Nigeria’s liberalized foreign exchange regime: current impacts, the near future

Externalization of Differentials on OTC FX Futures Contracts

 TheOTC FX Futures contract, as earlier indicated, operates by settling (in Naira value) the difference in the Spot FX rate at the NIFEM and the bespoke FX Futures rate at maturity. Where a party to an FX Futures contract is a foreign portfolio investor (“FPI”), thereby necessitating the need to repatriate the settled differentials in the FX rates, the concerned FPI is expected to get a clearance to this effect (to be issued by the FMDQ) known as the “OTC FX Fu­tures Settlement Advice”.

This regulation is contained in the CBN Circular No: FMD/DIR/GEN/07/001 of June 24, 2016 titled “Externalisation of Dif­ferentials on OTC FX Futures Contracts for Foreign Portfolio Investors” and issued to all deposit money banks. Though repatriation from the country of any foreign currency purchased from the FX market by FPIs are guaranteed under Nigerian laws (see sec­tion 13 of the Forex Act and section 24 of the Nigerian Investment Promotion Commis­sion Act (Cap. N117, LFN 2004)), the OTC FX Futures Settlement Advice is henceforth required, in addition to the requirement of Certificate of Capital Importation (“CCI”), before proceeds of the FX Futures Contracts can be repatriated by FPIs trading in the Nigerian FX market.

 

All FX Trades by Corporates to be done on the FMDQ-Advised FX Trading System

Another CBN Circular No: FMD/DIR/GEN/CIR/07/002 dated July 8, 2016 and titled “Onboarding Corporates on FMDQ-Advised FX Trading and Surveillance System” was also issued to all Authorized Dealers, directing that effective August 1, 2016; all FX-related trades by Authorized Dealers among themselves and with their Clients (i.e. Corporate Institutions), must be executed through the FMDQ-advised FX Trading, Auction & Surveillance Sys­tems (“FMDQ-advised FX Systems”). Prior to the take-off date of the Circular, some transactions were being done outside of the FMDQ-advised FX Systems and were only voice-reported on it after, in line with the “Execution and Reporting” mandate contained in the new FX Guidelines.

In compliance with the directives con­tained in the Circular, all trades outside of the FMDQ-advised FX Systems have since become prohibited. Thus, by limiting all transactions in the market to just one, uniform and predictable platform for all participants, the activities in the FX market have become more streamlined, transpar­ent and seamless.

 

Sales of Foreign Currency to Bureau-De-Change Operators

As indicated above, a new role has recently been designated for the BDC operators. By a Circular No: TED/FEM/FPC/GEN/01/004 issued to all Authorized Dealers and BDC Operators and titled “Sales of Foreign Cur­rency Proceeds of International Money Transfers to Bureaux De Change Operators”, the ban from participation in the NIFEM earlier placed on the BDC operators has been lifted.

In effect, International Money Transfer Operators are now mandated to remit foreign currency to their agent banks for disbursement in Naira to the beneficiaries while the foreign currency proceeds are to be sold to the BDC operators. In doing this, full compliance with the extant Anti-Money Laundering Laws and the CBN’s regulatory frameworks such as the Know-Your-Cus­tomer principles, including BVNs, is to be observed. Furthermore, Authorized Dealers and BDC operators are required to give daily and weekly returns on their operations to the CBN’s Director of Trade & Exchange.

Further to this, the CBN on August 9 issued a supplementary Circular to all Authorized Dealers and BDC operators (Ref: TED/FEM/FPC/GEN/01/006), setting some limits to the BDCs’ trading in FX.

In line with the provisions of the supple­mentary Circular, Authorized Dealers are now to buy FX from approved IMTOs at a maximum of 10% above the inter-bank rates and sell to the BDC operators at a margin not exceeding 1.5%. The BDCs, in turn, shall sell the FX cash bought from the Authorized Dealers to end-users at rates not exceeding 2% of the rates for which the FX were bought. Additionally, all funds being retailed by BDC operators (regardless of source) shall henceforth be at a maximum margin of 2%.

 

Provisioning for Loss on Foreign Cur­rency Loans

In enforcing compliance with the Pruden­tial Guidelines for Deposit Money Banks in Nigeria, issued by the CBN on 1st of July, 2010 (“Prudential Guidelines”), the apex bank released a Circular dated July 27, 2016 (Ref: BSD/DIR/GEN/LAB/09/037), titled “Provisioning for Foreign Currency Loans”, which mandated all deposit money banks in Nigeria to review their loan portfolios latest by August 3, 2016.

By the date mentioned, all banks were to; 1) make additional provisions in their income statements in respect of the ‘un­provisioned portion’ of all Non-Performing-Loans (“NPL”) in their loan portfolios; 2) forward evidence of the additional provi­sions to the CBN’s Director of Banking Supervision; and 3) review all foreign currency-denominated loans and make adequate provisioning on all the delinquent ones, in line with the Prudential Guidelines.

