Central Bank’s Efforts

As part of recent efforts to calm the market and stabilise the naira exchange rate, the Central Bank of Nigeria (CBN) last month introduced new guidelines for trading on the interbank market. The policy allows the exchange rate of the naira to be determined by the market forces of demand and supply, as against the previous pegged rate system.

Under the new arrangement, the commercial banks act as FX Primary dealers. Part of the objectives of the new framework, which included the introduction of the naira-settled Over-the-Counter (OTC) FX Futures trading, was to discourage people from front-loading or hoarding forex due to uncertainty. The central bank also cleared the backlog of matured letters of credits.

The new forex framework allows the market to operate as a single market structure through the interbank/autonomous window, while the exchange rate is market-driven using the Thomson-Reuters Order Matching System as well as the Conversational Dealing Book. The CBN however participates in the market through periodic interventions to either buy or sell forex as the need arises.

However, the implementation of the floating exchange rate regime triggered a 41.1 per cent depreciation of the naira. Also, the positive sentiment that trailed the new interbank market framework was short-lived as the emergence of autonomous players in the FX market has not been as swift as anticipated.

Also, as part of efforts to boost dollar liquidity in the market and ensure stability of exchange rate, the central bank directed banks who are agents to approved international money transfer operators to commence the sale of foreign currency accruing from remittances to licenced Bureau De Change operators.

“The foreign currency proceeds of international money transfer sold to BDC operators shall be retailed to end-users in compliance with the provisions of Anti-money Laundering Laws and observance of appropriate Know-Your-Customer (KYC) principles, including the use of Bank Verification Numbers (BVNs),” it explained in a recent circular.

What Determines Exchange Rate
Exchange rate is the price of one currency in terms of another. Similar to any other commodity, factors that affect either or both the demand and supply affect this price. For instance, a reduction in the supply of dollar will lead to an increase in the exchange rate of the local currency and vice versa. Equally, an increase in the demand for dollar will lead to increase in exchange rate; and this implies the depreciation of the local currency.

Analysts at the Financial Derivatives Company Limited had pointed out that there are many factors that have been used to explain exchange rates. According to the report, the common ones are the demand and supply of a currency, and relative price changes (inflation) in the countries of trading partners.
“Nigeria is an import dependent economy. Companies import raw materials and intermediate goods for their production while traders and consumers import several finished goods for final consumption.

“Due to a low competitiveness and high cost of doing business, a lot of what could have been produced locally is also imported. In addition, many Nigerians consume foreign services like travels, tourism, health and education.
“All these lead to high demand for dollars to make payments for these goods and services,” it explained.

On the other hand, Nigeria obtains the bulk of its dollar supply from the exports of a single commodity: crude oil. Consequently, the report noted that increased supply of dollars is only enjoyed when the global prices and/or domestic production of crude oil rise.

Therefore, the country is susceptible to undiversified export base, events that shape global oil prices, and domestic oil production. This explains the tendency for the supply of dollar to fluctuate markedly in the face of a constantly rising demand for dollar. Thus, it explains why the naira is usually devalued or depreciates against the dollar whenever the global prices of crude oil decline.

“On the impact of inflation on exchange rate, the relative version of the purchasing power parity (PPP) framework argues that the currency of a high inflation country will depreciate relative to that of a low inflation trading partner in order to restore competitiveness.
“This is because excess money in the former country will be used to demand for the currency of the trading partner both for import and speculative purposes,” it added.

Achieving Exchange Rate Stability
To the President/Chairman of Council, Chartered Institute of Bankers of Nigeria (CIBN), Prof. Segun Ajibola, there is an urgent need for Nigerians to start looking inwards by consuming goods and services produced locally.
As a country, Ajibola stressed the need to start taking seriously, export promotion strategies, adding that there was need to diversify the country’s earning base.

