• Friday, May 24, 2024
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The CBN’s arrow on carry-trade


By Victor Ogiemwonyi

Last week, the CBN issued a circular in respect of FX collateral for Naira loans, to the effect that it has now expressly forbidden the use of FX as collateral for Naira loans. Banks that are already exposed have been directed to wind down their positions in 90 days.

This circular, again, confirms there is a lot of solid thinking going on at the CBN.

Carry-Trade is what is referred to when you bring FX to trade in another jurisdiction by taking a loan in the local market and collateralizing it with an FX deposit. It purely signifies that the investment is short-term and only aimed at making a profit.

The CBN has used high interest rates to attract investors to its instruments, but it wants to make it clear that it will not allow unrestrained speculation.

Q: “Foreign portfolio investments of this type provide the immediate liquidity that is needed to fund the FX market, which gets the economy going while we work to restart properly.”

The policy is excellent in its timing, to be sure, to the extent that it will mitigate the speculative capital that can affect an economy quickly. We have seen the destructive impact of currency speculation evidently in the Asian Financial Crisis in 1997, when speculators took on Thailand’s currency, the Bhat, and Malaysia’s currency, the Ringgit, with economic consequences so severe that it prompted Mr Mahathir Mohammad, the then prime minister of Malaysia, to call billionaire George Soros a moron. He explains, “We spent years developing our economy, which has helped many rise to the middle class, and a moron like Soros comes around and ruins everything.”

Soros responded by describing Mr Mohammad as “a hindrance to his country.” Soros and other currency speculators say they are a “force for good“ in a market economy, given that their activities ensure bad economic policies and that propping up weak currencies is not allowed to stand. They argue that their speculation makes economies competitive.

Regardless of the economic logic for and against speculation, countries like Nigeria should be prepared. They have learned from the Asian crisis and will ensure speculators are aware that Nigeria is watching their activities. The recent notice from the CBN points to this.

The 90 days given to Nigerian banks to wind down the loans are also an appropriate time frame to wind down these loans. Most of the loans are already short-term in nature.

The carry trade is also a structured speculative trade. It is one of the ways to legally speculate in currencies and other market assets. It starts with pairing two interest rates and taking positions in currencies and other market assets.

If this practice is not checked early, it can become a contagious problem that can create bubble capital rapidly from speculative bets. This is commonly referred to as “hot Hot Money.” That is the capital that leaves without notice. We cannot afford such speculative trading now. Let us settle the money already in the system while we carry on with other reforms quickly to increase our attractiveness as a destination for investment.

The foregoing notwithstanding, we must also point out that speculative capital is not all bad. It is like taking a short-term loan to tidy up your position. Foreign portfolio investments of this type provide the immediate liquidity that is needed to fund the FX market, which gets the economy going while we work to restart properly. We must quicken our reform efforts to make our economy attractive and attract more foreign capital. We already have an attractively large market with our huge population. Further investment in health and education, with attention to our energy infrastructure and security, will greatly advantage our population.

We will also need to give our youth technical skills to make them more employable. Only strong growth will ensure full employment. We will need double-digit growth in the next decade to ensure this and make our economy attractive. This is why the current high interest rates need to come down quickly once the CBN achieves its objective of mopping up the excess liquidity in the system and restoring fair stability for the naira.

The Africa Continental Free Trade Agreement (ACFTA) is a gift to Nigeria, if we know what to do with it. We have the potential to substantially increase our exports and reduce our imports as we manufacture more of what we need. We must sincerely push our agriculture to produce more, both for our own consumption and for exports. We have all the God-given comparative advantages: good soil, a huge population, and a deep market that provides the incentives. As we become more productive overall, the naira will get stronger.

We have just passed a milestone that many are yet to take notice of: we have allowed the naira to find its value, even in a down economy. The naira found support at N1900. That means, in the short run, that is the worst we can expect the naira to dip. The CBN is also now preemptively and intelligently signalling price through the funding of the Bureau de Change market, which is essentially the black market. We expect companies that genuinely need FX to now be able to plan for it.

Victor Ogiemwonyi is a retired investment banker and writes from Ikoyi, Lagos.