At Last, Central Bank to Introduce Flexible Exchange Rate Regime

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Warns economy faces imminent recession, no quick fix to forex scarcity
Leaves interest rate unchanged at 12%
Blames economic woes on delayed passage of budget
Analysts caution against inherent abuses in forex window for ‘critical transactions’
James Emejo and Obinna Chima in Abuja

After months of resisting calls for the adoption of a flexible foreign exchange regime, the Central Bank of Nigeria (CBN) on tuesday finally bowed to pressure, stating that it would introduce greater flexibility in the interbank foreign exchange market structure and retain a small window for critical transactions for prospective investors.

It equally warned that the Nigerian economy might further contract in the second quarter (Q2) of this year into a full blown recession, as some of the conditions which led to the contraction in the gross domestic product (GDP) growth rate in the first quarter remained largely unresolved.

The Nigerian economy contracted by -4 per cent in the first quarter of 2016, signalling the deteriorating economic conditions in the country and its first economic contraction in 25 years.
The central bank added that the weak outlook for growth, which was signalled in July 2015 when it warned of the risk of a recession, could extend to the second quarter of 2016.
It blamed the delayed passage of the 2016 budget for constraining the much-desired fiscal stimulus, which edged the economy towards contractionary output.

Also yesterday, while citing limited options in an already tight fiscal environment and the need to allow previous monetary policy decisions to crystalise, the CBN resolved to leave the monetary policy rate (MPR), otherwise known as the interest rate, unchanged at 12 per cent with the asymmetric corridor at +200 and -500 basis points around the MPR.

Addressing journalists in Abuja at the end of the two-day meeting of the Monetary Policy Committee (MPC), the CBN Governor, Mr. Godwin Emefiele, said the central bank resolved to introduce greater flexibility in the interbank foreign exchange market structure and to retain a small window for critical transactions for prospective investors.

Emefiele’s statement aligned with President Muhammadu Buhari’s speech during his budget presentation before the National Assembly on December 22, 2015, that the central bank would consider the adoption of a more flexible foreign exchange regime.

Despite his statement, Buhari remained vehemently opposed to the devaluation of the naira and supported the currency controls introduced by the CBN, which are now partly to blame for the contraction in the economy.

Emefiele said in arriving at MPC’s decisions, the nine members of the committee, who attended the meeting, assessed the relevant risk profiles and came to the conclusion that although the balance of risks remained tilted against growth, previous decisions needed time to crystallise.

He said: “Consequently, in a period of stagflation, the policy options are very limited. To avoid complicating the conditions, the committee decided on the least risky option to hold.
“With the foreign exchange market framework now ready, the MPC voted unanimously to adopt greater flexibility in the exchange rate policy to restore the automatic adjustment properties of the exchange rate.

“Consequently, all nine members voted to hold and introduce greater flexibility in managing the foreign exchange rate. The bank would however retain a small window for funding critical transactions.
“Details of operation of the market would be released by the bank at an appropriate time.”
Emefiele stated that the committee had in July 2015, warned about the possibility of the economy falling into recession unless appropriate complementary measures were taken by the monetary and fiscal authorities.

He said: “Unfortunately, the delayed passage of the 2016 budget constrained the much desired fiscal stimulus, thus edging the economy towards contractionary output. As a stopgap measure, the central bank continued to deploy all the instruments within its control in the hope of keeping the economy afloat.
“The actions however proved insufficient to fully avert the impending economic contraction. With some of the conditions that led to the contraction in Q1, 2016 still largely unresolved, the weak outlook for growth which was signalled in July 2015 could extend to Q2.

“To this effect, today’s policy actions have to be predicated on a less optimistic outlook for the economy in the short term, given that even after the delayed budgetary passage in May 2016, the initial monetary injection approved by the federal government may not impact the economy soon, as the processes involved in MDAs finalising procurement contracts before the disbursement of funds may further delay the much needed financial stimulus to restart growth.”

Asked to comment on the way forward for the economy, he said: “I think basically, this has to do with the fact that the authorities certainly know what to do, but I think what is important is that one aspect that is largely contributory to the situation we find ourselves today is the delay in the passage of the budget.

“The delay in the passage of the budget has created a few distortions in the system. You can imagine a situation where a budget is passed in May, a budget that should have been passed in January or latest, February.

