The New Naira-Dollar Exchange Rate Policy By Yomi Olugbenro

The Central Bank of Nigeria (CBN) has released the much-awaited guidelines for the operations of a Flexible Exchange Rate system in Nigeria. The CBN Governor, Mr. Godwin Emefiele, made the announcement on 15 June 2016 where he highlighted the key features of the new policy. This was followed by the release of three sets of guidelines. These provide a broad framework for operation of the new FX policy, primary dealership and workings of the OTC FX Futures market.

The new FX regime is a child of necessity. It’s the reality of our times. Nigeria has been under the weight of harsh economic realities that challenges the wisdom of this delayed intervention. Our foreign exchange reserve dropped from about US$42.8 billion in January 2014 to about US$26.7 billion by June 2016. With very little coming in from non-oil exports, our fate turned bitter with over 70% loss in FX earning from crude oil exports. Despite the fact that oil accounts for just about 10% of Nigeria’s GDP, it represents over 80% of our FX earnings. Crude oil price fell from a high of well over $100 per barrel to below $30. While price of crude experienced slight recovery towards the $50 mark, Nigeria is losing nearly half of daily crude production to vandalism. As the CBN Governor explained, our monthly FX inflow fell from over $3 billion to less than $1 billion.

To further complicate issues, demand for FX had risen astronomically over the years. Import bill was around N148 billion per month in 2005 when crude was sold at an average of US$50 per barrel. Fast forward to 2015, average import bill had climbed above N917 billion per month. The combined effect of all these multi-faced issues facing a mono-product economy meant the country was in deep trouble. In clear terms, dollar became a truly scarce commodity that it is.

Every measure taken by the CBN, (and there were many steps taken), provided only temporary relief. Daily limit to FX cash withdrawals from ATMs outside the country were introduced, some Banks later revised to different amounts. In August 2015, daily cash withdrawal from foreign ATMs was reduced to equivalents of $300. Annual limit on usage of Naira denominated cards, which was initially $150,000, was cut down to $50,000. Some Banks later stopped usage of Naira denominated cards abroad altogether. Customers were asked to get foreign currency denominated cards to continue to have unlimited access to their funds while abroad. Some Banks introduced Dollar Credit Cards to eligible customers. And lots more.

Available but limited official FX were allocated on priority basis and everyone scrambled for cover in the parallel market. Businesses with huge FX exposure suffered, some were forced to shut down. Profit and capital repatriation became a huge challenge due to limited availability of the green back.

While the Government held tightly to a fixed official exchange rate of N197/$, the parallel market almost climbed to $400. It was clear that mere devaluation will provide only a temporary solution. Many canvassed for a new fixed rate in between the official and parallel, some even hazards a guess of N250 – N275. If this route was explored, there would have been persistent need for shift in goal post. Sound economic practice suggest a full float where exchange rate is left to the interplay of market forces. Despite best efforts at taming the monster and preventing the potential hardship that may follow/persist, we finally bite the bullet. We have now embraced an automatic exchange rate mechanism with the introduction of a flexible inter-bank exchange rate.

Let’s do a quick recap of the new FX policy and highlight the salient features of the new regime.

1. The fixed exchange rate regime is gone for good! Naira-Dollar exchange rate is no longer to be determined by fiat. It will now be left to the full force of demand and supply interplay. By the time we wake up on Monday, 20 June 2016, when the new policy kicks in, you’ll no longer hear of 197/$ rate. How much will the opening rate be on Monday? Well, I can’t tell. But it will be something in between the closing parallel market rate and current official rate. Floating the Naira and leaving exchange rate to market forces is not without its downside, but there isn’t any policy without one.

2. The new policy provides a single market structure through the autonomous/inter-bank market. Autonomous/inter-bank market is not new to us; it was in existence before it got closed. Now we are back. A single market structure means absence of rent-seeking practice that was possible (and allegedly practiced) under the old order. Prior to now, when someone asked me what the exchange rate is, my answer is: it depends on where you sit! Then, there were at least 4 different rates, depending where you belong. Official rate of N197, Interbank rate of N199, “Official-Parallel” of N285 for PMS Price and Parallel Market rate of whatever. With this type of spread, it is absolutely unthinkable that human beings will not exploit the opportunities. If anyone is able to get FX at official rate of N197, the temptation of a potential 100% gain if sold in black market is almost irresistible. That’s probably no better-paying business around! Millions and billions of Naira could be made overnight! That’s just too cool to be left unexplored, not anywhere in the world!

3. The market is open to big players, FX Primary Dealers (FXPD), who would be unveiled by CBN tomorrow. These are players that will deal directly with the Bank for large trade sizes (like spot deal of $10m plus) on a two-way quotes basis. To be admissible to this privileged club, would-be-FXPDs must meet certain conditions. At least, two of the following conditions must be met. The minimum requirements include Shareholders Fund of ₦200 billion; FX asset ₦400 billion, and 40% liquidity ratio. The license is renewable annually and new entrants are to be considered during annual registration evaluation exercise.

4. FXPDs, other dealers, oil companies, oil service companies, exporters, CBN, authorised buyers and other end-users will operate in the FX market. Non-oil export proceeds will be sold in the inter-bank market and exporters will have unfettered access to their FX proceeds. CBN will make strategic interventions by buying or selling in the market, as occasion demands.

5. The inter-bank market is closed to Bureaux-de-Change (BDC). That’s a serious one for BDC operators! BDCs operators would need to rethink their business models as access to FX is not contained. Under the new policy, inter-bank funds will not be sold to BDC. Perhaps, BDCs are back to the days of street cash and last resort for transactions that inter-bank market won’t fund.

6. The infamous 41 items prohibited from official FX sources (transactions classified as “not valid for FX”) will remain inadmissible in the new FX market. This position is one that has rattled my head the most since the announcement of the new regime. Some will beg to differ with the rationale for excluding certain transactions in this new open market. Many agree that the list include laughable, mundane and shameful stuff that we spend our hard earned Dollar on. Some of the items should ordinarily be available locally, but are they? If an individual goes on ego-massage by importing tooth-picks, some will say: let them be. My main worry is the pressure that will continuously be piled on parallel market which is the only option left for importers of these items. With the limited FX available to BDCs (as you’ll see in the previous point), parallel market may remain under pressure.

7. Another interesting bit is the introduction of hedging instruments to manage FX risk and inherent volatility. Over-the-counter (OTC) FX futures and forwards have now been introduced into the FX management framework. Authorised dealers are now permitted to offer Naira-settled non-deliverable OTC FX futures. All OTC FX futures and FX forwards sale to end users must be backed by trade transactions (visible or invisible). This is aimed at deepening the FX market, boosting liquidity and promoting financial security in the market.

So far, many views seems aligned on the inevitability of this new policy direction. Now that we’ve laid this to rest, we may now face the more daunting task of boosting the country’s foreign exchange earning capacity. This is the main task, unless and until sources of export earning is enhanced through non-oil exports, Naira may just be on a long race.

Footnote:
This article was posted in verses via my Twitter handle, @YomiOlugbenro, on Thursday 16 June 2016, during a tweet chat session. The tweets are subsequently posted as article on my blog www.yomiolugbenro.com and my social media accounts – facebook.com/YomiOlugbenro and LinkedIn.com/YomiOlugbenro.