“The reliance on oil as our major source of revenue is too heavy. We need to reduce the significance of oil on our economy. So, we can start diversifying into agriculture, solid minerals, manufacturing, and expand our export potential, we would be able to earn more foreign exchange from other sources than oil. That would help us.

“The challenge is coming to us today that we don’t need to rely too much on other countries to feed our population. The varieties we have in our agricultural sector can feed our population is properly organised and well harnessed. We can rely on our population for the provision of basic necessities of life –food, clothing shelter, we can de-emphasis a lot of things we import because of our mentality to consume imported items.

“So, the high propensity to import which is fuelled by cultural disorientation can be corrected through import substitution strategies. So, if we can embrace these two, we would be able to reverse the recession we are facing at the moment. It is when an economy fails to learn from this temporary setback, that recession moves to depression. Depression is a permanent problem that may remain with an economy for decades,” he advised.

Also, the Chief Executive Officer at Graeme Blaque Group, Zeal Akaraiwe pointed out that when the new forex policy was released about a month ago, a lot of analysts had the misconception that it was the only solution to the country’s perennial exchange rate crisis.

“It is not! People thought once we open the market everything would be okay. But opening the market was necessary for progress, but it was not the solution. The underlining fundamentals have not changed. The fundamentals that affect the currency have to do with balance of trade, which for the whole of 2015, was negative. The only other time we had a negative balance of trade as a country was 1983 and 1998.

“We are also running a deficit budget. So, in as much as we do not earn enough foreign exchange and we have not done enough to control the demand for foreign exchange, there would be pressure on the currency. We consume about $20 million of petroleum products per day by my estimate. And as Niger Delta Avengers blow up pipelines, our foreign exchange earnings are dwindling.

“So, as all these things are happening, it is only natural for the currency to be under pressure. And because we didn’t adjust the currency level when we should have, the pressure is being felt more presently, than if we had done it earlier ago,” Akaraiwe, who was a former bank treasurer, said.
He stressed the need to control the demand for forex in the country, by implementing import-substitution policies. Akaraiwe argued that the exclusion of 41 items from accessing forex for importation from the interbank market was a mistake.

On his part, the Special Adviser to the CBN Governor on Financial Markets, Mr. Emmanuel Ukeje, pointed out that achieving exchange rate stability has been the focus of the central bank over the years.
He stressed the need for the diversification of the economy.

“We all know the structure of our economy that is why we are saying that we must to a very large extent diversify the economy. See what it happening to crude oil prices and also our level of production. The amount we spend in importing petrol and other petroleum products is very huge.

“By the time all these refineries that are coming start functioning and take away that huge chunk being imported; you would have taken away almost 30 per cent of foreign exchange demand for import. So, for us, the best thing is that while we are doing demand management, we should also ensure that we diversify the economy and produce more.

“This is because the moment you start earning the foreign exchange, then you don’t have issues. No matter what happens internationally to the currency, it doesn’t affect your exchange rate adversely. This is because by then, you would have developed other areas to cushion the effect. Mind you, even the last time we had such slump in crude oil prices; we were able to overcome it because we had plenty of money in terms of Excess Crude Account (ECA) and the reserves,” Ukeje explained.

Continuing, while he decried that fact that presently the country does not have such strong buffers, he pointed out that the situation is not peculiar to Nigeria. He cited the turmoil that trailed the outcome of the Brexit referendum.

Furthermore, he expressed optimism that going forward, if the diversification drive is sustained, the country would no longer be susceptible to activities in the global market.

“This again has to do with the issue of demand and supply. When we have a situation when we continue to demand for a particular product and the supply is not enough to match the demand, then it becomes an issue. So if we are able to reduce our demand for import, we would be able to save currencies to be used to fund industrial production and not consumption items.

“People may argue that consumption is critical, but you need to produce before you consume. What is it that grows an economy? It is production. So, to a very large extent we all need to continue supporting government’s diversification effort so that we can be able to earn more dollars. There is no short cut to it. If we don’t earn dollars, the CBN cannot produce dollars,” he added.