The CBN and stability of the exchange rate 

OLUWATOSIN OLADETAN

Oluwatosin Oladetan, (MBA, ACCA, PMP, NIM, FMVA, BIDA), a business and corporate strategist, financial analyst, project manager, process improvement and engineering professional, is a Volunteering Contributing Analyst

The Central Bank of Nigeria (CBN) Act 2007 endorses the CBN with the right to control and administer the financial sector and monetary policies of the Federal Government of Nigeria. The stability of monetary outlook, prices and safeguarding the international value of the legal tender currency through external reserve maintenance are among the major objectives of the CBN. Ever since the recent liberalisation of the exchange rate through the CBN press release on the operational changes to the foreign exchange market, there has been high volatility in the exchange rate and a deeper gulf between the prices obtainable at the official exchange rate market (Investor and Exporters Window) and the unofficial (black market) for trading the same unit of a foreign currency instrument.

On January 31, 2024, CBN issued a circular directing banks to adjust the net open position limit of the overall foreign assets, liabilities, and off-balance sheet to be capped at 20 percent short or 0 percent long of the shareholders’ fund unimpaired by losses using the gross aggregate method. The banks were also required to have sufficient high-quality liquid foreign assets to cover their foreign currency obligations. The banks were also encouraged to avoid currency mismatches and interest rate mismatches while adopting adequate treasury and risk management systems to provide oversight of all foreign exchange exposures. The CBN also issued another circular that relates to the removal of the allowable limit of exchange rate quoted by the International Money Transfer Operators (IMTO). Hence, IMTOs are only allowed to quote exchange rates for naira payouts to beneficiaries based on the prevailing market rates at the Nigerian Foreign Exchange Market driven by a willing buyer, willing seller basis. The CBN also reviewed the guidelines for international money transfer services in Nigeria to aid in the liberalisation of the foreign exchange market, ensure transparency in foreign exchange market transactions, boost diaspora remittances and other foreign capital inflows to Nigeria, promote efficient price discovery mechanisms and the evolution of an appropriate market-determined exchange rate, and enhance the ease of doing business for international money transfer operators (IMTOs) in Nigeria and money transfer recipients. Two days later, on February 2, 2024, the CBN updated the Cash Reserve Requirement (CRR) mechanism to utilise the incremental approach: commercial banks will apply 32.5 percent and merchant banks will apply 10 percent to increase the bank’s weekly average adjusted deposits. A CRR penalty of 50 percent of the lending shortfall will be charged to banks that do not meet the stipulated Loan to Deposit Ratio (LDR) of 65 percent.

The CBN is carrying out all these reformations and positions in the market to facilitate the stability of the foreign exchange rate prices within the market, as there is no more intervention to peg the exchange rate at a relatively fixed price after the willing buyer and willing seller methodology was introduced. The Nigerian naira value against the United States dollar (dollars) has been on a downward trend as the market does not have sufficient supply of dollars to meet up with the demand for dollars in the market. Gaimin Nonyane, who serves as the director of Middle East and Africa Sovereigns, recently asserted that the Central Bank of Nigeria does not have enough foreign exchange to settle all the outstanding foreign exchange commitments, and the high cost of debt funding in proportion to the revenue of the country will result in a negative impact on the sovereign credit rating. Within January, the CBN released over $2.5 billion to various sectors of the economy to settle a portion of the over $7 billion outstanding foreign exchange obligations, of which about $2.2 billion are not suitable for settlement based on the report of the forensic investigation carried out by a management consultant presented to the CBN. The CBN governor, Olayemi Cardoso, has committed to the settlement of the due outstanding obligations within a short period of time.

Several factors contribute to the persistent depreciation of the Nigerian naira, such as the following: Nigeria is primarily an importing economy (resulting in a persistent trade deficit), has a large budget deficit financed by external borrowings, a weak position of the external reserves relative to the GDP, a slow GDP and an economic growth rate, among other factors. The federal government of Nigeria and the CBN have a critical role to play if these institutions are bent on ensuring the appreciation and stability of the Nigerian naira, as listed below.

