POLICY ACTIONS MAY HAVE ADDED TO GENUINE REASONS FOR PANIC

The Central Bank of Nigeria (CBN) announced the closure of the official foreign exchange window in a move that suggest readiness to transit from the managed float exchange rate regime to freely floating the Naira exchange rate. In a press release dated February 18, 2015, the monetary authority declared that the retail/wholesale Dutch Auction System (rDAS/wDAS) foreign exchange window at the CBN (official market) is closed effective immediately. Henceforth, all demand for foreign exchange should be channeled to the interbank foreign exchange market, which hitherto accounts for between 80% and 90% of the foreign exchange market. It however stated that the CBN will continue to intervene in the interbank foreign exchange market to meet genuine/ legitimate demands. According to the announcement, the CBN argued that the precipitated decline in oil price and the consequent fiscal sustainability threat that this poses through the decline in the country’s foreign exchange earnings have driven significant wedge between the interbank and official exchange rates. This according to the CBN appears to be promoting unwholesome practices including roundtripping, speculative demand and at times spurious demand and hence inefficient use of scarce foreign exchange resources by economic agents. This situation has put untoward pressure on the country’s foreign exchange reserves with no visible economic benefits to the productive sector of the economy. This action, to the monetary authority, is therefore ultimately imperative as an appropriate action to avert the emergence of a multiple exchange rate regime on the one hand and on the other hand, to preserve the country’s foreign exchange reserves.

RECENT PEG ADJUSTMENT HAS BEEN LESS HELPFUL

The recent widening of the gap between the official exchange rate, the interbank rate and the Bureau De Change (BDC) rate is clearly unhealthy for an emerging capital market. The dynamics of the foreign exchange rates across the market segments reflected the precipitated pressure on the Official exchange rate market. The interbank market spread on the official exchange rate rose gradually in January 2014 and peaked at N9.58/ US$ above the official rate on February 21 2014 following the suspension of the erstwhile CBN Governor. It stabilized afterward with the assurance of the then Acting Governor to continue to use the foreign reserve to intervene and stabilize the market. The dovish tone of the new CBN Governor on assumption of duty in June resulted in the reversal in trend as the spread widened again through the third quarter and averaged N6.68/US$ above the official exchange rate. The end of the US QE in October 2014 which coincided with the precipitated decline in crude oil prices sent the spread spiraling upward and reach a record high of N18.69/US$ above the official exchange rate on November 21, 2014. That was the penultimate week to the Monetary Policy Committee (MPC) meeting in which the Naira was officially devalued by 8.38% against the US Dollar by adjusting the mid-point of the official peg from N155/US$ to N168/US$ as well as the policy band from +/-3% to +/-5%. Despite the official depreciation, the interbank foreign exchange rate remained well outside the policy range for the rest of the year and the pressure continued into the current year. The interbank spread reached an unprecedented level of US$33.75/US$ on the official exchange rate on February 12, 2015 as interbank rates crashed to as low as N205.6/US$. The interbank market’s trading were suspended twice last week when the psychological sell pressure levels per trading day were breached as the interbank foreign exchange rate depreciated below N200/US$ under intense trading. On those days, the official rDAS/wDAS rate was at N168.00/US$. It is important to note that an important factor in the recent pressure on the exchange rate is the heightened political risks following the postponement of the general elections scheduled for February 14th, 2015 by six weeks. At the MPC meeting of November 2014, in addition to raising the MPR and the CRR on private sector deposit to deal with the banking sector excess liquidity, significant market rules and restrictions were deployed to curb the suspected speculative activities in the foreign exchange market by banks and other foreign exchange dealers/agents. The daily net open trading position of banks was reduced to zero as a percentage of their shareholders value from 1% earlier. In addition, banks and foreign exchange authorized dealers/agents were restricted to resell unutilized dollars sourced from all sources- official and autonomous- to the CBN within 48 hours. These were preceded by the restriction of all frontloaded real import demand for foreign currency from the rDAS market by the CBN. Only restrictive sets of real sector transactions that are backed with evidence of shipment and for which Letter of Credit are cash-backed or with matured clean lines or matured bills for collections were eligible to use the official rDAS market. This restriction effectively transferred over 90% of foreign exchange demand in the country to the interbank and the unofficial segments of the market. The effect of these market actions included a push of sentiments into panic mode as foreign currency dried up in the interbank market and genuine foreign currency demand began to face serious challenges to be met. The challenges resulted in the communicated consideration by the Index Committee of the JP Morgan Emerging Market Bond Index (EMBI) to remove Nigerian sovereign assets from the index on the ground of increasing illiquidity of the foreign exchange market and difficulty of proceeds repatriation. It appeared that Nigeria was moving close to a capital account control regime. While the CBN responded to this factor by relaxing the restriction on banks daily net open trading position in foreign exchange to 0.5% of shareholders’ fund and expanded the number of days for which unutilized FX must be resold to the CBN to 72 hours, the pressure on the Naira exchange rate persisted.

THE FOREIGN EXCHANGE RESERVES HAVE NOT BEEN SPARED; BOLD ACTIONS WERE TRULY REQUIRED

The consequence of the surge in demand for foreign currency as highlighted by the unwholesome expanded spread in interbank and other market segments’ exchange rate on the country’s foreign reserves was obvious. Along the line, the monetary authority continues to intervene through the sales of foreign exchange to the market. Hence, the foreign exchange reserves have depreciated significantly, an estimated US$1.6 billion have been used up in the reserves to support the foreign exchange market. This trend therefore suggests that the foreign reserves is significantly threatened at a time accretion to the reserves is largely flat considering the oil market scenario and the lack of economic buffer to the nation. In the run up to this action, the CBN was believed to have discretely commenced sales of foreign exchange to the BDCs at a lower exchange rate than the official rate. The BDC segment which is supposed to serve the consumer/retail demands for foreign currency have been particularly affected in the recent past as the segment came under heavy regulatory oversight and supply crunch. The CBN however has had to increase the regulated weekly sales to the segment from US$15,000 per week to US$30,000 per week. There are 2,572 approved BDCs in Nigeria. This translates to an estimated weekly dollar provision in excess of US$77 million by the monetary authority per week. Where this trend is sustained, an estimated US$4 billion in one year in foreign reserves depletion is implied. A bold positive step in the right direction We have consistently argued that based on the adopted exchange rate mechanism, the impossible trilemma would continue to haunt the Naira exchange rate. Further relaxation of capital control with the reform of the rule on foreign portfolio investment in Naira assets in 2012 besides a regime of semi-fixed exchange rate and independent monetary policy would almost always backfire on the economy in periods of economic shocks. In this respect we support this move which is a major move towards a free float exchange rate regime. We recognize that this regime is the popular and/or best practices amongst most central banks globally. In this regime, the central bank is not openly obliged to provide foreign exchange liquidity to support an indicative exchange rate, although it can always intervene in the market by creating supply and/or demand when it feels that market rates are disproportionate from its perceived equilibrium level. To this extent, we consider this a bold and positive move and expect to see the Naira exchange rate gravitate to its market determined exchange rate level. In addition, this action would provide significant respite to the country’s foreign reserves as interventions could be systematically planned and focused on factors that are genuine rather than the compulsive responses in the previous regime that continued to bleed the reserves.

QUICK CLARIFICATIONS REQUIRED

Hitherto, the official window meets over 50% of foreign currency demand in Nigeria,