CBN’s new Forex policy to improve market liquidity

Central Bank of Nigeria, CBN.

Central Bank of Nigeria, CBN.

21 February 2015, Lagos – The closure of the bi-weekly sale of forex through the Retail Dutch Auction System (RDAS) by the Central Bank of Nigeria (CBN) will significantly boost market liquidity and also lead to a decline in the currency pressure observed in the forex market in recent times, analysts have said.

They also stated that the move by the central bank had lowered the risk of JP Morgan removing Nigeria from its key emerging currency bond index. The central bank had on Wednesday announced the closure of the RDAS and Wholesale Dutch Auction System (WDAS) with immediate effect. With the new directive, the CBN will now sell dollars at a fixed rate of N198 to the dollar at the interbank market for time being.

Following the scrapping of the auctions, the central bank directed authorised dealers and members of the public to henceforth channel all demands for foreign exchange to the interbank market.

Bur analysts at the Financial Derivatives Company Limited (FDC) reasoned that the launch of the Interbank Forex Market, IFEM, by the CBN would typically lead to an efficient forex market system.

They also stated that it would lead to higher revenue for states and the federal government, adding that it amounted to the removal of exchange rate subsidy for individuals and corporates.

A report from the firm further described the policy as a prelude to full convertibility, adding that it would be a major boost to non-oil exports.

“Expensive dollar means lower demand. In the long run, BDCs are cut out. Why did the CBN do it now? There is never a good time to adjust a currency to its fair value. It is always better late than never,” it added.

Commenting on the impact of the policy, which has been described as a technical devaluation, the FDC report noted that with international airline tickets already up by 20 per cent, some parents would bring kids schooling abroad back home, adding that this would lead to improvement in quality of local schools and hospitals.

“Exchange rate will depreciate and converge to approximately N215/$. May begin to appreciate marginally. Market liquidity will improve and currency pressures will decline.

“As speculative activities and rent-seeking reduces, external reserves erosion will slow,” it added.

Also, in its report titled: “Nigeria: Tacit devaluation to N198/$1, from N168/$1,” analysts at Renaissance Capital Limited (RenCap), argued that the devaluation would significantly lower the risk of soft capital controls and aggressive rate hikes, “but does not spell the end of naira weakness, in our view.”

“In closing the DAS, the CBN has done away with an exchange rate policy that had become unsustainable, because of depleting forex reserves.

“As a result of this policy decision, we believe speculative forex demand that was driven by an expectation of a devaluation will fall, and in so doing go a long way towards conserving the remaining forex reserves.

“The tacit naira devaluation also reduces the risk of market-unfriendly policies being imposed to defend the naira, particularly soft capital controls and aggressive monetary tightening measures,” it added.

According to the report, the move by the central bank has lowered the risk of JP Morgan removing Nigeria from its key emerging currency bond index.

However, the report pointed out that the devaluation does not spell the end of naira weakness. It also stated that the naira devaluation implies inflation would continue to accelerate in the coming months into the lower double-digits.

“As the CBN will no longer be seeking to defend an unsustainable peg, we do not think a 2-5-per cent rate hike is warranted in the short term (from 13% today).

“The troubled Nigerian consumer will likely be hit by a further deterioration in real wage growth (owing to rising inflation), and an increase in naira fuel prices, due to the devaluation,” it added.

On its part, BGL Securities Limited support the move which it described as a major move towards a free-﬒oat exchange rate regime.

According to a report by BGL analysts, the current exchange regime is the popular and/or best practices amongst most central banks globally.

“In this regime, the central bank is not openly obliged to provide foreign exchange liquidity to support an indicative exchange rate, although it can always intervene in the market by creating supply and/or demand when it feels that market rates are disproportionate from its perceived equilibrium level.

“To this extent, we consider this a bold and positive move and expect to see the naira exchange rate gravitate to its market determined exchange rate level.

“In addition, this action would provide significant respite to the country’s foreign reserves as interventions could be systematically planned and focused on factors that are genuine rather than the compulsive responses in the previous regime that continued to bleed the reserves,” it stated.

In the same vein, WSTC Financial Services Limited stated in its report that at the macro-economy level, the policy presents an effective way of addressing the double jeopardy of low government earnings (on the fiscal side) and high interest rate (on the monetary side).

“Thus, we reckon that the re-pricing will engender stability of both fiscal and monetary policies. It simply implies higher government earnings from crude oil in Naira terms and will also give the apex bank the needed room for reducing the monetary policy rate.

“Notwithstanding, we expect yields to remain attractive, on risk-adjusted basis, in the fixed income market in the current year. We believe that rising domestic inflation and the need for the CBN to rebuild reserves amid weak oil prices will sustain the maintenance of a restrictive monetary policy throughout the year,” it added.
*Obinna Chima and Nume Ekeghe – Thisday

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