7 ‘unexpected’ lessons learnt from the CBN FX Windows

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Back in February 2017, the Central Bank of Nigeria opened a window that allowed retail buyers access forex for invisible transactions, at N366. To ensure that sufficient amounts of forex got to the end users outside the banking system, the CBN also boosted its supply to the BDC segment.

Just recently, it was revealed that the CBN Investors and Exporters window recorded a whopping turnover of $3.8 billion since it was opened in April. The CBN opened this window specifically for investors and exporters, enabling them to transact at a price determined solely by market forces. Prior to the introduction of this window, forex transactions were based on prices set by the CBN. This limited the amount of forex inflows into the financial system.

If there is any silver lining in the somewhat haphazard handling of Nigeria’s FX market since the onset of the drop in oil prices in 2014, it is the fact that the CBN has somehow found a way to stabilize the forex market. This event may indeed soon become case study material for students of economics to learn from.

The following are some vital lessons that we believe could be learnt from developments in the FX market.

Free market is king – Call it what you like – full float or semi float, but allowing the market to determine the price of the currency is still the best policy. However, in Nigeria’s case, giving consideration to its peculiarities, it is perhaps wiser to do so with a lot of caution. Unlike Egypt – which introduced an unconditional full float of the Egyptian Pound and reaped record levels of inflation as a result, the CBN took a controlled and measured approach to the Naira float, beginning with the investor window, which although is smaller in terms of participants but now snowballing in terms of transaction volume and value. When this window launched initially, it relied on the black-market price as a benchmark for setting its prices, since that was the closest to market price. As the market developed, the market relied on demand and supply to determine its prices, forcing the exchange rate to strengthen below the black-market price. For free markets to function properly, Nigeria needs to get its supply model free from regulatory meddling focusing only on policies that encourage foreign investments into the country.

Black market is not the problem – For years, Nigerian authorities have come to loathe the black market, blaming them for enabling “illegal” sale of forex across the country at prices other than the official exchange rate. The CBN at some point toyed with the idea of getting operators arrested for selling FX on the streets. Black marketers still coexist today with all the official channels.

Fixed currency does not fix the problem – The FX price convergence event has also told us that for a country’s exchange rate to be properly priced, fixing the price only goes so far, before prevailing macro-economic events begin to take their toll. The CBN fixed the exchange rate at N197 between December 2014 and June 2016 as it maintained for months that the black market was not a measure of the true value of the naira. The lack of adaptability of the CBN to the developing macro-conditions was one of the many triggers for the country’s economic recession. Even though the CBN still fixes the retail purchasers window at N368, the reason for the exchange rate convergence between this window and the parallel market has more to do with improved supply rather than the fixing of the exchange rate.

Supply was the big elephant – We have also learnt that for Nigeria to have a stable FX market, we will need to have a steady and sufficient flow of FX to the retail end of the market. A review of forex sale at the BDC segment in 2016 showed that only $58 million was sold in the whole of 2016 compared to $3.9 billion in the first two quarters of 2017 alone. The scarcity of dollars more than anything else was responsible for the depreciation of the naira, widening the disparity between the official and exchange rate to as much as N200 at some point. It is important to also note that one of the key reasons why supply diminished last year was due to the negative effects of pipeline vandalization by Niger Delta militants. As vandalizations seized and production resumed, Nigeria’s exchange rate earnings improved considerably.

Speculators were not the problem, CBN was – Another punching bag of the CBN last year, was a set of people referred to as speculators. These are players who profit from market volatility, buying low and selling high. They have patient capital and can take significant risks for short term gains, and do not care if it affects the local market. While market speculators are not typically seen in good light, they are only carrying out legitimate actions propelled by the profit opportunity brought about by a rigged system. By holding a fixed rate for too long, the CBN created a huge chasm between the official and parallel market, allowing speculators to profit from and worsen the situation.

CBN prioritized higher interest rates – One other thing the CBN has been doing lately is mopping up excess liquidity (cash) by selling treasury bills and other securities at rates that are very attractive to investors. The idea behind this move is that exchange rate pressures would reduce if there was fewer naira chasing the available dollars. While this has so far worked out as planned, it does not particularly work for small businesses looking to borrow money from banks at moderate interest rates.

41 banned items still an elephant – The CBN had been adamant about lifting its ban on the 41 import items prohibited from accessing the official forex market. Critics have blamed this stance as one of the factors that worsened the FX situation and the economy to a larger extent. The CBN eventually caved in sometime in May, lifting a ban on select items from that list after pressure from the Manufacturers Association of Nigeria. The rest of the items still banned from accessing the forex window remains a determining factor in Nigeria’s FX supply and demand dynamics. For now, the CBN may be winning due to lower consumer demand which has made imported goods highly unattractive. One day, the chicken will come home to roost.

 

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