If you’re not a Nigerian, please stop reading and close this page. Thank you.
Ehen, now it’s just us Nigerians left, we need to talk about something important. Just because you fought for a policy for one year does not mean that your work is finished once the policy comes into being. This is not America where Barack Obama will say something and then the whole machinery of government goes into action to bring that thing to life. In Nigeria, there are demons. These demons can be sleeping for years but when they hear Nigeria has come up with a new policy, they spring into action and get really excited at the prospect of derailing the policy.
Why are these demons in Nigeria truncating policies but not in America? Well, I don’t know. But if you recall Rita from the Koko Mansion about 7 years ago — she addressed this point in a very profound way
We Nigerians, majority of us, we do demons
Cicero could not have put it better.
Think about it — Nigeria has had so many well-intentioned policies in the past only for them to end up as terrible disappointments. Why? Demons. And now that the naira has been floated and left to market forces, there will be demons.
But maybe if we try to identify the types of demons beforehand, we might have a chance of stopping them when they turn up.
Demon of Price-Fixing
This is the biggest demon that can scatter the market-driven exchange rate policy that started this last Monday. The people who have now agreed to float the naira are the same people who spent the last 1 year refusing to do so. Remember that nobody willingly floats their currency so just because someone agrees to something doesn’t mean they won’t try to disagree with it.
For people looking at the country from outside — foreign investors — the exchange rate is like a window they look through. If the exchange rate is fixed, they can’t see through the window which means they have to take a gamble and jump inside without knowing what’s going on. The rate (what you see when you look through the window) is not even that important. What is important is that you can see through the window. This was what was wrong with the N199 fixed rate — no matter what was happening in the Nigerian economy, the rate was N199. So people outside the country could not look before leaping into the country.
Remember — the whole point of this new exchange rate policy is to increasethe supply of dollars in the economy. That is 100% of what it is meant to achieve. If the supply of dollars does not increase, the demons have won and the policy has failed. And one of the surest ways to make this fail is to attempt to fix prices using all sorts of tricks such as someone in CBN calling bank treasurers and telling them not to bid above a certain amount. If that happens, people will know and they will stay away.
This demon is very deadly. Watch out for it.
Demon of Anti-Liquidity
Before this whole forex wahala started in 2014, the interbank market was trading around $300m every day. This $300m liquidity was not from the CBN. It was money going in and coming out of Nigeria from foreign investors, the diaspora etc. So imagine you’re an investor who wants to bring in $20m into Nigeria for a year, you look through the window and see $300m moving in the market every day. Forget the actual exchange rate —this gives you the confidence that when you’re ready to leave, you will be able to get your $20m out easily. So you jump in.
The moment CBN decided to fix the exchange rate stubbornly, that $300m liquidity dried up. People ran away and those outside could no longer see the Nigerian economy properly using the exchange rate as a window so they too stayed out. Again, the actual exchange rate does not really matter — what matters is that people can see how the exchange rate is cooked.
It was that liquidity that encouraged the JP Morgan Government Bond Index — Emerging Markets (GBI-EM) to come into Nigeria in the first place. The moment that liquidity dried up due to exchange rate price-fixing, they had no choice but to leave. The GBI-EM had a total size of $200bn. JP Morgan allocated 1.5% of it to Nigeria. This means the fund would have parked $3bn in Nigeria and left it there to chill. Nigeria needs to attract this kind of money back and the only way to do it is through liquidity.
On Monday, CBN cleared the backlog of $4bn that had built up over the last year. Because it was done by auction, banks had over N1.3trn debited from their accounts once CBN approved their bids (the clearing rate was roughly N280 to $1). Remember that these banks also have a lot of bad loans they are nursing on their balance sheets and the economy is generally weak. So when you add the N1.3trn sucked out of them on Monday, the banks don’t really have a lot of money with which to trade.
This problem has a solution and the solution is transparency. If you say you’re running a market-driven exchange rate system yet every day the rate never rises or falls below a certain amount, people will know you’re playing games. After putting padlock on the rate for 15 months, this week should have been wild with the naira bouncing up and down enjoying its new freedom before settling down after a few days. This has not happened. Maybe people are still wary and nervously observing things.