“And the Minister of Budget and National Planning has himself commented that this would be the last time that would happen.
“Basically, the important thing is to note that a lot of activities are predicated on the passage of the budget; when the money in the budget is available to be spent either for capital projects, construction workers can get back to work, roads can begin to be reconstructed again; people will buy gravel, sand, cement; labourers would earn money and it would engender consumer purchases.

“What you find is that consumer purchases plus other expenditure constitute close to 85 per cent of the GDP computation. I think all of us must have learnt from this bad experience. And I am hoping that going forward, we would work together to ensure that we are well coordinated to this objective.”
The governor further claimed that Nigerians are currently buying forex at a higher rate than the official price.

He said: “That is untrue. The central bank still sells forex at N197 to the dollar but unfortunately, the situation is that people are not able to get the quantum of dollars they need and I imagine that people can understand that this is because of what the central bank has in its kitty as the supply of foreign exchange is too inadequate to meet demand.
“So what we do is to provide what we have available and expect that those who require foreign exchange will resort to other sources.”

He further foreclosed expectations that the new policy on forex flexibility would translate to the resumption of dollar sales to bureau de change (BDC) operators.
“The flexibility we are talking about will be worked out and details will be provided in the coming days but of course, BDCs are part of the foreign exchange market.

“But I am not by any means saying that we are going to restore BDCs as in providing dollars from the CBN to fund BDC operations. They will continue to operate in the autonomous market,” he said.
He also threw more light on what he meant by supplying forex for critical transactions, stating: “There are people who would want to import plant and equipment to produce goods where raw materials are almost 100 per cent available locally.

“We would support such attempts by people to set up factories, foreign direct investment coming in, or even local direct investment coming in, if they want to import plant and equipment and their raw materials are almost entirely available locally.
“We will look for an opportunity to provide the incentives that they need to import the equipment so we can produce locally and stimulate growth.
“Of course, where we have people who are producing items where the raw material content is so minimal, naturally we would give them assistance.

“But purely it would be for raw materials with content that is very low in terms of the import requirement, not people importing almost everything from plant and equipment to raw materials.”
However, he said the committee recognised that the exchange rate is a very important macroeconomic variable, “which must be earned by increased productive activity and exports”, noting that the central bank had made very significant and satisfactory progress with the reform framework for the forex market.

“The committee was of the view that the current adverse global and domestic economic and financial conditions and the imperatives imposed by the demand and supply shocks to the domestic economy and considering the express intentions of government as enunciated in the 2016 budget, the policy must respond appropriately as the market continues to demonstrate confidence in the bank’s ability to deliver a credible foreign exchange market.

“Accordingly, the MPC decided that the bank should embrace some level of flexibility in the foreign exchange market. Given the imperative for growth, the management of the bank has been given the mandate to work out the modalities for achieving the desired flexibility that is in the overall interest of the Nigerian economy and when the implementation of the new framework would begin,” he said.
Commenting on the outcome of the meeting of the MPC, financial analysts expressed divergent views on the decisions reached by the committee.

Speaking in separate phone interviews with THISDAY, they however warned that the move by the central bank to continue to allocate forex to “critical transactions” could lead to abuse in the system.
The Deputy Managing Director at Acquila Capital Limited, Mr. Oyelami Adekola, said with inflation higher than the MPR, the decision by the MPC meant that the negative incentive to invest would continue.

“This is because when inflation is 13.72 per cent, higher than your MPR of 12 per cent, then there is a big issue. Except you are telling me that the inflationary pressure is temporary, which I don’t think is the case.

“That is because with petrol at N145 per litre and not likely to change and with importers not likely to get cheap dollars to import, that tells you that the inflationary pressure would continue,” he said.
In terms of the MPC’s pronouncement on exchange rate flexibility, Adekola said: “I think we don’t have any other option. With the MPC saying they are coming up with a flexible exchange rate structure, unlike what they have been doing which was all about attending to the demand side of forex, they are now attempting to address issues of the supply side.

“That is because when you devalue, investors – the foreign direct investments and foreign portfolio investments – that have been waiting on the sidelines before would start taking us serious and that will boost the supply of dollars. When you boost supply of dollars, it reduces pressure on the parallel market.

