Nigeria’s “Managed” Floating Exchange Rate System – Restrained Freedom

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After months of local and international clamour, the Central Bank of Nigeria (CBN) finally allowed the re-opening of the Nigerian Foreign Exchange market under what it tagged a “Floating Exchange Rate system”. Hitherto, rapid local currency depreciation triggered by market illiquidity on the back of dwindling reserves and spiralling oil prices had forced market participants to reach a consensus to halt the market.

Following the market shut down, the Nigerian economy continued to haemorrhage billions of dollars as investors scurried back to the safe havens in usual fashion. Further foreign currency outflows followed from October 2015 as JP Morgan after a series of warnings proceeded to delist Nigeria from its Emerging Market Government Bond Index (GBI-EM). Nigeria had earlier been included in the index in 2012, based on the existence of an active domestic market for FGN bonds. This action saw another estimated $2bn flow out of the economy further denting the already battered foreign reserves. JP Morgan’s decision was obviously made with some reluctance considering that at the time Nigeria was included, the country’s sovereign bonds were offering yields of up to 16% compared to the GBI-EM Index average yield of 5.8%. Barclays was to follow in February 2016 to also delist Nigeria from its EM Local Bond Index.

When, the CBN announced its new FX guidelines and set 20th June, 2016 as the market re-open date, there were mixed reactions as on one side, Foreign Portfolio Investments (FPIs) saw the much awaited opportunity to re-enter a market that offers fixed income yields in excess of 14% at the long end of the curve, while Importers on the other hand feared for huge potential losses for their unmet demand. This fear came to quick fruition as the apex bank intervened shortly after the market re-opened with a 42% devaluation in its pricing to sell USD to end-users at N280.00/$ across various product segments as follows:

Product US$ ‘m
Spot       532.87
1m Forward       698.89
2m Forward    1,220.72
3m Forward    1,568.15
Total    4,020.63

Based on the foregoing result, $4bn of outstanding FX demand had been cleared out. The CBN was adjudged once again to have acted wisely as the re-opening of the FX market without clearing demand backlog was akin to attempting to ride a bicycle with a ton of rocks tied to its rear wheel. That burden would certainly need to be taken off to give the rider any chance of making progress.

Eventually, it was noted that the $4bn sale had not effectively cleared all outstanding demand as timing delays as well as delays in funding and documentation had prevented another estimated $1.5bn outstanding demand from being presented at the CBN’s maiden Secondary Market Intervention Scheme (SMIS) sales.

Going forward, conservative estimate shows that outstanding demand is already creeping back up towards the $4bn mark again just 3 weeks after the CBN action. This is despite the fact that even while some banks have stopped accepting fresh requests for import Letters of Credit,  the apex bank is estimated to have continued daily FX interventions since the market re-opened with an average of $50m to $100m in a concerted attempt to provide liquidity required to jumpstart the market. Like Lou Holtz former American football player, coach, and analyst aptly said, “It’s not the load that breaks you down, it’s the way you carry it”.

Furthermore, since the flag off of another brilliant initiative, the FMDQ OTC Futures market, we have seen market take up about $100m Non-deliverable forwards. A lot of local banks are still stuck up with documentation constraints thus limiting the volumes seen to date in the Futures market. Expectation is that this window will mostly be patronised by the Foreign Portfolio Investors (FPIs) as their investments begin to trickle in on the back of more favourable asset conversion price levels and a more flexible financial markets system. In addition, the Non-deliverable forwards initial curve priced at a discount (Backwardation) is very attractive to investors as it also offers the immediate opportunity to lock into exchange gains in addition to benefitting from higher yields available in the Nigerian Fixed Income market space on one hand, and lower asset prices currently available in the Equities market.

 

International Oil company sales as well as domiciliary swaps are also beginning to pick up since the market re-opened all contributing positively to the supply end of the market. Although there is broad scepticism with regard to whether or not the CBN will meet its initial 1-month forward obligation due on July 22nd, 2016, it is the opinion of the author that it is a gross aberration to even contemplate such a default. It is expected that the CBN will honour this obligation on due date rather than seek to explore the wild conjecture of a roll-over option which would be akin to an outright default.

Given the foregoing, one would be compelled to tentatively say the CBN with the help of the FMDQ (Financial Markets Dealers Quotation OTC Securities Exchange) and other stake-holders, has done a good job within its powers towards resuscitation of a sound financial system in Nigeria.

 

 

The Challenge,

Despite the foregoing, the CBN still faces perhaps its biggest challenge ever…the insatiable appetite for consumption of the average (empowered) Nigerian. Recall the mention of the rapid build up of conservatively estimated outstanding demand within the past 3 weeks to another $3bn to $4bn. This of course is regardless of the fact that a significant level of national demand is still being met at the unofficial market currently trading at N355/$ at the time of this write-up. It thus calls to wonder where all the local currency liquidity to effectively back up this demand is coming from, despite the fact that the CBN has effectively sterilised the funding for both spot and forward demands in the table above. Corruption, corporate reserves, personal savings, borrowings? Your guess is as good as mine.

Meanwhile, in the inter-bank Foreign Exchange market, liquidity remains a challenge with dealers providing quotes all anchored around the central bank intervention levels. Until liquidity levels improve, authorised dealers will continue to enjoy the freedom to trade albeit with obvious constraints in volume. Notwithstanding, in the new Foreign Exchange regime, businesses with foreign exchange interest can at least take solace in the relative ease of price discovery for their foreign currency assets and liabilities which hitherto was questionably available even if unrealistic.

In the coming weeks, observers will continue to watch the activities of the government both on the monetary and fiscal side to see what action(s) it will take on the payments/“demand” side of its Balance of Payments Report. For now, all focus seems to be on the receipts/ “supply” side. There is no gainsaying that if nothing is done to begin to check the ever-growing demand pressure in view of extant supply constraints, the naira will continue to remain under pressure in the near and medium term.

O.H. (13/07/2016)