Just because a Nigerian politician doesn’t understand something does not mean he won’t have a strong opinion on it. In the last year, we have seen all sort of nonsense talk by politicians masquerading as roadside economists. These politicians have no clue how the exchange rate works but they know what the ‘correct’ exchange rate should be. When the exchange rate is not telling them what they want, they will start doing what they do best — using politics to achieve what they can’t through the markets.
They will start acting ‘feem’ for Nigerians maybe by summoning some people to the National Assembly to come and testify on one thing or the other on the exchange rate. Or just generally talking anyhow and sponsoring stupid articles in the newspapers (it only costs N5k or less). Before you know what’s happening, the policy has either been totally watered down or completely reversed.
This will be a good time for government officials to start coming out publicly to say they are committed to the new exchange rate policy to keep everyone calm. Or they can just shut up if they have nothing to say.
That is how to kill this particular demon.
Demon of Banning Things
Ideally, it would have been better for the CBN to remove the restriction on the 41 items from last year. Having banned items means that we will continue to have a black market with a different rate out there. This problem can be tolerated and is not the end of the world.
Where this idea of banning things starts to cause problems is in the gap between the official interbank rate and the black market rate. When this gap starts to widen, it is a sign that the economy is having headache and pains. Again, we saw what happened in the past year — slowly but surely, the gap between the N199 official rate and the black market almost got to 100%.
The black market is where people go when they can’t get dollars from the official markets. If the gap between the official and black markets start to widen, it means people cannot get from the official and they are now putting pressure on the black market. A useful rule of thumb is that the gap between both markets should not be more than 10% — so if the official interbank rate is N300, the black market should be no more than N330.
The way this demon will manifest is that if the naira comes under some pressure, there will be pressure to maybe even increase the number of banned items accompanied by noise about how ‘we can produce this is in Nigeria’. Don’t forget that the wider that gap, the more people will decide to play games where they take money at the official rate and sell it on the black market. Once this game starts, there is no end to it. Everyone will be doing it and the pressure will be too much to contain.
There are other small demons that don’t even look like demons. But those listed above are the main ones. One potential demon has already been put to the sword this week. When the CBN announced the policy last week, it released some arbitrary rules based on bank size to qualify as FXPDs. By those rules, only Zenith, UBA, Access, GTBank, Diamond and maybe Union Bank qualified to be FXPDs. But forex trading requires more than the size of a bank. For example, foreign banks in Nigeria like StanChart, Citi and StanbicIBTC will have access to forex from outside Nigeria but did not meet the size criteria that CBN set.
Naturally, banks complained and eventually CBN relented and allowed any bank to apply for FXPD status. This was probably a good thing. If there were only 6 FXPDs (all local banks), it would have been a lot easier for them to come to an ‘agreement’ to fix prices by not trading above a certain amount. It is harder (though not impossible) to fix prices with 15 or more banks. Demons can be killed.
Although the naira has been floated, the CBN reserves the right to intervene in the market using something called SMIS (secondary market intervention system). If it has enough dollars to burn, the CBN can enter the market using SMIS and flood the place with dollars using the iyalaya anybody principle. Again, this is not a problem per se. As long as it is done through the open market in a transparent manner, it will not disturb anybody from going out or coming in.
Why are foreign investors so important? Because when you are a poor country, it takes a lot of time for capital formation to happen. Without capital formation, there can be no investment in the economy. Remember that the vast majority of Nigerians are poor living on $2 a day. These are people who don’t have enough to eat let alone save money in the bank or in a pension.
Conversely, in rich countries, there is more money than opportunities to invest in. You can wait till you form your own capital. Alas, Nigeria needs roads, power and many other types of infrastructure today. So foreign investment helps to speed up that process considerably. But the money coming from rich countries belongs to pensioners and savers and has to be invested with care. Which is why it’s so important to do away with all our usual shenanigans and keep our word when we say we will do something.
Open your mouth and pray against these demons. Or just keep your eyes open and shout when you see the demons.
Article is obtained with permission from Feyi Fawehinmi. Follow Feyi on Twitter @doubleeph