The Dawn of a New Forex Regime


With the new forex regime, market forces will now determine exchange rate

The introduction of a flexible foreign exchange framework by the Central Bank of Nigeria has opened a new vista of opportunities in the economy, but not without the initial pains, write Kunle Aderinokun, James Emejo and Olaseni Durojaiye

Expectations of a possible reflation of the economy was rekindled as the Central Bank of Nigeria (CBN) announced the much-anticipated flexible foreign exchange policy believed to be crucial in bringing stability to the troubled naira as well as incentivising foreign investors who had stayed away over concerns that the local currency may be “over-valued”.

In its bid to reset the foreign exchange landscape to reflect current realities, the apex in the new forex framework decided to among other things allow the local currency to float freely in order to find its true value through the activities of market forces of demand and supply, although the CBN also made it clear that it would intervene in the market whenever appropriate.

The release of the new framework came after three weeks of due diligence and consultations with stakeholders particularly the banks on the need for a more flexible forex market to among other things to reduce pressure on the local currency and incentivise foreign investors as concerns mount over the deteriorating development in the macroeconomy.

Amid galloping inflation, the country economic fortunes have plummeted as GDP growth rate in the first quarter of the year came out negative, signalling a trajectory into a possible recession. Also, unemployment had also been on the rise while foreign trade further recorded a negative balance in the first quarter.

Nevertheless, the new forex framework which comes into effect tomorrow will allow a single market structure through the inter-bank/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.

CBN Governor, Mr. Godwin Emefiele, further announced that forex trading will now be undertaken by forex primary and non-primary dealers only distinguished by the volume of foreign exchange deals they transact while a single forex widow will be maintained.

Also, a significant aspect of the new policy is the re-emergence of the foreign exchange futures platform where forex seekers could front load their demands at a specified rate instead of a practice whereby forex is obtained and hoarded for future use because of fear of uncertainty, a development that continued to exert undue pressure on the local currency.

According to Emefiele: “I know a couple of people, particularly those who have matured letters of credit, who expect that they want to buy their foreign exchange would say what happens to the matured transactions? The important thing is that all backlog of transactions will be taken to the market for the clearance. And let me say this, the CBN has foreign reserve of close to about $26.5/26.7 billion-this is certainly substantially higher than the level of any demand that is in the market.

“And we are making efforts at the supply of forex in the market and we are also optimistic that the steps that we have taken today will help to further deepen the market and also get foreign exchange into the market. We are very hopeful that this will work. We are saying independently, the CBN is working to even ensure that we improve the level of supply on its own into the market. So those demand would be met at the market.”

Continuing, he added: “There’s no need for everybody to rush at the same time into the market: indeed, you may find yourself losing money when you rush into the market and take some emergency decision that will hurt you, hurt your profit, hurt your balance sheet and ultimately, if you are taking a bank loan, hurt your interest charges on your bank loans. We need to be very careful.

“And that’s the reason we’ve provided for you to go to the futures-take it easy, I repeat, take it easy, if you are not too sure, go to the futures, commit yourself to a rate, you’ll find a deal-all the bank’s will provide you with fx futures rate whether from one to nine months…so with that, you are able to go about business without necessarily bothering.

“We’ve committed ourselves to the level of guarantees to say, it’s like a bet-if the rate that you get eventually at the of your futures maturing is higher than the deal date, we will pay you the difference. But if the rate on that day is lower than the deal date rate, you’ll pay us the naira. We are just trying to say be calm, no need to worry, everything is well.”

However, the new flexible exchange regime is expected to rouse the appetite of foreign investors to put their funds in the economy as the naira finds it true value through market forces.

Analysts, Stakeholders React…

Expectedly, diverse reactions have been pouring in from operators in the economy. While majority hailed the new policy as impressive and opined that the CBN should be commended, the others plead for caution and argued that the policy was not a guarantee for inflow of FX through foreign investors.

Reacting to the new development in the forex market, President of the Manufacturers Association of Nigeria (MAN), Dr. Frank Jacobs, said the new policy was a welcome development and praised the fact that “It will enable manufacturers, traders and exporters buy foreign exchange at the same single rate.”

According to Jacobs, The new flexible foreign exchange policy is good. Going forward, there will be no more unnecessary fluctuations in the market. Besides, “It manufacturers, traders and exporters buy foreign exchange at the same single rate and I think the CBN should be commended for coming up with the policy,” he stated.

