Time to unify exchange rates

By Rafiq Raji, PhD

With their trading volumes clearly being hurt by the increased interventions of the central bank in the foreign exchange market, bureaux de change operators recently asked that the current multiple rates regime be abolished. Aminu Gwadabe, their representative, made the suggestion in an interview with Reuters, a wire service, in mid-June. For such a call to come from participants who have profited hitherto from the market distortions induced by the central bank’s unorthodox FX policies is almost surreal. They are just being rational though. Black FX market operators have seen their margins diminish significantly since the central bank’s ramped-up interventions began. The bank has sold more than US$5 billion this year already, after OPEC production cuts in late November 2016 pushed up international crude oil prices, boosting government revenues and the central bank’s FX reserves. Besides, it was almost always going to be the case that most customers would prefer to do their transactions with banks if they could secure competitive rates.

Other stakeholders sense an opportunity for the central bank to finally integrate the market as well. In remarks to Bloomberg, another wire service, in mid-June, Bola Onadele, the head of FMDQ OTC Securities Exchange, the over-the-counter markets platform which handles the new Nigerian Autonomous Foreign Exchange Rate Fixing (NAFEX) mechanism – better known as the investors’ and exporters’ FX window – by the Central Bank of Nigeria (CBN), seemed to suggest a single foreign exchange market was only a matter of time. Six weeks after it was introduced on 24 April, NAFEX has recorded more than US$2 billion in inflows. More importantly, the central bank reportedly intervened less than 30 percent of the time. And in the week just passed, the naira was trading at about the same level in both the NAFEX and parallel markets; raising hopes of convergence in the at least six FX markets. Noteworthy is also how the new FX window has mirrored the parallel market thus far, with the naira sometimes trading weaker in the former, vindicating much held views that the latter was more reflective of demand-supply dynamics.

Remove bottleneck
Still, a lot of global fund managers remain wary of putting money in local currency assets. The more Afro- and frontier-markets-centric ones have been increasing their Nigerian exposure owing to the NAFEX window, however. Some context is needed at this point. Before the FX shortages began, foreign portfolio and direct investments typically averaged about US$3 billion a quarter. In a good year, 2014, say, one quarter recorded as much as US$6.6 billion in foreign investment inflows. And the year before that, quarterly capital importation was about US$5 billion. So the US$2.2 billion FX inflows via NAFEX six weeks on (latest data) is significant. Should the remaining sceptical foreign portfolio investors join in, there could be a deluge; in a good way, of course. The importance of enticing them back into the Nigerian market cannot be overemphasized. The Nigerian economy remains in a recession primarily (in one’s view) because of the hard currency supply bottleneck. An analysis of economic growth data since the contraction began in the first quarter of 2016 shows sectors dependent on hard currency are primarily those weighing on the economy. Take one not so dependent, the agriculture sector, for instance, which incidentally also constitutes about a quarter of output: it grew by 4 percent on average in 2015-16. That more dependent on imported inputs, the industry sector (almost a quarter of output as well) for example, contracted by more than 5 percent in the same period. Not until 2016 did the remaining half of output, the services sector, record a contraction; below 1 percent at that. And when dissected, quite a few sub-sectors in services have been surprisingly resilient.

Short party
Considering crude oil prices have been sticky around the US$45-50 area lately, short of fully converging the markets, the CBN may soon become hard-pressed to sustain the current momentum. This is especially as the outlook for oil prices remains somewhat bearish. Despite the extension of OPEC’s 1.8 million barrels per day (mbpd) production cuts in late-May for almost another year, improved production by Nigeria and Libya, which are exempt from the cuts, have undermined the expected price-boosting effects. With the Forcados pipeline system back online, Nigeria has added at least 200,000 barrels per day to its production. Improved conditions in Libya has seen it add at least as much. Some estimates put incremental production between the two since the cuts began late last year at about 600,000 barrels per day, almost half of the cartel’s agreed cuts. So not only would the fiscal authorities likely need to borrow more than the US$3.5 billion they plan externally in the 2017 fiscal year, the monetary authorities may see their external reserves deplete quite significantly (or accrete slower) as well; that is, if current interventions continue. But with proof that a more transparent market would encourage needed FX inflows and is not all too destabilizing, as demonstrated by the NAFEX window, the CBN has an opportunity now to fully liberalize the market. In that event, it would not matter which way crude oil prices go.

Also published in my BusinessDay Nigeria column (Tuesdays). See link viz. http://www.businessdayonline.com/time-unify-exchange-rates/


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