The Naira Conundrum — What to do?

Central Bank of Nigeria (CBN) says Naira should exchange at N197 to $1 currently. CBN is actually well within its rights to do so; section 16 of the CBN Act 2007 (see here) empowers the regulator to determine the Naira’s exchange rate based on “a suitable mechanism devised by the bank for that purpose”. On this basis the CBN’s position on the rate should be unquestionable so one wonders why there seems to be a problem with this. Why does every analyst and almost every Nigerian insist that the CBN is wrong?

The disagreement arises from a number of issues — firstly CBN in response to the downward pressure on its reserves decided to pursue a Demand Management policy, excluding the importation of certain items from its forex windows (see here). Essentially, CBN was saying it does not have enough forex to sell at the price it had determined to everyone willing to buy and was not willing to increase price which would naturally reduce demand. Secondly, there exists a parallel market with a spread which began to widen such that as of today it prices the Dollar at about 35% higher than the CBN rate! Thirdly, banks began to restrict the use of Naira denominated cards for foreign currency withdrawals and international transactions…..cue panic stations! As we begin 2016, a lot of focus is on the Naira as pressure mounts on the CBN to devalue the currency (there have even been calls for currency to be floated). In his maiden media chat, President Buhari expressed an unfavourable disposition to devaluation of the Naira to further add fuel to an already smouldering situation.

Is the CBN’s position inherently wrong? Not necessarily as they should be the primary authority on the value of the Naira. However, being unable or unwilling to meet all demand for forex at the price they have quoted does not show that the price they have determined was wholly based on economic indices. This is fine though as unlike monetary policy, forex management policy has a more pronounced political nuance, especially as Nigeria continues to enjoy a positive balance of payment (see here). CBN also has to manage the views of its only customer and chief supplier of its forex, the government of Nigeria. So how does the CBN keep everyone (government, analysts, banks, BDCs, businesses and citizens) happy while carrying out its defined function? History suggests that the CBN has been all too quick to pull the devaluation trigger rather than put it’s house in order — in 1999 Nigeria had $5B in external reserves, a GDP of $36B and exchange rate of N90 to $1, plus oil price at about $16 per barrel. Today, oil price is about $37 per barrel, reserves are at $29B and GDP at $467B (2015 annualized) suggesting an improved economic situation, but in the same time Naira has depreciated by 119% to N197 to $1! Surely this makes no sense and suggests the CBN should be looking critically at how it manages the currency and pursuing an alternate strategy. To be clear, having a fixed exchange rate is not peculiar to Nigeria, a number of countries such as the UAE and Saudi Arabia have this and manage effectively. These countries also have positive balance of payments as Nigeria does and have significantly higher import bills.

To do this, CBN must unify the Nigeria forex market by using its regulatory might to bring all supply and demand to the same arena which should lead to an end to the parallel market. CBN has been a silent supporter of the parallel market by turning a blind eye to the practice as long as spread did not become unmanageable. This is clearly a contravention of the CBN act which states that only the CBN can determine the value of the Naira. It has created a situation where banks focus on exploiting the arbitrage opportunity to boost their bottom line rather than focus on “real banking”. This is fine when spreads are no more than 10% above CBN rate which is not the case now. Not only is it creating undue economic pressure on the Naira, there is also the political pressure as everyone naturally assumes that the CBN rate is wrong and parallel market rate is the true reflection, despite CBN saying the parallel market is a very small part of forex activity in the country.

So what to do? CBN statistics database (see here) shows there is net positive forex cashflow in Nigeria every month, even with reduced oil receipts. The key therefore is to ensure all inflow becomes available for those that need to make outflows i.e. create one market for supply and demand rather than what happens now. The following actions are proposed:

Go electronic! — All forex in Nigeria should be converted from cash to electronic balances within a 30–60 day deadline. Everyone will be given this period to pay all forex into bank accounts after which forex cash will no longer be accepted. This is very key to creating a single market and ensuring that the parallel market no longer exists as most parallel market transactions are cash based.

Make transactions in forex cash illegal in Nigeria — The only legal tender in Nigeria is the Naira and it should be the basis for all transactions. In particular, no cash payments or transactions should be allowed in any other currencies. Banks should no longer pay out cash in foreign currencies to customers in Nigeria, customers who received forex inflows should receive funds in Naira. Personal Travel Allowance and Business Travel Allowance should be provided in the form of prepaid foreign currency denominated cards. This should immediately set back the parallel market and ensure it is starved of a key part of the trade.

Domiciliary accounts should have 30 day limit for holding balances — Nigeria currently has about $23B sitting in domiciliary accounts (see here for CBN report, external reserves currently at $29B) which should actually be transit accounts for funds coming in or going out. By enforcing a time limit on existing balances requiring funds to be transferred abroad or converted to Naira at the CBN rate, reserves can be almost doubled immediately. This makes forex available for sale and relieves pressure on the Naira. What’s more it reinforces CBN as official hub for all forex transactions in Nigeria and strengthens its ability to determine value of the Naira.

Prescribe and enforce margin band around rate for banks and BDCs — Banks and BDCs should not be able to charge more than a prescribed margin on forex sales to or purchases from customers. This will ensure that the rate does not deviate far from that set by CBN and also take away arbitrage opportunities, a key driver for the black market.

Monitor bank and BDC forex balances with prescribed time limit — CBN should ensure that banks and BDCs do not exceed a maximum threshold for amount of forex they can keep on their books at any point in time to discourage hoarding and creation of an artificial scarcity situation. Also review transaction activity of banks and BDCs to ensure only those that have a vibrant transaction activity are allowed access to forex sales.

Reduce forex cash that can be brought in and taken out — The limit on forex cash that can be brought into Nigeria should be reduced to $5,000 and limit on cash that can be taken out to $2,000. The idea is to truly go cashless and take away any opportunity for a parallel market.

As shown above, Nigeria gets enough forex to meet demand and grow reserves over time. The key is for CBN to consolidate the forex market into one by bringing all inflows together under its control and then closing all loopholes for forex trading outside of the financial system. It is imperative that government also does its part by leaning on the CBN and declaring any creation of arbitrage opportunity illegal. CBN has for too long taken the devaluation route too easily to the detriment of the nation, it is important that other measures be pursued at this time.