“I am sure they (MPC members) just want to watch out and see where inflation would go before they come up with measures to address the forex policy.”
Also, a top bank executive, Mr. Abdulrahman Yinusa, said it was good to reintroduce the autonomous forex market, which according to him had been squeezed because there was no freedom of price determination when all the transactions were being done at N197 or N199.

According to Yinusa, what the central bank wants to do is to create some liquidity in the forex market so that the price can respond to supply and demand, noting that the CBN cannot continue to subsidise forex.

“My only objection is the issue of still using the CBN rate for what they called ‘critical transactions’. There was no definition of what they called ‘critical transactions’.
“It was a loose definition and there should be clarity because before you know it, CBN officials may abuse it if there is no clarity. In our own opinion, we would rather have everybody use the autonomous rate and move on.

“I am also disappointed that they left all the rates unchanged. They didn’t change the CRR and MPR or even liquidity ratio. I am wondering why if Nigeria is almost heading towards a recession, nobody is trying to reflate the economy.

“Nigerians had expected this at this point in time; they should have taken a gamble and put some money into the economy so that it can grow.
“You cannot have an economy that is shrinking and you leave the interest rate unchanged. What they were supposed to do was to loosen liquidity.

“We have to decide what to do – it is either we grow the economy or we continue to look at those statistics and keep saying we are focused on inflation-targeting. The economy is shrinking, so we need to increase money supply to jumpstart the economy,” he said.

The Managing Director of Financial Derivatives Company Limited, Mr. Bismarck Rewane, described the decision by the MPC as a move in the right direction.
“Adopting a flexible exchange rate policy is what I have been talking about for a long time and everybody knows that. Now, the question of having a rate for critical transactions is a recipe for abuse and it should be discouraged immediately.

“Everybody should go to the autonomous market. The market structure has to be supported by market dynamics,” he said.
Also, the Head of Research at Afrinvest West Africa Limited, Mr. Ayodeji Ebo, said the decision by the MPC would excite the market, adding that it was a big shift from the past stance of a fixed forex regime.

“With the MPC attempting to adopt a flexible exchange rate regime, this would excite the market. I expect the equities market to sustain its positive form which was in anticipation of this flexible regime and fixed income investors would come back to the market,” Ebo predicted.
The Head, Research at Cowry Asset Management Limited, Edgar Ebinum, said that the current inflationary pressure would continue unrestrained as budgetary disbursement commences.
He also predicted that interest rate would continue to hover at current levels, with increased double digit outlook.

“We also expect the naira to remain under pressure as market forces adjust to the fixed CBN clearing rate to a more realistic parallel market rate. Also, likely foreign exchange inflows from domiciliary accounts estimated at $20 billion as currency exchange risk minimises.

“Capital market activities are expected to witness gradual recovery as foreign exchange risk diminishes with the adoption of a more flexible exchange rate regime,” he added.
The Lagos Chamber of Commerce and Industry (LCCI) also commended the decision of the CBN to adopt a flexible exchange rate regime.
The chamber said it believed the policy choice would help improve efficiency in foreign exchange allocation in the economy.

Director General, LCCI, Mr. Muda Yusuf, added that it would help address the distortions that currently characterise the forex market and bring the economy closer to equilibrium.
Furthermore, he said it would help to improve liquidity in the forex market; lead to a reduction in the current trade arrears; and reduction in the arrears for forex requests that have accumulated in the past 18 months.

“We also welcome the decision of the CBN to refrain from further tightening at this time. The current context is that the economy is contracting, unemployment is on the rise, manufacturing capacity utilisation has been weakening, and investor confidence has been at its lowest ebb. The decision not to tighten monetary policy is therefore appropriate,” he said.

However, Yusuf proposed that in moving towards a flexible forex regime, the CBN should adopt a transparent policy, which guarantees a level playing field for all participants.
He also pointed out on the need for clarity on what the CBN described as a special window for critical transactions for which preferential rates would apply.

“We would like to caution against possible abuse and distortions that such a window could create. It could pose a risk to the entire system. We would like to be assured that the window for the critical transactions will be managed transparently and in a manner that it will not create distortions in the economy.

“CBN should revisit the list of items that have been placed on the exclusion list of the forex market. Many critical inputs of manufacturing companies are on the list and this has crippled the operations of such companies creating significant job and output losses,” he said.