CBN Unveils new FOREX Policy - Nigeria

Finally!!! Details of the much awaited FX market structure announced in the May MPC meetings are here. The CBN has finally addressed its primary function to maintain stability for the country's price and money, issuing legal currency and maintaining foreign reserves to ensure the international value of the domestic currency. Other functions of the CBN include the promotion of a sound financial system domestically.

Let’s highlight “to maintain stability for the country’s price and money” and dwell on it a bit.
The National Bureau of Statistic released May 2016 inflation data. The consumer price index has jumped to 15.6%, reaching a 6 year high. Inflation touched 9.6% in January 2016, yes; it soared by ~5% in the space of 5 months. The purchasing power of consumers has taken a nosedive of 5% in less than half a year!

The hike in inflation was driven by the ripple effect of a weak FOREX policy, an increase in petrol price also driven by the exchange rate and a surge in food prices. A combination of 3 factors with a running theme – weak exchange rate policy.
At this point, we desperately needed a revitalization of FOREX plan and couldn’t afford to wait any longer.

Nigeria Floats the Naira

Nigeria’s central bank allows the naira exchange rate to be market- determined (a single market) with the CBN intervening when necessary to smooth out volatility . Meaning there is only one rate and one market; the Central bank will only step in when there are bottle necks e.g temporary scarcity or an oversupply. Unlike of the past system that maintained two different markets – the interbank and the parallel market. There is just one market, driven by demand and supply. The Naira will determine its price without artificial force. Market players are estimating a price range of N300 – N350 per Dollar.

Going by the forward contract which is an indicator of what the Naira is expected to trade at, the Three-month non-deliverable naira forward contracts closed at N310 per dollar. Unlike of the prior system, the interbank market is open to Authorised Dealers, Authorised Buyers, Oil Companies, Oil Service Companies, Exporters, End-users and any other entity the CBN may designate from time to time.

Inter-bank funds shall NOT be sold to Bureaux-deChange. And the forty-one (41) items classified as “Not Valid for Foreign Exchange”remain inadmissible in the Nigerian FX market.

What does it entail?
During the prior FOREX administration – managed float. The CBN governor mentioned that the volatility in the parallel market was driven by speculation.

Will the new FOREX policy mitigate that risk? Yes. Actually, speculation is not a bad thing. Perhaps, that is why people invest in the stock market and other hot money investment.

However, with this new system, there is room to officially hedge – that is speculate. “To further deepen the FX market, in addition to the already approved hedging products referenced in the CBN “Guidelines for FX Derivatives and Modalities for CBN FX Forwards”, Authorised Dealers are now permitted to offer Naira-settled non-deliverable over the-counter (OTC) FX Futures.”

Voila, so there is no need distorting the daily demand and supply to hedge, you simply take a long position (that is purchase dollar now at a future price).

Will this float have an impact on petrol prices? It depends on the price discovery of the Naira - what the market determines to be its true value. For the purpose of PPPRA petrol price calculation, petrol price was pegged at N298/$. If the true value of Naira is higher, it is left for the government to determine if there will be a further hike or the subsidy resumes. However, if the value of Naira is lower than N298/$, petrol price will most likely be reviewed.

Our eyes have been fixated on oil as a key source of FOREX for so long, that we ignored other sources in a bid to achieve an artificial price. Did you know that Foreign investment  proceeds was more than half of oil receipts? It is a key supply of FOREX.

Although, some of the inflow is fuelled by foreign portfolio investment - prone to quick exit in the case of a weak economy or a crisis. The beauty of a flow is its cyclical nature; as one exits another enters. This cycle should be guarded jealously as it helps balance the supply and demand chain. Rather have a continuous flow of foreign currency than a dearth of it.

With improved liquidity coupled with fiscal policy, the effects of a stifled economy due to shortage of dollars and incoherent policy begin to pale. The capital controls that hindered the flow of foreign investment and business environment has been displaced to kiss the economy back to life.

A year of unnecessary bleed to the economy is on its way to recovery. Nigeria is open for business.