We believe the floating of Nigeria Naira was done in good faith. One that is needed to create a level playing field in the foreign exchange markets. It allows all participants to buy and sell at the same price. This is the case in all efficient markets where the value of the currency depends on demand and supply.
The benefits of a floating currency/exchange rate are the lack of a need for large reserves. It also gives the Central Bank the ability to target domestic conditions more effectively e.g. to price stability, money supply, full employment, and stable growth.
So why has the floating rate environment not helped the Naira? There are two factors (1) trade imbalance (2) Lack of transparency of Import and Export Window (IEW).
Factor 1: Nigerians import more than they export. There is less demand for Naira, hence, it is cheaper than other currencies in demand that it is paired against.
Factor 2: The IEW is not a level playing field for all participants in the FX markets. There are groups of Nigerians hoarding foreign currencies and speculating on the price to make instant gain.
For example, Company A requested USD 200 million from the IE window to legitimately purchase goods from abroad. However, it needs USD 75 million to pay foreign partners. Company A now has USD 125 million to hoard and speculate on. This amount is no longer available to other participants. Now multiply this practice by 100. The effect on the economy is better left to one’s imagination. This hoarding practice by those in the IEW creates artificial scarcity of foreign currency (Demand & Supply effect).
To ensure stability of the Naira, we recommend adopting the following 7 steps:
Collapse the I&E window:
Floating the naira and at the same time maintaining the Import and Export Window (I&E) window is a recipe for corruption. It is no surprise the spread between official and black-market rate has widened despite the new government’s effort to align both. The I&E window is not transparent; it favours round-tripping and above all pushes up the price level. It should not exist in a free float.
Importer A and Importer B import the same product, however importer A sources most of its funds from the IE window while importer B sources its funds from the black market. It does not take a rocket scientist to know importer B will have to close shop. Importer A now has a monopolistic hold. He has a free reign to do as he pleases with price, increasing inflation rate in the process. To curb the increase in inflation, the Central Bank increases rates and the beat goes on! – a case of a dog chasing its tail! The central bank is continuously behind the curve hence why real interest rates are always negative!
Everyone should source their FX needs from the Interbank/OTC market. Nigeria should operate a market that is fair to everyone. There should be no exception to the rule.
If the CBN believes the value of the naira is below its fundamental value, it should intervene in the interbank/OTC market. That way the tide coming will lift all boats, not a selected few as it is today in the IE window.
A regulatory body should then be given the task to oversee the activities of the FX market to forestall and stamp out market abuse.
Limit monetary financing:
The government should limit its borrowing to the amount stipulated in law. Not adhering to this limit increases money supply which puts pressure on the exchange rate. The government should investigate widening its tax base as an alternative to monetary financing.
Zero tolerance for corruption:
Corruption is basically eating up the country. A lot of Nigerians as an example have huge dollar obligations outside the shores of Nigeria which they must service. Most of these obligations are being serviced by corrupt practices. A crackdown on this hydra headed problem will mean a lot of Nigerians will have to unwind dollar obligations reducing demand pressure on the dollar.
Nigeria needs to embrace risk management principles and refrain from policy driven by emotions and public pressure. Economic agents including the government will have to learn how to hedge their exposure to volatility and depreciation/appreciation of Naira. Nigeria has market infrastructure to regulate the Over-the-counter transaction. FMDQ is positioned to provide a safe depository for financial markets assets, as well as facilitate settlement of capital market transactions. It can also help many exporters in hedging against any future increase in price, this is a multibillion-dollar financial instrument that can be offered to many importers to ease the burden of persistent rise in price.
For example, Importer A has a dollar obligation to settle in 3 months’ time via Bills for collection. There is the possibility the naira depreciates within the 3 months. Importer A will have to sell a 3-month naira futures contract to lock in today’s exchange rate. This simple risk management tool ensures the depreciation of the naira is not passed to the final consumer.
The government could encourage speculators to actively participate in the FX market. A huge percentage of the 6 trillion-dollar daily FX turnover in the Global FX markets is speculation. Speculators take the other side of a trade and provide liquidity to the market which helps reduce volatility and reduces bid ask spread for corporate users.
It is not the job of the government to provide liquidity to the FX market unless it is intervening to shore up the value of the naira.
Export and infrastructure:
Export of semi processed and finished goods should be actively encouraged. More jobs are created this way that will encourage FDI flows rather than ‘hot’ money flows. Incentives should be provided to exporters of semi processed and finished goods. Infrastructure helps increase the output capacity of a country ultimately reducing overheating.
Nigerians must be patriotic. The country is basically eating itself from the inside. Most of the issues are purely self-inflicted. There is no free lunch anywhere in the world. It is what you sow you reap.
The government via CBN should refrain from throwing funds at shoring up the value of the Naira. It is like jumping in front of a fast-moving train. It is a no-win situation. We should learn one or two things from other countries that have burnt their reserves trying to protect the value of their currencies.
Most funds raised should be used to address structural rigidities within the economy and not used to intervene in the FX market.
Niyi Omidire; A Macroeconomist and a licensed Commodity Trading Advisor;
Ajibade Yusuf; Treasurer and Liquidity Management Professional. For comments and enquires contact Ajibade Yusuf at [email protected]