Restoring Confidence in Nigeria’s Forex Market

By OBINNA CHIMA

In a bold move aimed at restoring confidence in the Nigerian economy, the Central Bank of Nigeria (CBN) recently announced the re-introduction of a market down two-way quote single interbank foreign exchange market.

Emefiele

The Policy which came three weeks after the Monetary Policy Committee’s (MPC’s) decision to adopt a flexible exchange rate system, allows the exchange rate of the naira to be determined by the market forces of demand and supply, although the Central Bank would step in whenever appropriate.

It has been hailed by market analysts, rating agencies as well as multilateral institutions across the world as a true path that would help heal the Nigerian economy, which has been hit by lots of macroeconomic shocks. The new forex policy has also been received by investors as the stock market has maintained an upward trend since its announcement, which naira appreciation has been stimulated.

The new guidelines came after weeks of consultation with stakeholders, including the banks, on the need for a more flexible forex market, to among other things, reduce pressure on the local currency and attract foreign investors.

Nigeria Stock Exchange

CBN Governor, Mr. Godwin Emefiele, said the Central Bank had resolved to henceforth deal with FX Primary Dealers (FXPDs) under the new arrangement. He also said the existing ban of 41 items from accessing forex from the official window would remain in place.

He said part of the objectives of the new framework, which included the introduction of the naira-settled Over-the-Counter (OTC) FX Futures trading, was to discourage people from front-loading or hoarding forex due to uncertainty. He also assured the markets that the backlog of matured letters of credit would be cleared. Emefiele said the new forex framework would allow the market to operate as a single market structure through the interbank/autonomous window, while the exchange rate would be purely market-driven using the Thomson-Reuters Order Matching System as well as the Conversational Dealing Book.

He said the CBN would however participate in the market through periodic interventions to either buy or sell forex as the need arises.

The CBN governor said to improve the dynamics of the market, the Central Bank would further introduce FX Primary Dealers (FXPD), who would be registered by the CBN, to deal directly with the bank for large trade sizes on a two-way quote basis. He said the primary dealers would operate with other dealers in the interbank market, among other obligations that would be stipulated in the Foreign Exchange primary Dealers (FXPD) guidelines.

According to him, selected FX Primary Dealers would be notified as at June 17, 2016 on the new guidelines while all other non-primary dealers would remain valid and eligible to participate in the market. He said interbank trading under the new guidelines would begin on June 20, 2016, while tenors and rates for the naira-settled OTC FX Futures would be announced on June 27, 2016.

According to Emefiele, “The big point here is that we’ve decided that the CBN will deal primarily with what we call the foreign exchange primary dealers. We will have non-primary dealers and primary dealers.“The guidelines for the qualification for being a foreign exchange primary dealer would be on our website. There are a number of qualifications, either the size of the bank, or the size of forex transactions it had done before, the level of liquidity, the extent to which those banks have complied with CBN guidelines, regulations in the past and their level of preparedness in terms of being able to provide all the soft and hardware that is needed to operate in a very transparent manner that can handshake with the Thompson Reuters and FMDQ software – these will be the basis.”

Emefiele said based on what the Central Bank had published the level of trades as a primary dealer would be set at a minimum of $10 million. “So what that means is not about talking about the standard trades of those days when a dealer said it’s about $100 and you say, I close on you for $100,000.

“Now, we are talking about a minimum of $10 million and to do that, you have to have strong capacity; you must have prepared yourself, you have to be ready to play with the highest level of professionalism and transparency and nobody is going to take any nonsense from you if you decide to breach the regulations or guidelines.

“And that’s the reason I said we will expect those who are going to deal here to be people who can deliver on their words. They must be people who understand the implications of whatever decisions they take regarding the size, talking of the volume and the exchange rate they decide to quote.

“It’s intended to ensure that we don’t have speculators, we don’t have rent seekers who just want to come into the market, particularly the primary market, to just come and start auctioning and staking on prices against each other for what I can call private benefits,” he clarified.

