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Nigeria’s FX market and CBN’s containment initiative

Nigerian News Update » Nigerian Newspapers
Daily Trust Newspaper
At the risk of being perceived as sounding alarmist, permit me to say that the Central Bank of Nigeria (CBN) has just averted a potential social upheaval because of its recent successful intervention at the foreign exchange market. At over N500 to a dollar, the exchange rate had crossed a very significant psychological mark. Left unattended or had the Bank approached the situation in the business-as-usual manner, it would perhaps have been only a matter of days for the Naira to lose its last and remaining attribute as a medium of exchange, having already lost its attribute as a store of value. 

Foreign exchange rate management in any economy that relies on a single product for its FX supply could be a very daunting task for its central bank.  In what had appeared as the helplessness of the CBN to halt the decline in the exchange rate value of the Naira against the dollar, it is not surprising that the recent success in halting the slide has elicited so much interest. The simple reason is that everyone can connect directly with the reality of a failing currency than they can with say, movements in the balance of payments. 

This direct impact is a reason people can take to the streets in protests as has happened in Latin America and South East Asia and Egypt, for example. We should be thankful that the temporary firming up of the exchange rate value of Naira has brought psychological relief as well as the potential for dampening of the inflationary pressures if sustained. For this we should note that it is a cycle; exchange rate is a significant predictor of inflation rate and output. 

Essentially, currency economics is not the preserve of the highly learned alone. In fact, an hour chat with an honest black market forex dealer opposite Sheraton Hotels in Abuja could cause even the economic policy maker or business analyst to begin to re-examine his models and knowledge of the workings of the economy. Expectedly, the recent policy actions of the CBN and the accompanying moderation in black market exchange rates are still being explained. For some, those I would refer to as the ‘highly vocal few’, it is simply another triumph of the market mechanism. And we must not deny the role of the supply side of the force in this regard. CBN has experienced an improvement in the supply of dollars as export volumes increased, thanks to the reduction in militant activity, along with improvement in crude oil prices.

To provide some context, in 2015, the Nigerian economy started to experience considerable slowdown in GDP growth. In attempt to stem the slide in GDP growth, the CBN in November 2015 introduced the so-called asymmetric corridor to encourage banks to lend to businesses rather than deposit monies with the CBN. This measure increased excess liquidity instead.  In 2016, the CBN hiked its benchmark monetary policy rate (MPR) to rein-in excess liquidity and ease the pressures on the Naira and inflation. Proponents of the market forces looked forward to an improved inflow of foreign investment, especially the portfolio investment. Foreign investment inflow did not happen as expected. Instead, the massive increase in the MPR served the immediate interests of the bankers who increased their deposits with the CBN, taking advantage of the two hundred basis point increase from 12 per cent in March to 14 per cent in July. It afforded them a second advantage of the re-pricing of their assets and extracting short-term gains, even as that would harm their fundamentals in the medium to long term, such as increasing the incidences of non-performing loans.

As it turned out, the pressure persisted, but the CBN had already boxed itself into a corner by the massive MPR hike: it could not move further up nor come down as speculators would have borrowed Naira massively and turned it to demand for the dollar. Matters got really complicated for the CBN by output contraction.  As the debate about how to stabilize the naira heated in 2016, the CBN, without interrogation of the demand side for FX, caved in to the very loud voices of the pro-market advocates by devaluing the naira from around N200/$ to N300/$ at the interbank segment hoping that by doing so, the currency would gain some stability. This didn’t happen; instead the premium or spread between the interbank rate and the parallel rate widened even as the Bank managed to keep the interbank rate at around N300/$. 

Proponents of market forces blamed the CBN for not acting on time, and for them the impact of the ‘ineptitude’ has become cancerous and never healing. The problem wasn’t just that the CBN delayed action - devaluation per se was simply not the correct remedy in the face of a fraudulent manipulation of the demand for FX. In this mess, the CBN further got itself hung by trying to operate a discretionary forex policy, which was good in intentions but impossible to implement in a market environment that was lacking both in discipline and integrity. The CBN it seemed at the time, appeared driven by interests both from within and outside it could not extricate itself from, pushed for the ‘expert opinion’ that the ultimate solution to the FX troubles laid squarely with the market forces of demand and supply.  In this highly lucrative business of ‘making money out of money’, bankers and speculators fell over themselves as the Naira slid. Banks in Nigeria make more money from FX transactions than any other single source. Some of the banks indeed make more profits from FX dealings than all other sources combined, particularly in periods of exchange rate instability such as we are currently in. They simply take undue advantage of the FX crisis and without any qualms even directly engage in outright sabotage of policy to make cheap monies which their owners benefit to the detriment of society. 

The CBN appears to have, in its recent measures, taken the view that we do not need to take the market forces of demand and supply as GIVEN. The reason being that what manifests as ‘demand and supply’ in most settings including ours, often emanate from organised manipulation of the market by a few selfish and unpatriotic expert voices for their gain.

As it appears this time around, the CBN has decided to become smarter than the market manipulators, by putting on its cap of authority to look beneath the market forces. The Bank has not only taken advantage of the improved supply of FX for which it has little control over, but has also interrogated the demand side of the FX equation. Immediately beneath the demand side is a pile of ‘fake’ demands for the green back. The hands of banks are up in the air in suggestive innocence as to who is funding the fake demand. Determined to stem the tide of embarrassment and rescue the Naira, the CBN has moved to pin down the demand for the dollar and regain oversight on payments for medicals, school fees and travels which used to be the immediate layer of the smoking screen. And marginal fraudsters have taken flight.

 So, much more than the extra injection of FX liquidity therefore, the determination of the CBN to track the demand for the dollar is what has produced the temporary halt to the decline of the Naira exchange rate. We should never be mistaken, it doesn’t matter how much the CBN injects under the manipulated market force of demand, if it is not followed by a DISINTERESTED supervision on the part of the CBN, including extra pressure being put on banks for greater accountability, the manipulators of the FX market will continue to win - they will simply drain the supply of FX and restore the regime of unending depreciation of the Naira. And the war has just begun; they will regroup.

The temporary reprieve for the Naira brought about by the new FX policy should not be taken for granted by the CBN as they exist more complex mechanisms for FX manipulation, especially by banks. There are other such manipulations like use of ‘in-house’ accounts by banks and multiple applications using the same documentation by customers, among other desperate strategies that even with BVN, extra efforts will be required by the CBN to detect them. 

The CBN should avoid rushing up the exchange rate value of the Naira even with significant improvements in the supply of FX. CBN cannot substitute for fiscal policy which policy effect will be the ultimate driver of the value of the Naira.

In the immediate CBN should, through the Ministry of Finance, seek cooperation and collaboration with the Customs and Shipment agents to track and determine the actual or genuine demand for the dollar on a continuous basis.  Government should look into the ‘dark room’ of import duty waivers and how they are administered as part of the strategy to sanitize the FX demand.
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