International rating agency, Fitch, in a report issued recently noted that the backlog of unmet dollar demand has built up and any inability to clear significant portion of that backlog early in the transition would hinder the effectiveness of the new framework”.
History will be made as the Central Bank of Nigeria (CBN) finally commences the much-awaited market-driven flexible exchange rate regime to ease the foreign exchange (FOREX) scarcity in the country .This however is coming on the heels of various endorsements given to the policy by financial analysts who see it as the final solution to the volatility in the FOREX market. For the first time in 16 months, the naira will be left alone to face the push and pull of the forces of demand and supply.
Following the introduction of the policy, President Muhammadu Buhari explained that Nigeria needed it to boost its supplies of foreign exchange, adding that the country would need to radically increase its exports and productivity as well as improve the investment climate and ease of doing business.
The Vice President of Chartered Institute of Stockbroker (CIS), Mr. Dapo Adekoje has assured investors that uncertainty, which characterized the investment climate would soon disappear completely, adding that the new policy of the Central Bank of Nigeria on the FOREX has been endorsed by the International Monetary Fund.
This, according to him, would however bring about price transparency in the market. He said the reason why investors were leaving was the controversial exchange rate of the naira to convertible currencies but with this new development, the market will become the toast for foreign investors.
The Director-General of the Lagos Chamber of Commerce and Industry (LCCI), Muda Yusuf has described the new flexible foreign exchange framework as not surprising, stating “there will be significant improvement in the allocative efficiency of foreign exchange, supply of FOREX to the FOREX market will be enhanced as confidence improves, especially from the capital importation, export proceeds and Diaspora remittances.
There will be moderation in exchange rate as supply of FOREX improves , also the Federal Account will benefit from better revenues inflows from the CBN as sale of subsidized FOREX comes to an end, the policy is a major incentive to exporter as they will have unfettered access to their export proceeds. It would encourage exporters of Nigerian products, since they will now have better values to their exports.
By this development, the interbank foreign exchange market, which has been dead for some time now, is revitalized on unrestricted exchange rate basis, while the Bureaux de Change, BDCs, would continue their operations, thus creating multiple exchange windows.
Meanwhile the Bureau De Change operators are not satisfied with the policy which they say takes the market away from them to the banks. According to them, by adopting a single market structure, the apex bank solely recognizes the interbank as the only channel for foreign exchange supply to the economy.
Mr. Emefiele’s press conference in Abuja announced a series of measures to manage the new FOREX policy; these includes the introduction of FOREX Primary Dealers, a futures market to enable end users to lock down rates and 12 other measures to ensure transparency and stability of the new market.
By the new exchange rate regime, CBN would allow the Naira to float against the US dollar at the inter-bank market, rather than holding on to a fixed peg. What this means, however, is that buyers of foreign exchange for importation of goods, holiday, school fees, medical tourism, online payments etc, will have to source from the inter-bank market-determined rates and will no longer be able to buy FOREX at N199 or whatever official rate the CBN decides to adopt. By this development, the parallel market would have been suppressed, while there would be a near rate convergence among the different market segments except the special window.
It also means that round tripping and arbitrage have been curtailed. However, exchange rate is expected to spike, even as many dealers have already speculated that rates would go up by over 50 per cent. Analysts at Naira metrics said “It is unclear how this will work as the CBN will need to put a massive structural operational framework in place to ensure this works perfectly. “A market determined rate will also require strong regulations around a market that involves everyone with prices that are market determined. “One expects the black market to disappear as all you need to do is walk to the bank and ask to buy FOREX at the market rate.”
With this new thrust, policy decisions will impact the economy on several fronts
We expect current inflationary pressure will continue unrestrained as budgetary disbursement commences. Also, Interest Rate is expected to continue to hover at current levels with an increased double digit outlook. Likely increase in liquidity mop up through Open Market Operation in response to expected increase in budgetary spending. Naira will remain under pressure, as market forces adjust the fixed CBN’s clearing rate to a more realistic parallel market rate. There will likely be foreign exchange inflows from domiciliary accounts estimated at USD 20 billion as currency exchange risk minimizes and capital market activities expected to witness gradual recovery as foreign exchange risk diminishes, with the adoption of a more flexible exchange rate regime.”
However, analysts at Vetiva Capital Management expect inflation to spike in the near term. They said that “it is clear that the MPC has chosen its battle carefully, deciding to loosen one of the key impediments to economic growth (the FX illiquidity). Following from this, we expect the inflation picture to worsen in the near term as a result of the emergence of a new exchange rate to consumer prices. Like we had noted in our April inflation note, we expect inflation to recoil in 2017 from base effects. We believe this view could have further emboldened the MPC’s resolve to adopt the more flexible FX framework.”
A free-floating and weaker naira however won’t be just good news, it may fuel inflations, already at a six-year high, and force the Central Bank to raise borrowing costs, hurting those who can at least afford it ‘the poor’. The economy is going to struggle for the rest of the year partly owing to the delay in implementing a floating exchange rate.
Potential for too much use of expansionary monetary police
The downside of being able to conduct autonomous monetary policies has the ability to create higher inflation rates. Under a flexible exchange rate regime, expansionary or contractionary monetary policies can address recessionary or inflationary pressures respectively. Especially when the expansionary monetary policies are frequently used, higher rates of inflation flows.
Questionable stabilizing effects
Exchange rates change in the appropriate direction when the country’s inflation rate, output and current account balance change, especially in terms of current account imbalances, exchange rate determined in the foreign exchange market are supposed to change to prevent the occurrence of persistent and large current account deficit and surpluses. Therefore it seems flexible exchange rate do not change frequently enough to eliminate current account imbalances. An adverse effect of these misalignments is that they give deficit countries the motivation to impose trade restrictions
Pressure on CBN
The apex bank has been under immense pressures from the International Monetary Fund, IMF, some financial analysts and interests that represented foreign investors to devalue the Naira. The Buhari administration has until now resisted the calls, explaining that being an import-depending nation, it did not see how such a strategy would benefit the economy, arguing that the Nigeria economy would be worse off with a further devaluation of the Naira.
