Thursday, 7 July 2016

New forex regime, the economy and the Presidency


Written by the Editorial board of The Guardian Newspaper

The Central Bank of Nigeria (CBN) has begun the operationalisation of its new forex regime aimed at market-driven exchange rate determination and hopefully, a bit of sanity and predictability would return to the system. The new exchange rate, which opened at N250 to the U.S. Dollar, compared to the fixed rate of N197, has now been hovering around N282, while the parallel market rates now stand around N352, although it initially fell to N330.

One week ago, the CBN also started operationalising the foreign exchange futures market via the over-the-counter (OTC) market securities exchange. At this market, the Naira futures deal points to N210 in April 2017 and N225 in one year.According to the CBN, the Naira-settled OTC FX Futures market is expected to be competitive, transparent, liquid and diversified.

The new foreign exchange regime instituted by the CBN has received wide applause from both local and foreign investors and by market participants. The Naira-settled futures market is indeed novel and innovative in Nigeria’s financial markets landscape. Hedging exchange rate risks, improving business planning, attracting foreign capital flows, reducing exchange rate volatility, and moderating exchange rate in the spot market have been touted among the expected benefits of the new foreign exchange rate regime and futures market.

This new foreign exchange regime, along with the partial deregulation of fuel prices, represents a departure from what some have termed a “Command and control economy,” often associated with the mindset of the current Nigerian Presidency to economic management. This mindset appears to have re-surfaced recently with President Buhari asserting that he does not see the benefits of the new foreign exchange rate regime and still needs to be convinced by the economic explanation given so far. He is reported to have asked a Group of visiting Business Operators: “How much benefit can we derive from this ruthless devaluation of the naira?”

While the market-oriented approach to economic management should be welcome, and the institutional independence of the Central Bank of Nigeria be respected, the concerns of the President should not be dismissed off-hand. Afterall, the President is an elected official and he is accountable, not the financial markets participants, not the unelected technocrats at the CBN, to the electorate on the economy. The President is the one who ultimately has to explain to Nigerians why the country’s overhyped rebased GDP in dollar terms has been cut by a third and why the misery indices have been rising due to falling per capita income, higher unemployment, and inflation rates. Whichever way it is coloured, official Naira devaluation or depreciation via the markets by nearly half, results in falling standards of living of Nigerians.

It must also be borne in mind that most Nigerian banks are forecasting subdued credit growth to the private sector due to the depreciation of the naira exchange rate and the liberalisation of the forex market, which enable them to earn more treasury incomes as opposed to extending perceived riskier loans in the midst of rising non-performing loans in a weakening economy.

The CBN thus has its work cut-out for it. Given the perceived restored autonomy of the institution on the exchange rate regime, the CBN must ensure that the real benefits of the new forex regime do not amount to mere hype. The CBN remains the dominant supplier and player in both the spot and futures markets. While it is fervently and currently ensuring appropriate supply of dollars to the foreign exchange markets, will this be sustainable over the medium and long terms or is the CBN simply kicking the foreign exchange shortage can down the road?

Liquidity in the foreign exchange markets is at present very low. Foreign portfolio investors are still staying on the sidelines. They need comfort in seeing that the new operationalised foreign exchange markets will work efficiently and smoothly.

They are also worried about policy somersaults in respect of the new policy regime. The CBN had to reverse course on the number of banks that can participate as primary dealers as charges of price fixing and collusion were labelled. Should the spot and futures market rates revolve around some arbitrary numbers, price fixing charge between a monopoly supplier (CBN) and oligopsony buyers (banks) would remain a constant feature of the new regime. For example, the futures rates appear to decline in a linear fashion and suggest that they are being artificially guided to N250 by December 2016 and to N225 by July 2017. Further, the CBN had already reversed itself on the decision on direct sales of foreign exchange to Bureaux de Change (BDCs), after castigating the same BDCs. What other policy reversals are in the offing?

Investors also pay attention to economic fundamentals; some have argued that current and projected oil prices, real economic growth rate, and the supply of dollars would not have recovered sufficiently to justify the implied futures market rates of N225 in the next one year. In essence, the implied rates being driven essentially by the CBN are overly optimistic as foreign portfolio investors worry about emerging global economic uncertainties. They also expect further increases in Nigeria’s interest rates.

The new foreign exchange rate regime is not a panacea total solution to Nigeria’s fundamental economic challenges. While it may be necessary, it is not sufficient to generating more and sustainable foreign exchange, which will come with other macro-economic policy levers, fiscal discipline, institutional and structural reforms to tackling underlying productivity that would promote non-oil exports.

On this score, the President cannot be faulted for stating the obvious: the need for diversification of the structure of the Nigerian economy battered by several years of mismanagement. The long-term sustainability of the new foreign exchange regime depends crucially on it.

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