Boost for Economic Activities
The former Group Managing Director of the United Bank for Africa Plc, Mr. Philips Oduoza, described the move to a flexible exchange rate regime as positive for the economy. “This is one of the best monetary policy decisions in recent months and a very big commendation to CBN governor for this. It will turn around the economy rapidly,” Oduoza said in response to an enquiry.

On his part, the Managing Director/Chief Executive, Cowry Asset Management Limited, Mr. Johnson Chukwu, expressed satisfaction with it, saying that a flexible exchange rate would provide opportunity for inflows from other sources other than crude oil sales. According to him, the decision to allow foreign remittances to be converted at the interbank rate as well as inflows from foreign investment would help to address the disincentive that operators and other players in those areas had witnessed in the last couple of months, forcing inflows from those sources to dry up.

“So I expect that in the medium-to-long term, but not immediately, we should begin to see improvement in inflows from other sources. I want to believe the federal government would back this up with other fiscal policies, particularly as it relates to investments and in an area like infrastructure by making the infrastructure sector attractive for private sector investments. “That would now help drive inflows. But what the Central Bank has done was most expected. I think clearly, in the medium term, it would help open up the economy and help stabilize the exchange rate,” Chukwu said.

The Head of Research at SCM Capital Limited (formerly Sterling Capital), Mr. Sewa Wusu, described the decision by the Central Bank as a positive and good move for the economy, adding “Although it was delayed, it is better now than never.”

“We have seen the impact of that delay on the market and by extension the economy. All the same, the adoption of flexibility around the interbank market is a policy that would help bridge the gap that had existed in the forex market in the past, particularly the gap between the official and parallel markets. We expect that gap to fizzle out.

“Now what has been adopted is more or less a floating exchange rate, which entails that we would see the interplay of demand and supply. That would by extension determine the true value of exchange rate in the country. What that means is that businesses would be able to plan with respect to their forex requirements and that is very critical. It would also help reduce the volatility we have seen the market over a long period of time.

“Also, the introduction of the futures market is a positive one. It would allow for demand to be met and apart from that, you can also hedge in your transactions. So that would help for proper business planning,” he said.

However, Wusu expressed concern over forex supply in the market considering the weak value of the country’s external reserves. In a note, London-based Economist at Exotix Partners LLP, Alan Cameron, said judging from the statement, the CBN would keep the bulk of its intervention for the NDF market (forward market) while futures would also be introduced, with FMDQ acting as the platform.

“Overall, this looks like quite a bold step towards liberalization – and certainly better than many investors’ expectations (and our own), who have seen many false dawns before. The key feature here is that the multiple tiers/layers have been removed – the sub-text of this decision that the President (Muhammadu Buhari) has finally recognized that multiple tiers lead to arbitrage, and arbitrage creates opportunity for fraud. Reading a bit deeper into things, we are also tempted to conclude that this is a sign of Buhari handing the reins of the economy (back) over to his ministers,” he added.

Also, analysts at Ecobank Nigeria stated that CBN’s actions were aimed at unlocking the interbank foreign exchange market that hitherto has been inactive due to challenges arising from sustained low oil prices, low level reserves and strong import demand. They however expressed displeasure over the continuous ban of the 41 items, saying: “While this move may help to conserve FX reserves, we believe that this policy measure is counterproductive and will continue to damage the economy via higher inflation, slower growth and FX market uncertainty given the concerns already existing about weaker oil production in the economy.

“While the CBN did not announce any exchange rate, it is our opinion that a new exchange rate will emerge from the interbank exchange market, which will likely be above the current rate of $1:N197, at which the CBN has been selling dollars to banks. We think this rate is initially likely to be around $1:N285-320 as pent-up demand for dollar is released onto the market. Over time, the move is likely to increase the supply of US$ liquidity to the interbank market as remitters and exporters are likely to be more willing to sell dollars at the interbank rate.