Likewise, applauding the latest development, Managing Director, Financial Derivatives Company Limited (FDC), Bismark Rewane, noted that, “it is a move towards equilibrium pricing…it is good for the market, it is good for the economy.”

Specifically, Rewane pointed out that the new policy “reduces distortion in allocation of resources in the economy,” enthusing that “it will lead to greater productivity, lower inflation and higher growth.”

Similarly, in his own reaction on CNBC Africa programme immediately after Emefiele announced the new forex policy, Head of Markets and Country Treasurer, Citi Nigeria, Bayo Adeyemo, stated that, “I am actually very delighted by most of the actions taken by the Central Bank of Nigeria; they are very positive for the market and very positive for the economy. I am not sure that investor could have asked for more actually.”

“Having said that, a lot of the actions will be hinged on exact execution because in the initial stage the banks will depend on the CBN for supply so the issue of backlog is very critical for the inter-bank to work very effectively until a substantial part of the backlog is cleared then the market will take its key from there. Essentially the intervention by the CBN at the initial will be very critical to the success of this new FX policy,” he however added.

Aligning with Adeyemo, Chairman of the Nigeria Economic Summit Group, Bukar Kyari, who also spoke on the CNBC Africa programme, stated: “It’s all good. For the first time in Nigeria, the CBN and we all are clear on issues of FX policy; we are more focused on the fact that we are going to have more liquidity rather than devaluation. Heritages such as FMDQs have been there for quite some time and they have been playing in that part of derivatives market and it is something that we should allow to grow and mature.

“The second thing is that , liquidity is going to be there for the market, people who have been holding off are now going to appear. I do see that this is the right move; there will be transparency because there were people who were talking about allocations and what is the basis of the allocations; all those discussions will be mute now.”

Speaking along the same line,Macroeconomics and Fixed Incomes Analyst of FBNQuest, Chinwe Egwim, noted that, “we expect the FX policy will provide liquidity to the market,” saying “This is a bold move by the CBN. It seems this will allow the interbank market come back properly.”

On the CBN governor’s assurance that the FX reserves, which stood at $26.5billion, could cover existing demands, Egwim said “the CBN’s willingness to fully participate by supplying dollars will be tested.”

To the Managing Director, Global Analytics Consulting Ltd, Tope Fasua, “this is perhaps the best option open to the CBN. Some have been clamouring for devaluation. The problem with a simple devaluation would be its arbitrariness. If the government had simply devalued the naira officially to say, N300 to the Dollar, we will soon discover that the pressure will return and they will have to devalue again.The approach they have chosen is to try and get out of the retail market.”

Also, an economist and former acting Unity Bank Managing Director, Mr. Muhammed Rislanudenn, was excited that the new framework will help foreign investors take positive decision on the economy.

According to him, “This policy pronouncement effectively means naira will be traded on a single exchange rate at market determined rate while CBN intervenes from time to time, albeit with weak reserve that can only finance five months of imports. Naira will no longer be pegged at artificial rate of 197 to a dollar.

“Open and transparent two way quote will help in dealing with speculators and rent seekers . Three months Forward non deliverable contracts have already surged to N333 per dollar according to Bloomberg. The policy is more like free floating currency. It will hopefully help foreign investors take positive decision and bring in liquidity into the market with medium to long term effect of bringing down the rates and also dealing with imported inflation.”

He said: “Note however that CBN have not committed themselves to any exchange rate. The new market will take effect June 20. One wonders why the economy was allowed to be so badly bruised for a whole year leading to stagflation and near recession before taking a right decision.”

In the same vein, an economist and research Analysts with a foremost economic advocacy group, Rotimi Oyelere, commended the apex bank for overcoming the blunders and pressures of not pegging naira at a particular rate (N280-N290) as anticipated by some stakeholders because it would have been extremely difficult if not impossible to defend such decision.

Sharing his thoughts with THISDAY, he said: “CBN has carefully dodged official devaluation of the naira but rather introduced more flexibility (not total) into the FX market. CBN intends to promote liquidity by boosting supply and equally promote financial security in the market. We cannot sacrifice security on the altar of promoting liquidity because in the long run we stand the chances of losing both,” he stated.

Continuing, Oyelere, however noted that, “There are few concerns that may require further clarifications. Like on what conditions would “CBN Interventions be, directly in the inter-bank market or through dynamic “Secondary Market Intervention Mechanisms” be based?”

