Three months ago, the U.S. Dollar was one of
Nigeria’s scarcest commodities, priced at ₦500 in
the black market. Today, it trades below ₦400/$1, a drop initiated by aggressive dollar sales by the Central Bank of Nigeria (CBN) in the past
two months.
These
foreign exchange (FX) sales have been done via an unending series of auctions,
or “special windows”, as opposed to a general market sale. Most recently, the
CBN opened such a window for “Investors & Exporters” transacting in invisibles
(non-physical goods), with the aim of further boosting liquidity in Nigeria’s fragmented FX market. Unlike previous windows for Personal Travel Allowances,
etc., this “NAFEX” window
covers invisible transactions like loan repayments, dividend remittance, and
capital repatriation. In short, the primary beneficiaries will be foreign
portfolio investors i.e. foreigners participating in Nigeria’s financial
markets. Understandably, the culmination of these moves has triggered international attention.
With
dollars now readily available for most – to the point that banks are scrambling for naira to
fund their dollar purchases – we can ask the question: Are Nigeria’s FX
market woes over?
Hold the currency, no matter what?
To
answer this, we must first understand how we got here. After the 2014 oil price
collapse that decimated our export revenues and government finances, the CBN
resisted calls to allow the naira weaken. The apex bank decided to peg the
naira at artificial levels to deter inflation. Despite twoforced devaluations, the apex bank kept pegging the currency and
imposed various controls to
restrict who could buy dollars and for how much.
As textbooks would prescribe, capital fled from Nigeria. This merely
dried up supply in the FX market. The situation persisted through Nigeria’s
recession until the OPEC oil deal and rebound in our oil production increased
dollar earnings. Then the CBN started selling dollars again.
So,
for a long time, the FX market was the scourge of Nigeria’s economy. The
exchange rate became a national obsession, and it was all international partners wanted
to talk about too. And for critics of the CBN, the chosen policy stance merely
deepened Nigeria's recession. By their accounts, the recent loosening of dollar
liquidity is either unsustainable if oil prices fall, or simply too little, too
late. Regardless of your thoughts towards Emperor Emefiele, it is worth assessing the state of the FX market now. Does
the Emperor really have new clothes?
The merits of the CBN's choices
Looking
at where we are now, it is easy to understand why CBN Governor Godwin Emefiele
could be satisfied. He has managed to avert another devaluation and in doing
so, stop further inflation. Egypt,
often used in comparison after they floated their currency in November 2016,
experienced 31% inflation in March 2017. Pre-float, inflation was 14%. The
comparison is crude but shows the potential inflationary effect of a weakened
currency. Nigeria also experienced imported inflation in 2016 but to a
significantly smaller degree: Inflation pre-devaluation was 16%. By the turn of
the year, it was 19%. Considering the hardship caused by even this rise –
inflation was 9% in 2015 – it would be churlish to discount the “deflationary”
benefits of the CBN’s policies.
Meanwhile,
it's hard to assess the CBN’s FX policies without accounting for the Federal
Government’s (FG) long-term economic plans. As the Economic Recovery & Growth Plan suggests, the FG hopes to reduce
Nigeria’s import dependency and to develop self-sufficiency in essential foods
and petroleum products. Doing this will require a mix of FX demand management –
like the 41 banned items – and industrialisation. And though till recent
dollars have been scarce, the CBN prioritised industries that
would most serve this agenda.
Despite
these admissions, we will find that the FX conundrum is far from settled.
More windows. Same problems
Crucially,
the FX market remains fragmented. Previously, Nigeria was rumoured to have as
many as six different exchange rates. Now, the CBN itself has created a range
of sub-markets through “Special Windows”. Apart from this new NAFEX
window, there are windows for nearly every other reason for FX demand – personal travel, importing raw materials, and even importing petroleum
products. Besides, these sub-markets are all still controlled or heavily
influenced by the CBN, mainly because it is the primary supplier of dollars in
those windows.
With
all these markets – none of them “free” – it is difficult to ascertain the fair
value of the currency. This means that some devaluation risk persists. At the
same time, arbitrage is a major concern when multiple markets exist. The
combination of all these erodes confidence in the market, a precursor for the
reentrance of foreign investors.
And
make no mistake about it, for Nigeria’s FX woes to end, we need these
autonomous dollar suppliers. Foreign Portfolio Investors (FPIs) are the obvious
source and incidentally, are the presumed targets of this new NAFEX window. But
an additional window will not be enough to entice them. They will likely wait on the sidelines and observe trading activity at this
window, gauging liquidity levels and price discovery. Short of a full currency liberalisation,
the success of the NAFEX window may be our best hope of attracting more.
Only then, when the CBN is not the only relevant FX supplier in the market, can
we consider the FX debacle to be near its end. Nigeria still needs an FX
market, not a bunch of windows.
Source: StearsNG
