ABUJA, June 15 (Reuters) - Nigeria's central bank said on Wednesday it would begin market-driven foreign currency trading next week, abandoning its 16-month fixed exchange rate policy and setting the stage for the currency to fall sharply.
Nigeria's central bank previously pegged the naira at 197 to the U.S. dollar but the currency trades at about half that on the black market. Interbank trading begins on Monday, Central Bank Governor Godwin Emefiele said.
The central bank will still be able to inject dollars into the market, giving it some control over the exchange rate.
Emefiele hopes opening up trading will ease severe U.S. dollar shortages caused by a slump in oil revenue.
With a likely sharp fall for the naira, Nigerian products will become relatively cheap and imports more expensive, which should stimulate the domestic economy but also lift inflation.
"To improve the dynamics of the market, we will introduce foreign exchange primary dealers who would be registered by the CBN (central bank) to deal directly with the bank for large trade sizes on a two-way quote basis," Emefiele told reporters.
Nigeria's stock market gained 3 percent following the announcement.
"It's a pretty important step in the right direction," Exotix economist Alan Cameron said. "Basically it amounts to a managed float, which is better than what most people were expecting. It's a pleasant surprise."
The central bank said eight to 10 primary dealers would supply the interbank market with dollars, handling minimum volumes of $10 million.
The primary dealers will be allowed to sell back 70 percent of any dollars bought from the central bank on the day of purchase. Sales must be backed by a specific customer order to avoid currency speculation, the central bank said.
Nigeria's retail currency operators will not be able to buy from the interbank market, meaning dollars will remain in scarce supply for private individuals and small businesses.
Emefiele also said the central bank would open a foreign exchange futures market to ease demand on spot trading, reduce volatility and give businesses the opportunity to hedge risks.
Africa's biggest economy, which contracted by 0.4 percent in the first quarter, faces its worst crisis in decades after the decline in oil prices and last year's introduction of a currency peg that prompted a large-scale capital flight.
"Over the long run, a weaker currency will help Nigeria's economy by encouraging import substitution and attracting foreign investors, who have shunned the country for fear of a devaluation," Capital Economics' John Ashbourne said.
"But the move will be painful over the short term. Higher import prices will add to inflation ... This will probably force the authorities to tighten monetary policy." (Additional reporting by Alexis Akwagyiram, Chijioke Ohuocha, Sujata Rao and Camillus Eboh; Editing by Louise Ireland)