It is fair to say that under President Muhammadu Buhari’s relatively short tenure, the Nigerian Financial Sector has endured its reasonable share of activity and critical scrutiny. Three major incidents have stood out, and these incidents are intertwined in terms of the collective impact they have all had on the sustained call to devalue the Naira: First, in the past year alone (dating back to the previous administration), the Central Bank of Nigeria (CBN) has reeled out a series of policy reforms on the foreign exchange market that has sent panic to the market. Leading up to the general elections conducted earlier this year, the market began to experience a significant shortage of dollars. This dwindling of our reserves was caused by falling oil prices, while the huge demand was fuelled by election spending and the accompanying market nervousness about the possible change of government.
The CBN’s response to these events further exacerbated the situation, and this has driven the parallel market rates to the roof.
Secondly, the Federal Government issued a directive on the consolidation of Government revenues into a single treasury account (TSA), a bold policy currently being implemented at its infancy stages by the CBN. The immediate effect of this policy has been the estimated movement of over N2 trillion from private banks to the CBN, which has dipped liquidity and spiked interbank and other interest rates.
Thirdly, and probably as a result of the first two points, we received the curious news that JP Morgan Chase-an American-based International Financial Service Firm- would be delisting Nigeria from its Government Bond Index for Emerging Markets (GBI-EM) in what they called “a phased-out process” between September and October this year. JP Morgan cited a lack of transparency and liquidity in our foreign exchange market as the primary reason for its decision. The significance of this announcement cannot be understated, because JP Morgan Chase provides the pricing and trading platform for foreign investors who hold or are planning to hold Nigerian Government-issued bonds, and they also create and sustain an active market for these bonds.
The immediate impact of this announcement was a panic sell-off at the Nigerian Stock Exchange (NSE) by foreign investors in the market. Instantly, the NSE market capitalization of listed equities lost about N311 billion or 2.98%. In addition, the announcement threatened the stability of the Nigerian Bond market and the ability of the Government to use the market to raise funds in the near future. The CBN was forced into damage-control by issuing a public statement to the effect that it disagrees with the expulsion, and denied the claim of a lack of transparency and liquidity in the market. Some industry analysts have joined in supporting the CBN’s statement, while downplaying the possible negative effects on foreign investment and the Nigerian economy.
You see, JP Morgan’s argument was fairly straightforward. Their argument was basically: “We know the level of your reserve and we know it is dwindling. We know why you have been tinkering with your foreign exchange policy in recent times, because you are protecting your naira and keeping the value low. We know that your currency is overvalued and underpriced. So, release your hold on pricing mechanisms and let the forces of ‘demand and supply’ determine price”. You have to say it is a fair argument. Of course, JP Morgan’s primary interest is the protection of its clients- the foreign investors playing in the bond market- because that is its main responsibility.
These three major action points, alongside some of the uncertainties that have arisen as the Federal Government patiently articulates its holistic fiscal policy and medium-term Economic framework, have created deep-rooted cracks on the naira exchange rate. The cumulative effect has been the sustained pressure (both locally and internationally) carefully mounted on the CBN to devalue the naira to reflect its ‘true’ value at the parallel market. But is there sufficient justification for devaluation at this time? The simple answer is no, but the long answer requires a thorough understanding of historical context.
The rapid evolution of the Nigerian foreign exchange market began in 1982, when comprehensive foreign exchange controls were enacted to manage the monetary crises that ensued that year. We subsequently moved to the era of Second-tier Foreign Exchange Market (SFEM), introduced in 1986 to manage the fall-out of the exchange control system introduced in 1982. Further liberalization reform measures were introduced by the introduction of the Bureau-De-Change (BDC) market to improve access to foreign exchange by small and retail users. This particular measure, without clear guidelines and monitoring systems, pushed the parallel market to the forefront with full force. The resultant volatility caused by the flourishing parallel market led to the introduction of further reforms by way of the Foreign Exchange Market in 1994.
These new reforms included the formal pegging of the naira exchange rate, the centralization of the market at the CBN, the restriction of the operations of BDCs, and the discontinuation of the Open Accounts and Bills for Collection System as a means of payment. Further measures were implemented in 1995, with the introduction of the Autonomous Foreign Exchange Market (AFEM) when, for the first time, the market was liberalized with end-users able to buy and sell foreign exchange from CBN through banks at market-determined rates. By 1999, we began to witness a further liberalization of the market by the introduction of the Inter-bank Foreign Exchange Market (IFEM).
The current foreign exchange regime is an off-shoot of the last major reforms between 1995 and 1999. Unfortunately, the structural impediments were left intact, and the parallel market has continued to flourish by filling the gaps created by these bureaucratic impediments and policy flip-flops- all of which are still prevalent today. Rather than removing the bureaucratic bottlenecks in the system, successive CBN administrations have been focusing on defending the naira by tinkering with the pricing mechanism, while letting illegal operators take the initiative.
Rather than solving problems, these new reforms have driven buyers and sellers to the parallel market, making the official market more unstable. It is almost like playing a football match with all the outfield players defending when they are already four goals behind. You may arrest the bleeding, but you just can’t win.
