There are at least seven things Nigeria can do to improve dollar liquidity in its foreign exchange market after a bold move this month to float the naira, according to financial market experts who spoke with BusinessDay.
The Central Bank of Nigeria (CBN) on June 14 floated the naira in a marked departure from years of controlling the rate, with banks now allowed to trade FX at market rates- a move that has been lauded as the critical first step in fixing the country’s broken FX market.
The naira shed a record 36 percent percent of its value against the dollar in one fell swoop on the day and has traded closer to the parallel market rate since then, closing at N767 per US dollar on Friday, June 23.
With the necessary first step of allowing market forces to determine the naira exchange rate out of the way, analysts say the next focus of the CBN should be on how to boost dollar supply and improve liquidity in the market.
BusinessDay spoke with financial market experts who said restoring transparency and engendering investor confidence in the market are the next steps if Nigeria must unlock the dollar flows needed to support the naira and suggested ways Nigeria can regain this confidence.
–CBN’s sale of dollars
The first step is for the CBN to consistently supply the market with dollars, no matter how small.
“The apex bank should do this consistently and the sale should be spread among all banks,” one of the sources interviewed said.
“The sale should be the same amount and at the same market rate and the CBN can use spot and forwards to deliver on trades ,” the person said.
The CBN sold $29.5 million to nine banks last Thursday at between N765 and N775 per US dollar.
–Allow banks trade without restrictions
Another critical step towards attracting dollar inflows is allowing banks to trade FX without any restrictions.
Since Nigeria floated the naira this month, banks have been allowed to trade dollars based on a willing buyer/ willing seller basis without any attempt at price control by the CBN.
Investors will hope this is sustained and is not another false start like in the past.
–Effective & transparent communication
The CBN will also need to consistently speak to the market to engender confidence. Effective and transparent communication is vital at this crucial time when market players still seek clarity over the new policy.
–Clear unsettled trades
Clearing all the CBN’s unsettled trades is another vital step towards restoring dollar inflows. The IMF estimates that Nigeria has a dollar demand backlog of around $2 billion and settling that backlog will go a long way in convincing foreign investors to return to the market.
–Restore naira-settled OTC future prices
Naira-settled Over The Counter (OTC) FX Futures are non-deliverable Forwards (i.e. contracts where parties agree to an exchange rate for a predetermined date in the future, without the obligation to deliver the underlying US Dollar (notional amount) on the maturity/settlement date).
On the maturity date, it will be assumed that both parties would have transacted at the Spot FX market rate. The party that would have suffered a loss with the Spot FX rate will be paid a settlement amount in Naira. This ensures that both parties enjoy the rate that had been guaranteed to each other through the OTC FX Futures.
Restoring the OTC FX Futures will help attract significant capital flows to the fixed income and equity markets as returns can now be enhanced as FX exposures are hedged. Foreign Portfolio Investors (FPIs) will be able to use the OTC FX Futures for capital protection.
–Sell OMO bills to FPIs at 18-20%?
The financial market experts also identified the need for the CBN to resume the sale of its Open Market Operation (OMO) bills to foreign investors at a rate of between 18-20 percent (which is closer to inflation rate) to lure foreign capital back onshore.
Some foreign fund managers have already indicated that higher interest rates on government debt could entice them back into the market.
However, allowing interest rates to go up from their current levels to compensate foreign investors would pile more pressure on the borrowing costs of a government that spent 96 percent of its revenues servicing debt last year according to World bank data.
–Oil companies to sell to I&E market
Getting oil companies and oil servicing companies to sell their dollars at the I&E window at the prevalent market rate will also help grease the market while removing the N1 cap between the buying and selling rate is another vital step towards improving dollar liquidity in the market.