The Central Bank of Nigeria reintroduces the Flexible Exchange Rate Inter-bank Market as part of measures to make the foreign exchange market as transparent, liquid, and efficient as possible

DollarandNaira_For more than 12 months, Nigerians agonised as their businesses and social activities were starved of foreign exchange. Despite the challenge, the Central Bank of Nigeria (CBN) had maintained it would neither devalue the Naira nor allow the forces of demand and supply to determine its exchange value vis-a-vis other major currencies. As the matter lingered, the gap between the official and unofficial exchange rate of the Naira to the Dollar widened to N197 and N375 respectively.

In a twist of event, on June 15, this year the apex bank re-introduced the flexible exchange rate system.“Having consulted widely and prepared carefully, the committee of Governors of the CBN is delighted to unveil to relevant stakeholders and the general public, the broad framework and guidelines of the Flexible Exchange Rate Inter-bank Market, which we alluded to at the end of that MPC Meeting,” Godwin Emefiele, governor of the CBN said while announcing the new policy.

He explained that the policy, which finally took effect on June 20, was borne out of the Central Bank’s conviction that the “time is right to restore the automatic adjustment mechanism of the exchange rate with the re-introduction of a flexible inter-bank exchange rate market. The workings of this market will be consistent with the Bank’s objectives of enhancing efficiency and facilitating a liquid and transparent Foreign Exchange Market.”

Key aspects of the policy
The key aspects of the new foreign exchange policy are that the market shall operate as a single structure through the inter-bank/autonomous window; that the exchange rate would be purely market driven using the Thomson-Reuters Order Matching System as well as the Conversational Dealing Book; that the CBN would participate in the market through periodic interventions to either buy or sell FX as the need arises.

Furthermore, the CBN would introduce Foreign Exchange Primary Dealers (FXPD) who would be registered by the apex bank. They are to deal directly with the CBN for large trade sizes on a two-way quotes basis to improve the dynamics of the new foreign exchange market.

These Primary Dealers shall operate with other dealers in the Inter-bank market, among other obligations that will be stipulated in the FXPD guidelines. The CBN emphasised that there should be no predetermined spread on foreign exchange spot transactions executed through its intervention with primary dealers. Notwithstanding, all foreign exchange spot purchased by authorized dealers are transferable in the inter-bank forex market.

Nevertheless, the 41 items previously classified as “Not Valid for Foreign Exchange” as detailed in a CBN circular still remain inadmissible in the Nigerian forex market.

The re-introduction of flexible exchange system was accompanied by new financial products such as the forward and features markets, which were hitherto unknown to the Nigerian financial system. They will mitigate foreign exchange risks due to market’s volatility and enhance liquidity in the market. The sale of foreign exchange in the forward market by authorized dealers to end-users must be trade-backed, with no predetermined spreads. In addition, the CBN would introduce non-deliverable over-the-counter (OTC) Naira-settled Futures, with daily rates on the CBN-approved FMDQ Trading and Reporting System. “This is an entirely new product in the Nigerian foreign exchange market, which would help moderate volatility in the exchange rate by moving non-urgent FX demand from the Spot to the Futures market. The OTC FX Futures shall be in non-standardized amounts and different fixed tenors, which may be sold on any dates thereby ensuring bespoke maturity dates,” Emefiele explained.

Henceforth, the proceeds of foreign investment inflows and international money transfers shall now be purchased by authorized dealers at the daily inter-bank rate. Likewise, non-oil exporters are now allowed unfettered access to their foreign exchange proceeds, which should be sold in the inter-bank market.

The Central Bank, according to Emefiele, is determined to make the market as transparent, liquid, and efficient as possible. Therefore, it would neither tolerate unscrupulous behaviour nor hesitate to bring serious sanctions on offenders. It also expects the highest level of professionalism from all authorized dealers. “We expect them to understand the spirit and letter of this transition to a market based system. The CBN will not allow the system to be undermined by speculators and rent-seekers. Permit me to emphasize that any attempt to breach any aspect of this new framework will be heavily sanctioned by the CBN and this may indeed result in the suspension or withdrawal of the FX dealing license of an offending authorized dealer,” Emefiele said.

He urged market participants to assist in ensuring that the new system enables the CBN “to pursue its mandate in a more effective and efficient manner to guarantee preservation of our scarce commonwealth, stability of our financial system, and growth of our economy to the benefit of all Nigerians.”

Initial effect of the policy
How far the market participants would ensure the efficiency of the new flexible exchange system would be seen in the months to come. However, at the commencement of the new policy on June 20, the Naira depreciated at the official market from N197 to N280 in exchange to the dollar. But it appreciated at the unofficial market where rate of the Naira to the Dollar dropped from N375 to N330. The move reduced the divergence between the official and unofficial market from 90.4 percent to 14.3 percent.The re-introduction of the flexible exchange rate also enabled the Central Bank to record a full satisfaction of forex demand at the interbank market with a total of $532.867 million and cleared the backlog of $4.02 billion foreign exchange demand.

Isaac Okorafor, Acting Director, Corporate Communications of the CBN said the apex bank achieved its objectives to clear the forex backlog as a market intervention participant and re-launched a functioning and efficient interbank market. “The CBN, in line with its desire to promote a transparent, liquid and efficient market, and in order to engender market confidence and ensure credible price formation, intervened in the market through special Secondary Market Intervention Sales (SMIS) to address the issue of the FX demand backlog by clearing $4.02 billion through spot and forward sales. This served in no small way to stimulate price discovery, with the determination of a marginal rate of N280/$ through the special SMIS process,” Okorafor said. He assured the public of the apex bank’s commitment to make the Nigerian forex market globally competitive, credible, transparent, liquid and efficient.

The tempo of the market on the first day of trading under the new rules also showed that participants at the official window are beginning to have confidence in the country’s forex market. “For the first time in close to two years, we saw live trading. It was like the market coming back to what we used to see in the past,” said a participant who pleaded anonymity.

Reaction of experts
Tumi Sekoni, vice president and divisional head, Marketing & Business Development, FMDQ, explained that the interbank two-way-quote (2-WQ) forex market would serve to enhance greater investor confidence in the Nigerian FX market. “With its potential to drive transparency and liquidity, FMDQ, through the system, is adequately equipped to provide a complete and consolidated marketplace for FX trading and reporting, offering market participants and regulators a robust and flexible set of tools to support the full trade workflow,” Sekoni said.

Winifred Iyiegbuniwe, a professor of Finance at the University of Lagos, described the re-introduction of the flexible exchange rate as a step in the right direction, saying it would ease access to foreign exchange and curb the corruption inherent in rationing or direct allocation of foreign exchange to influential people and businesses. He, however, noted that the stability of the market would be determined by inflow of foreign exchange into the country. He warned consumers to brace up to inflation that would accompany high cost of imports.

Prof. Mike Obadan of the University of Benin also agreed that the time was ripe to allow greater flexibility of the exchange rate. He pointed out that a flexible exchange rate regime would result in initial sharp depreciation of the Naira in the market and lead to higher prices of imported and locally produced goods and services. But things will later stabilize and the exchange rate may even appreciate when foreign exchange earnings improve.

However, the flexible exchange rate has its economic implications. The exchange rate which will largely be determined by market forces would make it susceptible to fluctuation from time to time, which might tend to discourage international trade transactions. “The pass-through effect of the depreciation could be increase in unemployment and poverty as businesses may find it difficult to cope with the effects of a highly depreciated exchange rate. However, government naira earnings from monetized crude oil export earnings will increase if oil prices continue to increase and budgeted production level is achieved,” Obadan said.

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