Essentially, as a result of the “devalua­tion” of the Naira, which came with the introduction of the new FX regime, it has become more expensive for most bor­rowers to source FX to repay their foreign currency-denominated loans (which were executed and provisioned for, at the old CBN-pegged rates). Indeed, for those who may even be able to afford to buy FX at the liberalized inter-bank rates, the illiquidity in the market has led to an increase in defaults, hence the need for lenders to make new loss provisioning in their income statements in respect of their NPLs.

Since this directive was made, the banks have been calling on the CBN to amend the provisions of section 3.21 (a) of the Prudential Guidelines, which mandates that the banks retain in their records, fully provided NPL for a period of one year before write-off. Whilst the CBN has turned down this request by the banks, it has however granted a one-off permission to the banks to write off the said NPL only for the year 2016. It is generally believed that this would reduce the pressure that has been brought on the banks by the implementation of the new floating FX rates policy.

 

RECENT DEVELOPMENTS

Unfortunately, the new FX Guidelines has come at a time when the country is “techni­cally in recession”.

Decaying infrastructures and weak eco­nomic fundamentals have resulted in low productivity and competitiveness, high import bill and poor FX earnings. Under a floating FX policy, these factors combine to trigger the devaluation of the Naira with larger economic consequences. Challenges of volatility and illiquidity that trail the liberalized FX market with the attendant negative impacts on businesses (particu­larly imports, banking & loan markets and manufacturing) have a multiplier effect on the overall economy.

The manufacturing sector (being one of the worst hit by the impacts of the new flex­ible FX policy), has experienced incessant closure of factories and massive lay-off of workers in recent times. The Manufacturers Association of Nigeria (“MAN”) has consis­tently issued statements on how scarcity of FX for the import of inputs of production, in addition to the continued ban from sourcing FX from the inter-bank market for importation of the ‘41 blacklisted items; has continually dealt a death blow on the real sector of the economy.

Although the ban on the ‘41 blacklisted items’ remains, the CBN, in addressing the concerns of MAN, directed, in a Circular (Ref: TED/FEM/FPC/GEN/01/007) dated August 22, 2016 that, until otherwise direct­ed; all Authorized Dealers shall dedicate at least 60 percent of their total FX purchases from all sources, including inter-bank, to end users from the manufacturing sector for the purpose of importation of raw materials, plant and machinery while the balance of 40 percent should be used to meet other visible and invisible trade obligations. This regula­tory intervention is expected to revamp the production capacity of the manufacturing sector, in the short to medium term.

Recently, on August 23, 2016 the apex bank barred 9 deposit money banks (“DMBs”) from participating in the FX market, for failure to promptly remit to the CBN (in non-compliance with the Treasury Single Account (“TSA”) policy of the federal gov­ernment), the dollar proceeds of oil sales deposited with the banks by the Nigerian National Petroleum Corporation (“NNPC”). Notably, the affected 9 DMBs are Autho­rized Dealers and some of them are also Primary Market Dealers in the FX market. This, expectedly, worsened the challenges confronting the FX market as the Naira immediately fell further against the dollar at the inter-bank market and against the greenback at the BDC segment; with FX end-users finding it difficult establishing letters of credit through the affected Au­thorized Dealers. The ban placed on the affected banks was however lifted few days after, following series of meetings between the CBN and other market stakeholders, to resolve the crisis.

Nonetheless, the FX market has begun to record positive results lately, as foreign investors (confident of the transparency and credibility of price formation that are brought into the market by the new FX Guidelines) start to return into the country with millions of dollars’ worth of FPIs. As this development continues and increases in volume in the coming months, the liquid­ity challenge and the associated volatility of FX rates at the inter-bank market are expected to reduce.

 

CONCLUSIONS

The new regime in the Nigerian FX market, which became operational in June 2016, is still within its first six months of imple­mentation. We believe that whilst the flex­ible exchange rate policy, operated within a Single Market structure, is appropriate for rebuilding confidence of investors and attracting inflow of growth capital into the economy; the government and the apex bank must endeavor to keep the policy stable and without undue interference.

It is recommended that the current overall economic objectives of the CBN, articulated in the “Monetary, Credit, Foreign Trade and Exchange Policy Guidelines for Fiscal Years 2016/2017”, should be implemented with great care; so as not to trigger an unintended consequence of a further fall into economic recession.

We advocate an economic growth plan that will support local content development through massive incentives and adequate credit facilities made available to domestic industries. Naturally, as the national indus­trial capacity grows and local production rises, economic competitiveness will be enhanced and importation of items will ordinarily become unattractive.

In the near future, the economy is ex­pected to rebound as the apex bank main­tains policy consistency and a transparent exchange system. Hopefully, the Naira will soon find its equilibrium at the FX market and firm against the major foreign curren­cies.