By Anayo Nwosu

In a rapidly evolving economic landscape where currency fluctuations have become the norm, Nigerian businesses are constantly weighing their financing options. One of the biggest dilemmas faced by companies is whether to borrow in foreign currency or stick to naira-denominated loans. While foreign currency loans often come with significantly lower interest rates, they carry a hidden danger—FX Volatility Risk—which has led to the downfall of many companies.

The Temptation of Foreign Currency Loans

Imagine a manufacturing company in Nigeria that wants to expand by acquiring new machinery from an overseas supplier. The cost of this machinery is $1,000,000, and the foreign supplier agrees to ship the equipment with a one-year payment plan, provided a Nigerian bank issues a confirmed letter of credit as a guarantee. The loan comes with an attractive 7% annual interest rate, much lower than naira-denominated loans, which range from 19% to 32% per annum.

At first glance, this foreign credit arrangement seems like a great deal. However, the real challenge lies in how the company intends to repay the loan. If the company does not earn in foreign exchange (FX), it will have to buy dollars with naira at the prevailing exchange rate—a rate that has been consistently rising.

Who Can Safely Borrow in Foreign Currency?

Foreign currency loans are only advisable for businesses that generate FX revenue. These include:

• Export-Oriented Manufacturers – Companies that export goods and receive payments in USD or other foreign currencies can safely borrow in FX, as their earnings match their liabilities.
• Commodities Exporters – Those trading in oil, solid minerals, agricultural products, and processed goods can comfortably service foreign loans.
• Freight and Logistics Companies with International Clients – Firms that bill clients in dollars or other foreign currencies are also in a better position to repay FX loans.

For example, companies that convert scrap metal to billets for export can handle foreign loans because they earn revenue in USD. Their income stream shields them from naira depreciation, ensuring that their loan repayment obligations remain constant in their earning currency.

Why Foreign Currency Loans Can Be a Trap for Many Businesses

Many Nigerian businesses that borrowed in FX without earning in foreign exchange have found themselves in dire financial straits. The major risk is the ever-rising exchange rate, which significantly increases the naira amount required to service dollar-denominated debt.

Consider this scenario:

• A company takes a $10 million loan when the exchange rate is ₦430 per dollar.
• The naira depreciates to ₦1,270 per dollar within months.
• The company now needs ₦12.7 billion instead of ₦4.3 billion to settle the same debt.

This is the devastating effect of FX Volatility Risk—a financial hazard that arises when a company’s liabilities in foreign currency grow uncontrollably due to currency depreciation. Many Nigerian manufacturers, airlines, and logistics firms have collapsed under this burden.

Expert Recommendations for Nigerian Businesses

Given the current economic realities, financial analysts strongly advise businesses to take proactive measures to avoid FX Volatility Risk. Here are key recommendations:

1. Never Borrow in Foreign Currency Unless You Generate FX Revenue

If a company does not earn in foreign currency, it should avoid foreign currency loans at all costs. No matter how low the interest rate appears, the unpredictable exchange rate fluctuations can turn a seemingly affordable loan into an insurmountable financial crisis.

2. Convert All Foreign Currency Exposures to Naira Immediately

Businesses that already have foreign currency liabilities should hedge their risks by converting their obligations to naira. The cost of borrowing in naira—even at 19% to 32% interest rates—is far more predictable than the uncertainty of a rapidly depreciating naira against the dollar.

3. Only Consider FX Loans When the Exchange Rate Becomes Stable

Foreign borrowing may become an option only if Nigeria’s exchange rate stabilizes. Until then, taking on FX debt is an unnecessary gamble that could wipe out a company’s financial reserves.

Final Thoughts

The Nigerian economy has witnessed the adverse effects of FX Volatility Risk firsthand. Many companies—especially in the manufacturing and logistics sectors—have folded due to their inability to manage escalating FX debt. Businesses must be strategic in their financing choices, ensuring that any debt obligations are aligned with their revenue streams.

For now, the safest path for businesses that do not earn in FX is to steer clear of foreign currency loans and seek alternative financing solutions. The risks are simply too high in the current economic climate.