The Naira Conundrum 4.0 — CBN’s new policy and a quest for a new paradigm
The Central Bank of Nigeria (CBN) recently made some changes to its foreign exchange (FX) management policy, making a dramatic u-turn on some of the positions it had taken over the past 20 months. In this press release, the CBN removed the restrictions on access to FX for school fees, Personal and Business Travel Allowances and medical expenses, setting an upper limit of 20% on interbank rate. In addition, the CBN reduced the tenor for forwards from 180 days to 60 days and stated its intention to intervene to ensure adequate liquidity. Following up on this, the CBN released a little over $500Million into the market to back up the policy change. In line with the age old fundamental economic premise, the increased supply of FX has seen the Naira strengthen considerably: as of close of play Friday 24th February, the Naira traded at N460 to $1, down from N520 to $1 on Monday 20th February.
As can be expected the public response has been as sharply divided as the polity is, with those in support of the administration in jubilant mode while those opposed are keen to remind everyone that at 1 June 2015, the black market rate was between N215–220 to $1. However, it is important to take a dispassionate look at what the CBN has done with the intent to understand what it portends for the economy. It is important to bear in mind the context in which the recent CBN action has occurred, the reason this article is labeled 4.0 is because there are 3 earlier articles in this series, the last one can be found here. The CBN action has therefore not happened in a vacuum, there are several issues that need to be looked at to see where this is headed.
The Nigeria FX situation — The Backstory
The oil price crash in 3rd quarter of 2014 quickly brought to the fore the fact that the CBN (particularly under Governor Sanusi Lamido Sanusi) had not made hay while the sun shined. Nigeria had just gone through about 4 years of high oil prices and come out of it with barely enough to cover 6 months of imports! Add to the fact that with Boko Haram raging in the North East and the Jonathan administration becoming increasingly unpopular, the polity had become heated up and there were concerns for the elections coming up in the first quarter of 2015 (CIA had actually predicted Nigeria would break up in 2015). Foreign Portfolio Investment (FPI) flows started going out rather than coming in. With the Naira under pressure and government revenues under pressure due to falling oil prices, the Naira was devalued twice between November 2014 and February 2015, losing 27% on aggregate.
With the new government came a different stance towards the Naira. The position was to defend the Naira and resist devaluation, a strong Naira was important to a government that had campaigned on the basis of restoring the economy to greatness. However, with reserves having taken a beating, the CBN decided to implement stringent controls restricting access to its FX window and banning 41 items entirely. This led to a huge spike in the parallel market rate and the gap between the official rate and the parallel began to widen considerably. The CBN policy took its toll on the economy as manufacturing and trade were heavily impacted, this among other things pushed the economy into a recession.
By June 2016, the gap had almost widened to 100% and the government had revised the price of petrol on the basis of a FX rate much higher than the CBN rate. The CBN responded by “floating the Naira”, devaluing the Naira officially by 23% in the first instance in the hope that with the improved “transparency” and potential increased liquidity, the gap would close at a rate not too high. In time however, it became apparent that the CBN had set a ceiling above which it would not allow the Naira to trade against the US Dollar and very soon the gap would begin to widen again. By 20th February 2017 the gap between the parallel market and the CBN official rate had widened to 72% (add the fact that in between both there are 5–6 different rates depending on who you ask). It was against this backdrop that the CBN revised its stance on the FX market and injected the liquidity provided over the last week.
Have the issues been addressed?
While the primary issue is supply of FX (which explains why the Naira has rallied on the back of the recent injection of liquidity by the CBN), the sustainability of the measure is in question due to the fact that other issues remain unaddressed. Fundamentally, the CBN by this action is re-establishing itself as the pre-eminent (perhaps even sole) market maker in the FX space. What this means is the CBN is guaranteeing liquidity to the market despite the fact that history shows it has never been in control of up to half of the FX inflow to Nigeria, as this article shows. “Floating” the currency last year was meant to relieve the CBN of this responsibility and allow the market to function appropriately. However, political considerations appear to be winning again going by Acting President Yemi Osinbajo’s recent comments at the World Economic Forum in Davos that the Naira can’t be floated, see here.
To guarantee liquidity, the CBN must be in a strong position to back its position with regular and sustained interventions. While the oil price rally, improved crude production numbers in Nigeria and recent $1Billion Eurobond appear to have boosted foreign reserves, at less than $30Billion the kitty is still woefully short of what is required to sustain this policy. Should oil prices suddenly head south (winter is gradually coming to an end and more importantly, shale producers are increasingly in a position to cover gap left by OPEC cuts, causing a glut again) or militant attacks go up a notch, the CBN may suddenly find its position a bit shaky. Add to the fact that the 41 items remain banned and the demand for FX unabated. If the CBN wavers, the situation will revert to what it was and at a higher premium too as seen in the aftermath of the botched float.
A sound line of reasoning proposed by Seun Smith on Twitter suggests that the CBN is working on a short term measure to close the gap to an acceptable level before floating the Naira, ostensibly to ensure the subsequent correction isn’t too drastic. While I agree this sounds plausible (and reasonable), the CBN’s antecedents do not fill one with much confidence. The question is what is that acceptable level? N400? N350? N300? Does the CBN have the staying power (may require something between $2–3Billion, possibly more) to hold on till that level is reached and sustained over a period of 2–3 months to convince FPIs to jump in?
A new FX paradigm is required
The CBN needs to stop making the exchange rate into a big deal and focus on monetary policy, especially how to help stimulate growth in a recessionary environment (see here). The answer is to float the Naira and stop intervening as a player and primary supplier of liquidity. Nigeria couldn’t have asked for a better example to follow than Egypt and the CBN will do well to look at what has happened (and is happening) there. When Egypt floated it’s currency early November 2016, the Egyptian Pound was immediately devalued by 75% and hit rock bottom late December 2016 having devalued by 116%. The Central Bank of Egypt (CBE) has so far stayed the course and since hitting rock bottom, the Pound has rallied, gaining more than 15% in 2017 with foreign reserves also up by more than 35% since the float.
More importantly, the FX scarcity has eased as investment flows have improved. Bear in mind that Egypt is a country that doesn’t have a major FX earner like Nigeria and depends a lot on tourism which is struggling due to tensions in the region. Inevitably, inflation has spiked significantly, 28% in January 2017 up from the usual 10–12% (primarily because fuel prices went up by 35% in October 2016). However, Egypt is a country more dependent on imports than Nigeria with import to GDP at 22% compared to 11% for Nigeria (World Bank database 2015). No doubt there will be pain in the immediate term, however as the policy takes hold the benefits will begin to take effect as investments are attracted, infrastructure improved, jobs created and locally produced goods become more attractive for exports, earning more FX.
Nigeria will not achieve her full potential with a currency that is held bound by political considerations. The Nigerian government through the CBN has sought through its 56 year existence to control the value of the Naira and has failed woefully. Trying a different approach is long over due and allowing the Naira to find its own feet is the way to go. Concerns around the impact of the devaluation are blown out of proportion, the one item that will be mostly impacted is petrol given the anomalous situation in which we export crude and import almost all refined requirement. A phased increase in price of petrol can be implemented, using the increased Naira gained from any devaluation to subsidize prices in the short term until local refineries come into play. Social safety nets can also be implemented to help the most vulnerable in the society.
In the long run, the economy and ultimately the people will be better for it. All it takes is the will to play the long game and ignore political considerations…..our leaders owe us this, after 56 years it is time for a shift.