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Recently, in what analysts are referring to as a “desperate” move, the apex bank resorted to the use of force, arresting parallel market operators who attempt to sell the dollar above N400 to the dollar. This was after the central bank and the police had met with Bureau de change (BDC) operators and obtained assurance of their support in the battle to save the naira from further depreciation.
Apparently, the apex bank targeted the quasi or informal market, if you like, to deploy its newest and weirdest monetary policy tool (coercion) to enforce the cap since this is the only market that reflects the “real” weakness of the local currency.
The obvious thinking behind this method is that if the BDC operators are unable to sell dollars above N400, they would be forced to bring down their bid below N400 and thus prevent further depreciation of the naira.
However, what this move threatens to create is a black market within a black market for the following simple reason: prior to the announcement of the cap, quite a number of BDC operators were carrying stock of dollars purchased at rates well above N400/$. Selling this stock at N400/$ or lower would imply outright loss to the dealers.
No dealer will willingly take a loss on a trade, especially when he knows that people are willing to buy the asset he holds at a much higher price. As a result, such stock carrying dealers will go underground and find interested buyers who will take their stock at levels well above N400/$ thus creating a fragmentation in the market. In essence, the CBN has succeeded in creating yet another price band for an already fragmented market as follows:
· N199.5 – Pilgrimage estacode rate
· N304.90 – CBN rate
· N315 – Inter-bank rate
· N375 – International Money Transfer Organisations (IMTO) rate
· N380 – N400 (Official Parallel market/Travelex rate)
· Above N400 (Unofficial Black market rate)
Already, rates have been stabilized at circa N305 – N315 at the official interbank market even though actual trades that occur at those levels are few with insignificant volumes. Recently, the Financial Markets Dealers Quotation (FMDQ) made its position clear with regard to the “so-called” inter-bank closing rate mechanism which banks and multinational companies use in currency translation on their daily books. The regulator suspended the closing rates mechanism until further notice and stated that the last available executed trade on the inter-bank trading platform would be adopted going forward as the CBN closing rate. This publication became necessary after series of complaints put forward by preparers of financial reports from the regulator due to persistent confusion with regard to price formation and discovery for currency translation and financial reporting purposes.
Intervention or interference?
As a consequence of the central bank’s actions and implied effects on the market, market watchers have referred to the apex bank’s actions as interference rather than intervention.
Market interventions occur when a central bank participates in a market by injecting liquidity in order to achieve a desired result on the overall economy – example, the fragmented US Federal Reserve Quantitative Easing Program that lasted from 2008 until 2014 helped the country get out of the worst economic crisis since the Great Depression.
Another example is of the Swiss National Bank (SNB). The SNB introduced the exchange-rate peg in 2011, while financial markets around the world were in turmoil. Excessive demand for the franc by investors seeking a safe haven for their assets in the wake of the global financial crisis had seen the franc appreciate excessively. In response the SNB created new francs and used them to buy euro. Increasing the supply of francs relative to euro on foreign exchange markets caused the franc’s value to fall (thereby ensuring a euro was worth 1.2 francs or more but not less). Thanks to this policy, by 2014 the SNB had amassed about $480billion worth of foreign currency, a sum equal to about 70% of Swiss GDP. Although the SNB eventually jettisoned this program later in January 2015, the bank had succeeded in professionally pegging its currency from excessive appreciation for 3 years without the use of force or sanctions!
Market interference on the other hand is the use of unprofessional and unethical methods to illegally manipulate markets in other to achieve desired results which in most cases are not fundamentally realistic. A good example is the CBN’s attempt to keep the price of the naira against the dollar down despite excessive naira supply and very limited dollar reserves. This is against a fundamental principle of economics which states that higher demand in a period of limited supply will lead to upward adjustment in price of an asset (all other things being equal).
If the CBN had enough reserves (as it had in the past) it could simply have defended the naira by placing a firm order with its Foreign Exchange Department to sell certain volume of dollars in the free inter-bank market once the market hits N400. This selling pressure would automatically overshadow demand, create excess supply and ultimately trigger a retracement in naira depreciation. A continuation would ultimately lead to naira strength in the medium to long term. This would be an ideal market intervention
The state of the economy
Despite the Draconian policies of the CBN, latest inflation figures released for the month of October shows that it is not yet. The figures show head line inflation has now hit a 94-month high at 18.3% up 40basis points from the September figure. Some might find it disturbing to further note that the Nigerian inflation numbers have been on a steady rise since November 2015 despite various conventional and unconventional measures by the central bank to prevent this undesirable trend. With this current figure, one might wonder if the central bank’s repeated sale of Treasury Bills at 18.5% will now be sufficient to attract foreign investors. Which rational investor would seek to invest in a country where inflation is just 20 basis points behind your highest offered pre-tax returns on fixed income investment whilst also being exposed to currency exchange risk. Furthermore, GDP numbers for Q3 2016 shows a contraction of 2.24%. This marks the first three consecutive negative growth numbers recorded since 1987. Sadly, what this means is that Nigeria is officially in recession. If this persists, the country is in risk of going into outright depression and the CBN could well take a sizable chunk of the blame since its inability to attract, source and provide foreign exchange for our import-driven economy has been identified as the prime trigger for the situation the country finds itself in today.
The demand burden
On the reality of the value of the naira, the government must come to terms with the demand appetite of Nigerians for quality. This demand is effective as it is backed by capacity. Against all odds, another recent report has shown that Nigeria has the highest number of students studying in the U.S. amongst African countries and also ranks 14th in the world on the same subject. Despite the crunching economic challenges, Nigerian parents are still willing to pay well over N400 to purchase dollars for school fees and other related payments for their wards. Asides the education sector, there is huge demand for dollars across every other sector in the Nigerian economy from manufacturing to aviation; from telecommunications to hotels and accommodation and others. This huge demand is expected to be largely offset by supply from one sector alone – the oil & gas sector which ironically has its own dollar needs given the fact that despite all promises by the government to build refineries, the country continues to import petrol from other countries to meet its domestic needs. This petrol also needs to be paid for by the same dollars earned from crude oil export.
Possible way forward?
Given the foregoing, one cannot completely disregard the government’s dilemma. However, the use of force is not and will never be an acceptable solution/tool in financial markets. The better solution will be to allow those Nigerians who have the willingness and the capacity to buy dollars to continue to do so until the naira depreciates to levels where the buyers are no longer willing to buy wherein market resistance will set in. At that point, sellers will come in and flood the market with dollars – this was the original thinking of currency market experts as well as the FMDQ when pressure was placed on the central bank to allow the naira trade freely. A “managed” floating FX regime does not breed trust and will fail to achieve the objective the government had in mind which is currency price stability amongst other things. The CBN must understand that the much anticipated Foreign Portfolio investors will not bring funds into a market that lacks integrity, transparency and stability. The treasury bills bait and contractionary stance on Monetary Policy Rate which have been dangled long enough to the foreign investors has not worked. Instead, it has further dissuaded local banks from lending to the real sector. Why risk lending money to a comatose sector when you can invest in “risk-free” assets at effective yields in excess of 20%?
In effect, the CBN has done poorly in spurring growth, maintaining price stability and job creation which are all part of its key mandate, and gone ahead to point an accusing finger at the federal government and its extant fiscal policy implementation.
Olawale Hamed
