NIGERIA’S FLOATING EXCHANGE RATE SYSTEM, WHAT NEXT? -1

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It took the Central Bank of Nigeria (CBN) 16 months to succumb to domestic and international pressure to re-open the Foreign Exchange (FX) market after events bordering on illiquidity and difficulty in price discovery forced market players to unanimously abandon the market in February 2015. One of the major selling points for the CBN to yield ground was the idea that Foreign Investors would only return if an open market was in place, price discovery was easy and the naira was allowed to depreciate to market determined levels. From the sequence of events following the June 20 market re-opening, it appears the apex bank only attempted a lame shuffle to the tune of its critics and advisers alike but did not dance to the full song. Now it seems, they have to dance or the music will stop altogether.

Recently, the governor of the CBN and his deputy along with other members of the economic team, travelled to Britain and the United States to meet with foreign investors in a bid to allay fears about the nation’s economy and to win back their confidence. In other words, their mission was to “market” the nation and thus attract much needed Foreign Portfolio Investment (FPI) flows since it felt it had put in place a conducive domestic environment required to woo them back into Nigeria’s financial market space. However, the trip may not have achieved its intended purpose for a plethora of reasons as already summarised in the foregoing chapter. The CBN seemed to have underestimated the depth of comprehension of local markets by foreign investors. Our CBN’s mien can be related to the proverbial monkey whose showing off is limited to the confines of the forest.

Last week, in reaction to allegations from foreign investors about the level of transparency in the market, the CBN hastily nudged banks to allow rates move beyond the levels maintained since re-opening at circa daily CBN intervention levels (N280/$ – N285/$). Following this gesture, the naira rapidly depreciated by a further 9% during the week, after the initial 41% depreciation (or devaluation, if you will) that occurred after the new FX regime was announced and the FX market re-opened.  Furthermore, the apex bank released another directive to banks at the end of the week to begin to sell proceeds of International Money Transfers Operators’ inward money remittances to Bureaux De Change Operators (BDCs). Market watchers are already viewing this as a feeble attempt at preventing the parallel market rates from running away as the official rate struggles to play catch up and perhaps impress the foreign investors who view the parallel market rates (circa N380/$) as reflective of a more realistic value of the naira.

In like manner, recent activities in the Fixed Income market space suggest that the apex bank may be attempting to spice this market up with higher yields to attract foreign investment. On 18/07/2016, the CBN intervened in the market by requesting banks to provide 2-way quotes on securities. This activity led to a 300 basis-point rise in yields to current levels of 17% within just one trading session! This causes one to wonder if the CBN is actually making a concerted attempt to view the holistic impact of its actions. In a bid to portray attractive yields to potential investors who may not take the bait anyway, the apex bank may have inadvertently created another round of risk-free attraction to banks. Rather than lend funds to the ailing real sector at 22% with attendant provision requirements and other risks, commercial banks would prefer to continue to buy and hold securities at these high yields and maintain healthy profit margins, without playing one of their major roles to the economy – financial intermediation.

Today, the CBN holds its 4th Monetary Policy Committee (MPC) meeting for the current year. Although market expects that the CBN will keep the MPR unchanged at 12%, there is expectation that the asymmetric corridor of -5%/+2% may be changed, possibly to a symmetric corridor of -0/+5% in a tightening move indicating  banks could borrow from the apex bank at 17% as against current level at 14%. Another category of market watchers expect the apex bank to go more aggressive and tighten further by hiking its monetary policy rate by at least 200 basis points to 14%. Argument for this is that securities at 17% are currently trading at levels too divergent from the benchmark which is regarded as an anomaly. However, if the CBN leaves its benchmark rate unchanged, and refrains from further Open Market Operations (OMO) interventions, further purchase of securities at current yield levels could trigger a correction. Furthermore, depositors are pressing banks for higher rates on their investment which is currently much lower than the risk free rate for matching tenors. Banks are yet to cave in on this pressure despite the odds.

With inflation soaring higher at 16.5%, growth contracting further at -0.36% (all-time low) in Q1 2016 and private sector credit growth dropping to 2.7% in 2016 from 10.8% in 2015, only an insensitive central bank MPC would vote to hike its policy rate for a lame attempt at wooing foreign investor flows to stabilize its foreign exchange market. The apex bank must ask itself if its mandate is solely to maintain external reserves to safeguard the international value of the legal tender currency or whether it extends to performance of other major developmental functions, focussed on all the key sectors of the Nigerian economy including financial, agricultural and industrial sectors. One would expect this to extend to due consideration for the deficit (real) sector of the economy with specific focus on the availability of credit at affordable costs in order to enhance job creation and economic development. More-so, the contribution of these foreign investor flows has never formed the bedrock of supply in the FX market, but rather has always played a role of supplementary FX source for the nation.

O.H. (26.07.2016)