Déjà vu seems to be a common thing in policy circles nowadays. We see the same policies repeat themselves over and over again sometimes with the same outcomes. More recently we are seeing the CBN replicate its “windows” policy in debt securities markets like it did with the foreign exchange markets in 2015. Will the outcome be the same?
At this point, it is useful to understand what happens when, for whatever reason, people get kicked out of what used to be a unified market and the market is split into two (or three of four). The market where everyone still has access to will have a different price compared to the market that has some restrictions. If the gaps are large enough then you create all sorts of profitable arbitrage opportunities. But even if you somehow manage to stop the arbitrage you end up with distorted prices and participants who do not know how to deal with these distortions. Overall you end up with worse outcomes.
We saw this with the foreign exchange market in 2015. Remember, in that year we had the now infamous 41 items banned from accessing foreign exchange in official markets plus all other sorts of restrictions on who could or could not buy foreign exchange. In essence, we had the foreign exchange market split into two. In one market, the black market, everyone had access and could buy at whatever price without rules. In the official markets, you had all sorts of restrictions. The 41 items restriction had the effect of forcing participants out of the official markets and into the black market, and we saw the effects.
The price for dollars and other foreign currencies in the official market remained “stable” while the price in the black market exploded. At some point, the premium between the official and black markets was more than 100 percent. The arbitrage opportunities were exploited, and we kept hearing all sorts of stories of people buying dollars on the official market and then turning around and selling it on the black market. And of course, the economy suffered. No one wanted to sell dollars in the official market and investors who had to go through official channels opted out. The chaos from that foreign exchange market splitting policy did not end until the CBN backtracked and tactically unified the major foreign exchange markets. I say tactically because the “windows” are still there but the CBN tries to make sure the prices in most markets are about the same.
Here we are and a few years after that policy misadventure we are back again. A series of circulars released by the CBN has essentially split the debt securities market into two. Non-bank corporates and private individuals have essentially been banned from participating in the CBN securities markets on the one hand, with the federal government securities market still open to all participants. In essence, the CBN securities are now similar to the official foreign exchange market with the federal government securities similar to the black market. Everyone has access to the “black market” but only bank and foreign portfolio funds have access to the “official market”.
As with the foreign exchange policy in 2015 so with the debt securities markets in 2019. The price for CBN securities has gone one way while the price for federal government securities has gone the other way. The interest rates for CBN’s securities continue to climb while the interest for the federal government’s similar securities have collapsed. As at the time of writing this there was a more than 200 basis points spread between one-year debt securities. Or translated in English, the federal government can borrow for an almost two percent lower rate than what the federal government via the CBN can borrow.
The arbitrage opportunities are there but they will be more difficult to exploit. Human beings are geniuses though, so you never know. But the outcome on the economy will probably be similar to the negative outcome witnessed when we did this with foreign exchange. Interest rates for official securities have already fallen below the inflation rate with the inflation rate still looking upwards. Investors might look for better returns in the “real economy” like the CBN hopes. Or they may just buy foreign exchange. On the other hand, the CBN is going to face a struggle to mop up all the liquidity from its own maturing securities as foreign investors are unlikely to be able to pick up the slack. Even if they did it would come with a hefty price in foreign exchange that the CBN does not have.
Either way, as our parents say; “it’s like we don’t like to hear the word”. So, as usual, we will wait for the negative effects to show up before we try to backtrack. A few years will be lost but who cares.
Dr Obikili is chief economist at BusinessDay.