Of course, the primary objective has always been the efficient management of the foreign exchange market by determining the true price of foreign currency vis-a-vis the naira. The reality is that nobody- including the CBN- knows the true value of the naira. The value of a currency is its price, just like price determines the value of goods and services. The Naira-Dollar ‘product’ is like any other good; its price is determined by a complex interplay of demand and supply, which forms the price at equilibrium. The real conundrum is this: who knows the actual demand and supply? Of course, the CBN knows how much dollars are available for sale on a weekly basis, and how much naira is utilized to meet the demand for the dollar. The information that the CBN possesses comes from its position as the major supplier of both currencies, and its main function as the banker to our banks and the custodian of the foreign exchange market. In truth however, nobody has the authentic information on the actual volumes of Naira and Dollars chasing each other in our economy.
To make matters more complicated, this is only a segment of the market. For example, the official exchange rate is pegged at approximately N199 to $1 because it is based on CBN’s information on the official demand and supply, which is supposed to be the equilibrium price. Unfortunately, the mechanism for arriving at this rate is largely discretionary, unscientific and questionable. The CBN may have been right in arriving at this rate, but it very well may have been wrong in arriving at this rate as well. The parallel market rate is hovering around N226-$1 today because the market gets some of its supply from the CBN and will naturally add profit to resell. It is selling mostly cash, which always sells at a premium. Cash has a monopoly because the traders in this market have perfected the art of rigging rates. All these aggregately ensure that the parallel market rates will forever be ahead of the official rates.
It is therefore wrong to use the parallel market rate as a reference point because it is not quite determined by any traceable interplay of demand and supply. The rate is rigged and illegal, and should be ignored in its entirety.
It is therefore not unlikely that the parallel market might be bigger and more active than the official CBN market. Nobody knows the exact volume of dollars being traded in this unofficial market, or the naira-cash floating outside the banking system that is being used to buy and sell dollars. We do not have accurate estimates on the number of mallams, or the total volume being traded by them daily. We do not know the exact volume being traded by unregistered foreign exchange dealers all over the country. We do not know the actual amount being traded by registered BDCs. We also do not know the exact amount of raw cash dollars imported and exported by Nigerians and foreigners. So, how then can you determine the equilibrium price of a market with so many unknowns! President Buhari is correct in determining that our currency does not need to be devalued – for the time being. The sum-total of the aforementioned points is that it is unhelpful to conclude that our naira is overvalued and should be devalued, because we do not have any rational indices for measuring the naira’s true value.
A further devaluation will devastate our economy because it will technically make our imports more expensive and our exports cheaper. Of course, this is somewhat unhelpful to us because we import practically everything and export very little except oil, whose price is determined internationally, and our supply also quota-based. Therefore, the gains of devaluation would be inapplicable to our situation, while the adverse effects- higher import prices, higher rate of inflation, more pressure on the demand for dollar, higher unemployment and general recession- would be catastrophic to us. What then is the way forward? First, the Federal Government has to fast-track its efforts towards implementing a sustainable fiscal policy regime tailored towards boosting our local industry. Curbing corruption, promoting import substitution and the exportation of indigenous products will go a long way in achieving this aim. Many other countries like India, South Africa, Malaysia, Indonesia, Egypt etc have little or no oil dollars, but they all have more stable currencies and stronger liquidity than we currently do. They have been able to successfully tap into these “other sources” and develop a stable foreign exchange system with a thriving market to boost supply and manage demand.
Secondly, and perhaps more poignantly, a critical solution lies in our ability to bring sanity to our foreign exchange system and have better controls over the demand and supply mechanism. I highlighted these solutions in an earlier paper-
“The Grand Assault on The Naira”. The points canvassed in that article are more or less relevant in the context of this one: As a matter of national emergency, the parallel market has to be destroyed. The CBN has to overhaul the foreign exchange regime by bringing all legitimate buyers and sellers into the official market. The way to do this is to simplify the buying and selling process by making documentation easy and seamless, and accommodate all economic users of foreign exchange. The buying and selling process could be simplified through the authorized dealers with clear and unambiguous rules, while CBN provides adequate supply to the market at all times. It should be noted that the CBN is not the only supplier to the market. Other suppliers include oil firms, exporting firms, Nigerians in diaspora, foreign investors, foreign lenders, etc. These suppliers could provide a much higher volume to the market than the CBN if motivated and encouraged.
When the CBN successfully brings the legal buyers and sellers into the official market, it would become easier for the Federal Government to deploy its security apparatus and other legal instruments towards chasing away the remnant players in the illegal market. With regards to the parallel market operators, the Government should apply the same vigor that it is adopting in its pursuit of corrupt officials, because until the market is eliminated or reduced to insignificance every effort to manage our foreign exchange market will simply be like pouring water into a woven basket.
These issues have been with us for over 35 years. They are not going away until we take a firm stand to render the underground foreign exchange market insignificant and irrelevant. Only then can we start focusing on addressing the actual value of our currency against the dollar and other currencies. In the interim, any attempt to devalue the currency amounts to treating an ailment without a proper diagnosis.
Otunba Femi Pedro is a Banker and an Economist. He is a former Deputy Governor of Lagos State, and the former Managing Director of First Atlantic Bank (FinBank) Plc. He can be reached via the Twitter Handle: @femipedro