• Enhancement of a productive economy: the creation of an enabling environment for manufacturers who rely on materials and equipment that can be sourced within the country to thrive. The enabling environment can be strengthened through the advancement of the ease of doing business, a reduction in the bureaucracy of filing and record submission with the right authorities, and the stimulation of incentives that will aid manufacturers to source materials and produce more within the nation. This will not only reduce the volume and value of goods imported into the country but will also increase the nation’s value of exports, resulting in a larger value of exports and supply of foreign exchange through trade.

• Harnessing agricultural and natural resources export: Nigeria is a nation blessed with a lot of natural and agricultural resources that can provide international income for the nation, but these are not currently being explored maximally. The country’s major source of international revenue (crude oil) is performing below the supply threshold set by the Organisation of Petroleum Exporting Countries (OPEC) due to a high level of oil theft, spillage, and lack of access to huge deposits of crude oil. Crude oil and natural gas currently account for over 90 percent of Nigeria’s total exports, despite the likelihood of a decline in demand in the future as individuals, corporations, and institutions explore alternative sources of energy. There is an urgent need to revitalise and position the agricultural sector as a leading export sector in the Nigerian market. The federal government can also harness opportunities for foreign exchange lost in the extractive industries due to illegal mining activities and the poor structure prevalent within the sector across the country.

• Interest rate adjustment: The monetary policy rate has been pegged at 18.75 percent since July 2023, as the new leadership of the CBN has not had any monetary policy rate reviews. The monetary policy committee expects to hold the meeting to adjust the interest rate before the end of February 2024. The return earned on naira investments is significantly lower than the return on the equivalent value of investments in international currencies such as the dollar when converted back to the naira after the investment period. This has created an opportunity for people to convert their Nigerian naira to international and other currencies, which can result in a higher return in naira terms for the willing investor. Investors (private, institutional, government, or multinational institutions) will place a lesser demand for the dollar or other international currencies if they can earn a considerably higher return in the naira than the other currencies money market investors are currently converting their Nigerian naira to invest in. The decision on the monetary policy rate should be carefully reviewed to ensure that it aligns with enabling the attainment of a considerable inflation rate in the market in line with or lower than the target of 21.4 percent for the year 2024.

• Budget deficit management: The approved 2024 appropriation act has a planned deficit of 3.8 percent of GDP, considerably lower than the 6.11 percent of GDP recorded in 2023. The federal government should seek opportunities to further increase revenue and reduce expenditures for the 2024 budget implementation. The strategy of eliminating ways and means of lending to the government is a positive signal, as the government’s local debt funding is going to be priced purely based on the prevailing market indices. Remittance of crude oil exports through the CBN is also a positive signal, as it enables effective management of foreign exchange to clear backlogs and manage the demand-supply gap existing in the market. The Nigerian naira will further strengthen if there is a reduction in foreign debt interest and principal payments.

• Foreign exchange allocation efficiency: There is usually noise and distortion in the price of foreign exchange if market players are playing through different rule books. Just after the immediate disbursement of funds from the Federal Account Allocation Committee, there was a high spike in volatility and the price of the foreign exchange rate in the unofficial market. This infers that some of the beneficiaries of the disbursed funds have sourced foreign currency from the unofficial market to hoard and explore arbitrage opportunities over a while, as they expect to sell and make a margin on the further weakening of the Nigerian Naira. This action also resulted in higher prices due to the scarcity of foreign exchange available at the official window. The CBN should ensure that foreign exchange is strictly available from official sources and used for the right purpose to prevent price distortion. An efficient allocation and distribution of foreign exchange to the right medium in the market will assist in closing the arbitrage gap created by the unofficial market.

• business a.m. commits to publishing a diversity of views, opinions and comments. It, therefore, welcomes your reaction to this and any of our articles via email: comment@businessamlive.com