more attractive after adjusting for risk, the investor may decide that holding the dollar asset offers a better balance between return and safety.

This is why changes in US interest rates can affect currencies thousands of kilometres away from America.

A stronger dollar can also create problems for countries such as Nigeria because many international transactions, including the purchase of crude oil equipment, machinery, raw materials and other imported goods, are conducted in dollars.

If the dollar becomes more expensive against the naira, Nigerian importers need more naira to buy the same quantity of goods.

Companies with dollar-denominated loans could also face higher repayment costs when converted into naira, while businesses that rely heavily on imported inputs could see their operating expenses increase.

Consumers may eventually feel the impact if businesses pass higher import and production costs on to the prices of goods and services.

The impact on Nigeria’s currency will nevertheless depend on developments within the domestic foreign exchange market.

Nigeria has several sources of dollar inflows, including crude oil earnings, diaspora remittances, foreign investments and other external receipts. Higher inflows can help offset increased demand for foreign currency and provide support for the naira.

The country’s foreign reserves and the Central Bank of Nigeria’s management of the foreign exchange market will also remain important in determining how much pressure the currency faces.

Another factor is the interest-rate differential between Nigeria and the US. If Nigerian assets continue to offer significantly higher returns than comparable US assets, some investors may still find the Nigerian market attractive despite the increase in American rates.

However, higher returns usually come with higher perceived risks, meaning investors will consider not only the interest they can earn but also the possibility of currency losses.

For example, an investor may earn a high return on a naira investment but lose part of that gain if the naira depreciates significantly against the dollar before the investment is converted back into foreign currency.

This makes exchange-rate stability an important part of Nigeria’s efforts to attract and retain foreign capital.

The Federal Reserve’s latest decision therefore presents both a global and domestic challenge for Nigeria.

The immediate issue is whether the higher US rates will encourage investors to move more funds into dollar assets and away from emerging markets. If that happens on a significant scale, countries such as Nigeria could face weaker capital inflows and greater demand for dollars.

Reuters reported that the dollar strengthened following the Federal Reserve’s decision, while investors continued to assess the direction of US monetary policy and the possibility of further rate increases.

The development comes against the background of continued concerns about inflation in the US, with the Federal Reserve keeping its inflation target at two per cent.

For Nigeria, the bigger concern is not simply the US rate increase itself, but what it means for global investment flows.

A prolonged period of relatively high US interest rates could make it more expensive for emerging economies to attract foreign capital, particularly where investors have concerns about currency stability.

Nigeria would therefore need to continue strengthening confidence in its foreign exchange market, improving dollar liquidity, attracting stable foreign investment and maintaining policies that encourage investors to keep their money in the country.

The latest US rate decision underscores how closely Nigeria’s financial markets are connected to developments in the global economy.

While a US rate hike does not automatically mean that the naira will weaken, it can increase the pressure on the currency by making dollar assets more attractive and potentially encouraging investors to favour the safety and stability of the US market.

The direction of the naira will ultimately depend on how these external pressures interact with Nigeria’s own economic fundamentals, including foreign exchange supply, oil earnings, inflation, interest rates, reserves and investor confidence.

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