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The CBN and the floating exchange rate 13 Jul 2016

After one year of standstill, the Central Bank of Nigeria (CBN) has effectively abandoned its much-criticised fixed exchange rate. The pertinence of the floating exchange rate in addressing foreign exchange risk, especially under extant economic circumstances of the country, was instantly validated in the equity market. In three days of trading, from June 20th when the new forex regime came into operation, the All-Share Index (ASI) of the Nigerian Stock Exchange (NSE) gained a cumulative 8 per cent.
    
The new policy had sparked “buy” interests in Nigerian equities since the CBN announced its operational guidelines on June 15th, catalysing the ASI's dramatic change of course, from negative to the positive zone, year-to-date. The stock market resurgence, all things being equal, could inspire more positive narratives on wider investments in Nigeria, going forward. For example, Nigerian non-oil export trade has become commercially sensible again.

It was one big contradiction of the push for non-oil export growth that the government had insisted on an exchange rate regime that discouraged repatriation of export proceeds. Under the now defunct naira's peg to the dollar, exporters who sourced forex in the parallel market for primary or intermediate goods had to repatriate export proceeds through the official market where the exchange rate was lower by as much as 45 per cent.  Recognising the removal of this policy bottleneck, the CBN has accelerated the take-off of its N500 billion intervention fund for non-oil export growth, which will be managed by Nigerian Export Import Bank, for on-lending by the commercial banks.

But a floating exchange rate has its dreadful flip side. It fosters uncertainty and speculation; the naira depreciated sharply from N199 to the dollar to N282 within one week, from June 20th. Given this, investors and business managers will likely be cagy in the way they commit at this early stage of operating the new forex regime. Indeed, the CBN has been the only major seller in the market so far. To stimulate the market, the apex bank had to, on day one of trading under the new 'managed float' system, clear the $4 billion outstanding demand in the FX market. This move may have been aimed at reducing betting on the promise of periodic intervention by the apex bank so as to accelerate naira price discovery. But the market will wait longer for indubitable real value of the naira.

The CBN's regulatory resources would be tested under the new system. Without market discipline, on the part of the regulator and the operators, the new managed float regime will fail. Favouritism in FX allocation during the immediate past market regime, influence-peddling by the bureau de change operators, forex scarcity that may persist with subsisting low oil prices and limited political support constitute the litmus test for the putative market-driven policy. If foreign investors remain held back by the implication of low oil prices on dollar liquidity in Nigeria, it means the CBN will have to continue to piggyback the so-called autonomous forex market. So long would a sizeable gap in rate in the parallel market persist, driving the arbitraging impulse of bankers, and causing (export) manufacturers to convert to currency merchants.

The biggest risk to the new forex policy is the delay in its adoption. The policy came into effect after the long delay to its introduction had contributed to comprehensively negative macroeconomic data and outlook of the Nigerian economy. Inflation rate for May was 15.6 per cent. Unemployment soared to 12.1 per cent in March, as labour demand slowed and layoffs became rife, particularly in the manufacturing, financial services and SME sectors.

Introducing at this point a floating exchange rate, which is known to be inflationary, can result in contradictory policies for productivity growth and employment. In this regard, the MPC might raise its anchor interest rate, especially if naira liquidity resurge, as the federal government begins implementation of the 2016 capital and social investment plans. Therefore, as the new forex policy brings relief to segments of the financial markets, it may prove to be a negative policy for average Nigerians in the short- to medium-term.

The market had to endure the intransigence of President Muhammadu Buhari who had insisted on the naira peg. To that extent, the CBN might be absolved of responsibility for the negative economic consequences of the delay. Nevertheless, there remain issues around the forthrightness of the CBN as a regulator and policymaker.

It rings hollow that the CBN had to tag along since the President had insisted on dictating forex policy. The Monetary Policy Committee has to square with the truism that a regulator that hangs on to a job it is not allowed to do as he or she deems right is a betrayer of professionalism. The Governor of the Reserve Bank of India, Professor Raghuram Rajan, has now expressed his decision not to seek a second term in office. This follows his well-known disagreement with Prime Minister Narendra Modi on aggressive interest rate cuts. While the government and the Reserve Bank agreed on interest rate cuts, the latter prefers slower deceleration of rates, in line with its objective of price stability. Prof. Rajan also held the line on other points of conflict with the administration.

We also observed that, between the decision of the MPC in May to adopt a flexible exchange rate and the start of trading under the new forex regime in June, the CBN had contradicted its pronouncements three times, and a couple more times subsequently. First, instead of a two-tier market the MPC hinted, the CBN rolled out guidelines for a unified market structure. Second, while the CBN had said it could take three to four weeks to clear outstanding forex demand of N4 billion, it did so in one day. Third, the CBN has abandoned its initial statement of limiting the FX Primary Dealers to ten banks. And it appears the CBN will start selling FX to the BDCs again, in contravention of its operational guidelines.

This flip-flop is associable with a central bank that has lost its independence – and, by lack of practice, its professional acumen – due to executive interference in monetary policymaking. This is why President Buhari has to restore autonomy to the CBN. With that, the banking industry regulator and monetary policymaker will not only be more accountable for its policies, it will get better at exercising its mandates.