After about 16 months of battling to stabilise the naira-dollar official exchange rate at N197/US$1 in the face of macro-economic headwinds and dwindling foreign exchange earnings which fell “from about US$3.24bn monthly to current levels of below a billion dollars per month”, the Central Bank of Nigeria finally succumbed to pressure from both within and outside Nigeria to adopt a flexible inter-bank exchange rate system in which the exchange rate would be market-driven. Following the new policy, proceeds of foreign investment inflows and international money transfers would be purchased by authorised dealers at the daily inter-bank rate while non-oil exporters would be allowed unfettered access to their forex proceeds expected to be sold in the inter-bank market. A remarkable aspect of the policy is the introduction of new products, futures and forward contracts, which give traders the opportunity of hedging against the exchange rate risk by locking in the rate for future delivery of foreign currency. These derivative products would help to reduce the volatility in the forex market.
The new forex policy is expected to bring about a significant increase in capital importation and Diaspora remittances which will shore up the country’s foreign reserves. It is also capable of narrowing the huge gap between the interbank and parallel market rates thereby reducing round-tripping, arbitrage opportunities and artificial demand from the market. Being a managed float system, the CBN is expected to participate in the market through periodic interventions to either buy or sell foreign currency as the need arises and in a bid to boost liquidity in the market, the apex bank has also appointed primary dealers. Without doubt, these measures, which are intended to enhance efficiency and facilitate a liquid and transparent forex market, will rub off positively on the stock market. As a pointer to this optimism, the market performance on Wednesday, June 15, 2016, when the policy was unveiled, was quite remarkable with equities capitalisation rebounding from a previous three-day losing streak to close at N9.6tn- about the highest level in June 2016. In the same vein, the benchmark All Shares Index (ASI) gained 3.2 per cent to close at 27,891.96 points with all sector indices reflecting a strong appetite witnessed across board.
So, the general expectation is that the stock market will be bullish in the days ahead following the return of foreign portfolio investors who beat a retreat from Nigeria in the wake of capital controls introduced by the CBN. It will be recalled that foreign investors’ confidence was greatly dampened by JP Morgan’s decision to phase out Nigeria from its Emerging Markets Government Bond Index in September 2015 as well as the country’s ejection from the Barclays Index owing to currency restrictions and limited transparency in the forex market. According to the Nigerian Stock Exchange polls, trading figures from major custodians and market operators on their Foreign Portfolio Investment flows in December 2015, total transactions of foreign investors who are known to dominate trading on the Nigerian bourse “decreased by 33.39 per cent from N1,538.92bn recorded at the end of 2014 to N1,025.07bn at the end of 2015.” This is partly the fallout of the exclusion of Nigeria by the international index providers which comes with negative consequences for the stock market.
Therefore, the relative ease of capital flows associated with the new policy will enhance the country’s chance of re-entry into the JP Morgan index, after the minimum 12-month period, as foreign investors who track the GBI-EM series will no longer face uncertainty occasioned by the lack of a fully functional two-way forex market. Nigeria’s re-inclusion in the GBI-EM index and the diminished threat of reclassification and exclusion from the MSCI Frontier Markets Index will once again open the stock market to more investments and raise its image in the global financial markets.
On the flip side, the new policy is likely to exert more inflationary pressure in the near term as the naira is bound to weaken further in any contest with the dollar on strictly market forces dynamics given the import-dependent and shallow export base of the Nigerian economy. In its Consumer Price Index report for the month of May, the National Bureau of Statistics indicated that the cost of food imports contributed significantly to headline inflation which was put at 15.6 per cent compared to 13.7 per cent recorded in April 2016 with the imported food sub-index increasing by 18.6 per cent in May 2016. This further confirms the pass on effects of the increase in the cost of imported goods.
A further spike in inflation is a disincentive to domestic investors in the stock market considering its negative impact on real stock returns. Given the cost-push nature of the current inflationary pressure and the limitations of monetary policy tools in this regard, a number of countervailing fiscal policy actions, anchored on the stimulation of real sector growth, should be undertaken from the extra money which the government stands to reap following the participation of the CBN in the market at a forex rate expected to trade higher than the current peg of N197 to the dollar when the policy becomes fully operational. Spending the extra money on agriculture, infrastructure and SME development will go a long way in moderating the inflationary pressure and boosting activities in the stock market.
A similar policy some years ago during the regime of Gen. Sani Abacha resulted in more money into the coffers of the government. Addressing members of the Institute of Chartered Accountants of Nigeria in Lagos recently, Chief Anthony Ani, who was the country’s finance minister at the time, recalled how the introduction of the Autonomous Foreign Exchange Market in 1994 crashed the parallel market rate from N128 to N82/$1. According to Ani, “The CBN was also able to make a profit of N58 per dollar, on forex sales to the real sector which was applied to balance the budgets and also build infrastructure such as the Gwarimpa Housing Estate in Abuja”.
Overall, the new forex regime will impact the stock market positively in the short term. The sustainability of the expected increase in the tempo of market activities will be a function of how well the adverse effects are managed. Aside from the inflationary pressure and the attendant rise in interest rate, there is also the fear that the new policy is capable of eroding the assets of some banks and increase the rate of loan default by their customers. Stocks of banks worst hit by a weakened naira could be negatively affected. Perhaps, more importantly, the realisation of the full benefits of the new policy by the stock market is dependent on the ability of the government to negotiate a ceasefire with the Niger Delta militant groups in order to curtail disruptions in crude oil production and ensure a secure environment conducive for attracting investors in the Nigerian stock market.
GUARDIAN
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