He further predicted that investors may be a little cautious in the short run which may result in marginal rate increase at the parallel market and insisted that as the interbank market receives more liquidity, demand pressure on the parallel market will reduce thereby closing the gaps between the interbank market and the parallel market.

However, Managing Director and Chief Economist Africa, Standard Chartered Bank, Razia Khan, highlighted the implications of the new forex policy.

She said while the CBN’s apparent embrace of currency flexibility was positive, “macroeconomic concerns are likely to persist.” According to her, “How Nigeria’s accumulated backlog of FX demand will be settled is not yet clear. The risk is that if all of this demand is brought to the newly established interbank market at the outset, the USD-NGN FX rate would come under significant pressure.

“By establishing guidelines for a futures market, the authorities may hope to settle some of this backlog gradually over time. With May inflation reaching 15.6 per cent y/y, there is likely to be limited desire for further significant FX volatility, even as the CBN embraces currency flexibility.”

Similarly, Khan pointed out that, “a second concern is the lack of monetary tightening accompanying the move towards FX flexibility.”

“With Nigeria’s FX reserves already pressured by deteriorating fundamentals, and oil output threatened by a new wave of Niger Delta militancy, raising the policy rate and sterilising excess liquidity in the money market may have provided a better defence of the currency. As things stand, Nigeria’s entire bond yield curve is currently negative with respect to headline inflation. This may make it more difficult for Nigeria to attract meaningful offshore portfolio inflows. It may also weaken domestic confidence in policy, eroding trust in the NGN. In the absence of accompanying tightening of monetary conditions, the move to FX flexibility – with a properly market-determined FX rate – might risk further currency overshooting.”

Furthermore, Khan posited: “A weaker FX rate will likely boost Nigeria’s receipts from oil revenue, and help contain the overall fiscal deficit. However, there are potentially negative implications. The foreign exchange exposure of the Nigerian banking system, given the preference for USD-lending in previous years, remains a key concern. A much weaker FX rate may initially bring loan deterioration, with higher system NPLs. Even in the presence of accommodative monetary policy, appetite for new bank lending may take some time to recover. The benefits of this policy accommodation, and hopes for an imminent resurgence in lending, may not be realised.”

In conclusion, the chief economist noted that, “Our projection is for Nigeria’s current account (C/A) deficit to widen further near-term. Falling oil output will be a key source of stress on C/A receipts. Even with currency flexibility, this is unlikely to be fully compensated for by other inflows, at least in the near term. Nigerian FX reserves will likely remain pressured. More will be needed to boost confidence in the new FX regime, ensuring its workability.”

Also, criticising the new policy, Executive Director, Corporate Finance, BGL Capital Limited, Femi Ademola, said the stringent requirements set before end users to access the fx market as well as the continued ban on the 41 items could limit intended success of the policy.

Otherwise, he said: “The new fx policy is very apt and in line with practicable monetary policy. It would help to reduce speculative activities and round tripping. Since the currency is not artificially supported (at least not visibly), it allows creativity in hedging against volatility and would be attractive to foreign investors.

“No deliberate devaluation is expected going forward hence investment planning and exiting has been significantly improved. However, the issue of stringent requirements to access the market by end users and the ban on some 41 products from accessing the market could lead to continued patronage of the black market.”

Furthermore, an Associate Professor of Finance and Head, Banking & Finance, Department, Nasarawa State University, Keffi, Dr. Uche Uwaleke, noted that as commendable as the forex policy appeared, it could further fuel inflation and cause the naira to further weaken in the short run.

According to him, “The value of the naira is likely to weaken in the short run since it is going to be determined by market forces in an import dependent economy with a shallow export base. Also, a further spike in headline inflation from the current 15.6 per cent should be expected to result from imported inflation. Again, the policy may hurt deposit money banks with a large portfolio of dollar-denominated risk assets as their non-performing loans may shoot up affecting their bottom lines and possibly leading to further retrenchment of staff. On the flip side, the flexible forex policy is likely to shore up forex reserve arising from possible increase in Diaspora remittances and foreign portfolio investments (FPI).

“An increase in FPI will bouy activities in the stock market. Some foreign companies/airlines that exited on account of capital controls may consider returning now that the controls are being relaxed. Similarly, Nigeria may get readmitted into the JP Morgan bond index. Also, the wide gap between the interbank and parallel market rates is likely to close reducing opportunities for round tripping and similar abuses in the forex market.”