After months of resisting devaluation pressure by restricting access to dollars, the Central Bank of Nigeria has announced rules for a reformed foreign-exchange market. The new regime begins next week.
The new system is essentially a managed float, in our view. All of the existing segments of the market will be merged into a single “window,” with market-determined pricing and limited central bank intervention.
As far as we know, there will be no daily up or down limits, which would imply that with effect from Monday the market can price the naira where it wants.
Who Can Deal?
Banks will be the main participants in this new unified market, but they’ll be divided into “primary” and “non-primary” dealers.
The central bank said it expects to have about 8-10 primary dealers and our guess is that there will be another 10-12 secondary dealers. What separates the two is the ability to do a minimum ticket size of $10 million; plus the central bank will only deal directly with primary dealers, not the non-primary.
Non-primary dealers will apparently be allowed to sell dollars onwards at any rate they choose, as long as those sales are backed by proof of legitimate trade.
Can importers of toothpicks and incense finally get their dollars?
No. The famous “41 items” – toothpicks, incense, etc. – will remain ineligible. It is forbidden to sell foreign currency to them – at any price. This means that the parallel market will continue to exist, though in much diminished form, we think.
How far will the naira fall?
In terms of market dynamics, we would expect the spread between the parallel market and the inter-bank market to fall dramatically, perhaps even to collapse. The big question is whether that happens through a weakening of the inter-bank rate (starting point is 199 naira to the dollar) or a strengthening of the black market rate (starting point there is 367 to the dollar).
Our estimates on “fair” value for the naira still stand at 280-290 naira per dollar.
How big will the demand be for dollars?
The existing import backlog, which we would estimate to be somewhere in the range of $2-3 billion, will be pushed onto this new, unified market.
It’s uncertain if this demand will be cleared through central bank intervention, or from the natural inflows that it hopes this new system will catalyze. Whatever the case, there is now a revised, market-driven price for these dollars and we doubt that it will be 199 naira to the dollar.
How much intervention can we expect from the central bank?
Judging from the press statement, the central bank will keep the bulk of its intervention for the non-deliverable forwards, or NDF market, while futures will also be introduced, with the FMDQ over-the-counter securities exchange acting as the platform.
Although transactions on the new OTC futures market will technically need to be trade-backed, the tone of the Q&A session following the release suggests that the central bank will try to drive speculative activity onto that market. In other words, instead of over-invoicing imports and putting the resulting demand through the spot market, the Governor appeared to direct such activities to the futures market.
Is this the fix Nigeria needs?
Overall, this looks like quite a bold step towards liberalization. It’s certainly better than expectations – our own and those of investors, who have seen many false dawns before.
The key feature here is that the multiple tiers or layers have been removed. The sub-text of this decision that the President has finally recognized that multiple tiers lead to arbitrage, and arbitrage creates opportunity for fraud. Reading a bit deeper into things, we are also tempted to conclude that this is a sign of President Buhari handing the reins of the economy (back) over to his ministers.
Alan Cameron is Exotix Partners’ economist.