“Similarly, we believe that investors who have been sitting on the sidelines for fear of not being able to get dollar out of the economy will now be more willing to commit. Overall this greater flexibility will be positive for the economy as it will improve access to foreign exchange (albeit at a higher rate) for firms which have been struggling to buy hard currency.”

Also, Cyprus-based Research Analyst at Forex Time (FXTM), Lukman Otunugu, in a note on the new forex policy, said global markets received a pleasant surprise following the CBN’s “unanticipated decision to de-peg the naira against the dollar in an effort to revive economic growth. For an extended period, the incessant decline in oil prices has slashed the nation’s foreign exchange earnings, while the dollar peg heavily eroded reserves which simply pressured the nation further.

“With fears mounting that a recession could be pending in the second quarter amid depressed oil prices, the Central Bank’s move to de-peg the naira may have mitigated some concerns, consequently boosting sentiment. Although the naira may be set to depreciate to unfathomable levels as the natural forces of supply and demand determine its true value on the free floating exchange, this could encourage domestic import substitution, while re-attracting foreign investors. As of now, the CBN will need to act with haste by hiking rates, as ongoing naira weakness may punish Nigerians further while causing inflation to spiral uncontrollably,” he said.

The Head, Investment Research, WSTC, Mr. Tola Oni, said the new forex policy signposts the termination of a protracted period of constriction of trade and capital flows. The liberalization of the FX market will improve confidence in the CBN’s FX management and attract foreign portfolio and direct investments. The introduction of the FX OTC futures markets should subdue volatility in the spot market and foster appropriate planning of capital intensive projects in the real sector.

“The liberalization of the FX market is a necessary condition for a rebound of the domestic economy. Thus, we expect improvement in economic activities. However, we believe that the retention of the 41 excluded items from the FX interbank market (given the inability to meet demand through domestic supply) remains an inhibiting factor to the realization of the full economic benefits of an efficient market,” Oni stated.

IMF, Fitch Endorsement
The IMF and National Economic Council also endorsed the decision by the CBN to abandon its currency peg and adopt a flexible exchange rate policy, saying this was important to reduce fiscal and external imbalances.

IMF spokesman Geny Rice told a weekly news briefing that the fund wants to see how effectively the naira exchange market functions once the new float system is put into effect. I think the announcement to revise the guidelines for the operation of the Nigerian interbank foreign exchange market is an important and welcome step,” Rice told reporters. “It will provide greater flexibility in that market, the foreign exchange market.

“As we have said before, a significant macroeconomic adjustment that Nigeria urgently needs to eliminate existing imbalances and support the competitiveness of the economy is best achieved through a credible package of policies involving fiscal discipline, monetary tightening, a flexible exchange rate regime and structural reform,” Rice said. "Allowing the exchange rate to better reflect market forces is an integral part of that.”

In the same vein, one of the leading global rating agencies, Fitch Ratings joined other institutions and agencies in endorsing the decision of the new forex policy, saying the shift to a more flexible foreign-exchange regime could aid the country adjust to lower oil prices and support growth. But Fitch stressed that implementation may present challenges if not properly managed.

The agency, in a statement, explained that establishing the new framework’s credibility will be the key to its effectiveness in attracting portfolio flows and Foreign Direct Investments (FDIs) to make up for lower oil export receipts.

Continuing, Fitch Ratings stated that the CBN’s previous policy of restricting access to the official FX market and supporting the naira, rather than risk the inflationary impact of devaluation, has been negative for Nigeria’s sovereign credit profile. It also pointed out that defending the naira has lowered reserves and increased external vulnerabilities, while a shortage of hard currency has weighed on the non-oil economy.

“Even so, the CBN will probably have to deploy a large portion of its international reserves during the first week(s) of implementation. It also reserves the right to intervene by buying and selling FX to smooth market movements, although it has made no specific announcements about trading bands or break points that might lead to intervention. Nigeria’s unorthodox FX policy has made raising external financing more difficult".

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