CBN sees light as Nigeria gradually unifies FX rates

By Charles Abuede

• Apex bank embraces market fundamentals
• FSDH analysts say move could build investor‭ ‬confidence‭, ‬improve capital inflows
• As economy navigates through tides of uncertainties

The recent action by the Central Bank of Nigeria (CBN) to shift towards a more comprehensive, unified and market-driven foreign exchange rates regime by adjusting its official rate to reflect the FMDQ independently and objectively determined NAFEX rate, has received endorsements by high ranking members of Business A.M.’s universe of analysts’ communities who described the move as a positive one for Nigeria’s economy. In particular, they said the apex bank has taken a bold step towards ensuring clarity and improving market confidence which could, in turn, improve forex inflows into the economy.

Nigeria’s exchange rate has remained under pressure despite a consecutive two-quarters’ gross domestic product (GDP) expansion in Q4 2020 and Q1 2021. But a slowdown in output growth in the Q1 2021 data is seen as indicative and reflection of a fragile economic recovery for Nigeria as the non-oil sector grew marginally to 0.8 per cent from 1.7 per cent in the last quarter of 2020 while Nigeria’s trade sector, which is key to her economy, continued its contraction as a result of shortages of foreign exchange and weak aggregate demand.

The move towards a single exchange-rate system for the local currency is becoming a reality as the apex bank has before now, devalued the the domestic currency, the naira, by 7.6 per cent against the dollar; and by further replacing the fixed rate of N379 to the dollar for official transactions with N410 as contained on its website after the currency defied all interventions to retain its value. Godwin Emefiele, governor of the CBN, had said that the drop in crude oil earnings and the decline in foreign portfolio inflows (FPIs) had a significant impact on the supply of foreign exchange in Nigeria.

With the foreign exchange situation in the currency market and the level of illiquidity in the FX segment, analysts have projected the naira to trade at N460 to a dollar in 2021 in a worst-case scenario and to trade at N430 per dollar in a moderate case, as the economy recovers and embraces the new normal on the back of covid-19, oil price movement and a possible disruption in the local economy.

But since the first quarter of 2020, the naira has depreciated across the different foreign exchange (forex) markets while the existing gap between the apex bank rate and rates in the Importers’ & Exporters’ (I&E) window and parallel market has expanded due to forex shortage.

Recall that in 2020, the apex bank adjusted the official exchange rate twice following a wide spread between the official rate and the rate in the I&E window. Meanwhile, having multiple exchange rates has been a key factor that has limited the inflow of foreign exchange into the Nigerian economy. Although the inflows into the I&E window are yet to return to the pre-COVID-19 levels, they stood at $564 billion in April 2021. This is despite CBN’s efforts, such as the diaspora remittance incentive, to improve liquidity across the forex markets. However, economic analysts at FSDH Capital Research have opined that what the CBN needs to do is the alignment of forex management policies with fiscal, monetary and industrial policies to improve liquidity in the forex market.

Comparatively, over a 10-year period, the local currency has significantly been devalued relative to some comparable countries as the official rate depreciated by almost 163 per cent to N412 to the dollar as of May 2021, from N156.7 in 2011. This, according to experts familiar with the matter, is unimpressive when compared with performances of large economies such as Indonesia (58.3%), Malaysia (30.6%), Egypt (158.8%) and South Africa (72.8%), during the same period.

In recent times, the largest economy in sub-Saharan Africa by gross domestic product has grappled with a high frequency of policy shifts in foreign exchange management between January 2020 and May 2021. Thus, the time-span has seen the inclusion of fertilizer in the list of items restricted from foreign exchange (January 2020), followed by another move to restrict forex supply to authorised milk and dairy product dealers (February 2020); the apex bank then went ahead to devalue the official rate to N360 per dollar from N307 in March. The period between April and July last year saw an adjustment of the official rate for import duty payment from N326 to N361 per dollar; an increase of forex bidding price for SMIS operators to N380 per dollar; and the inclusion of maize in the list of imported goods banned from official forex access in Nigeria.

Furthermore, the second half of the year 2020 saw another adjustment of the rate to N379 from N360 per dollar as the apex bank resumed forex sales to BDCs in August after the initial halt due to COVID-19; the final two months in 2020 then came with an amendment by the apex bank to the rules for diaspora remittances which was to allow for recipients to receive foreign currency in cash while it instructed banks to transfer all diaspora remittances to beneficiaries. However, after introducing the Naira-4-Dollar scheme to encourage diaspora remittances in March 2021, the CBN further adopted the NAFEX rate as the official exchange rate. However, between January and April of 2021, inflows from the CBN intervention in the I&E window totalled $226.6 billion, indicating a significant drop of $2.27 billion from the last four months of 2020.

According to FSDH analysts, “In the first quarter of 2021, there was a change in the scale of CBN’s intervention in the I&E window. We observe the limited inflow from the CBN in the I&E window. The decline in overall inflow into the market was largely driven by over a 90 per cent drop in CBN interventions. If sustained, perhaps, this signals a breakaway from the heavy interventionist role of the apex bank. This could improve reserves position and boost market confidence. To get inflows into the window to pre-pandemic level, a fresh injection of a huge amount of forex, particularly from private sources would be needed.”

Factors shaping exchange rate movement in 2021

With experts  predicting that the naira will settle around N430 to the dollar in the latter part of 2021, more inflows of forex are anticipated to also improve, especially when Nigeria issues its Eurobond; but increasing demand pressures from imports and other payments is expected to continue exerting pressure on the rate.

Meanwhile, it is projected that in 2021, the movement in the exchange rate will be shaped by several factors such as (a) Persistent OPEC cuts and compliance among member countries, which could mean that Nigeria may not reap the benefits of higher crude oil price, implying lower petrodollar inflows in the short term; (b) that forex management will be crucial in regaining investors’ confidence in the economy and in turn, attract the much-needed inflow of foreign exchange; (c) the ease of doing business reforms and the situation which could serve as a setback for real sector investment in Nigeria; (d) movement in external reserves and also in interest rates on government securities, which will now be dependent on forex liquidity and capital restriction policies and (e) the performance of the real sector following the gradual economic recovery and the opening of the land border which is expected to trigger improved non-oil export; albeit below pre-pandemic levels.

On top of these is the expectation that Nigeria’s trade deficit will narrow in the coming quarters with reduced pressure on the exchange rate.

As economic experts have put it, Nigeria can also unlock funding from several multilateral organisations such as the IMF and World Bank in order to ease the pressure on the exchange rate in the medium term. However, exchange rate unification is not seen as a sufficient factor in attracting significant capital into the country. What should follow the CBN’s recent actions are a set of consistent forex policies that seek to improve market liquidity and prevent every form of forex arbitrage and unnecessary forex subsidies.

The CBN will also need to work assiduously to clear forex backlogs to further instill confidence in the market. In February 2021, the IMF estimated backlogs at $2 billion.