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Breaking News! CBN announces “purely” market-driven forex policy

CBN Governor, Godwin Emefiele

The Central Bank of Nigeria (CBN) has officially announced a new foreign exchange policy and has listed some implications of new development.

CBN Governor, Godwin Emefiele finally unveiled the flexible exchange rate policy on Wednesday. This comes barely two weeks after he announced at the Monetary Policy Committee meeting that he was going to allow the Naira float freely at the interbank market.

Here is what the CBN governor stated during the announcement:

“CBN will launch a foreign exchange interbank trading window on Monday to boost the supply of hard currency in Nigeria. The new window would have eight to ten primary traders handling minimum volumes of $10 million.The new system would help with economic growth and restore investor confidence,” he said. “The precise guidelines will be published later on Wednesday.”

The CBN governor stated that the window’s exchange rate will be purely market-driven.

“Nigeria will introduce fx primary dealers to operate with others in the interbank market. Under the new structure the 41 items previously not banned from getting access to forex in Nigeria will remain unchanged.Nigeria’s Forex Reserves is robust an can cover five months of import,” said Emefiele. “The time is right to reintroduce a flexible inter-bank forex market. Forex market will operate as a single market structure.”

The bank will open a “purely” market-driven window for interbank foreign exchange trading, shifting away from a fixed exchange rate, in an effort to increase the supply of hard currency, the governor of the bank said.

The central bank will use the new trading scheme to inject foreign exchange liquidity, if needed, which Nigeria hopes will ease severe dollar shortages caused by a slump in oil revenue, Governor Godwin Emefiele said.

It was not clear at what rate the central bank would supply dollars to the interbank market. The central bank’s official rate is 197 naira to the U.S. dollar, but the currency trades at around a 50 percent discount on the parallel market.

What does this mean?

CBN is shutting the window for buying dollars at the official rate 

Analysts have called this a ‘semi-float’ since the Central Bank still plans on holding on to the official exchange rate of N199 per US dollar for funding “critical transactions.” 

According to Reuters, letting the market set the naira’s value is likely to drive down its value. That will make Nigerian products cheaper and competing imports more expensive, which should stimulate the domestic economy.

“The market shall operate as a single market structure through the interbank and autonomous window. The exchange rate will be purely market-driven,” Emefiele told reporters.

“To improve the dynamics of the market, we will introduce foreign exchange primary dealers who would be registered by the CBN to deal directly with the bank for large trade sizes on a two-way quote basis,” he said.

Investors approved of the idea: Nigeria’s stock market gained 3 percent following the announcement.

“Its a pretty important step in the right direction,” said Alan Cameron, an economist at Exotix in London. “Basically it amounts to a managed float, which is better than what most people were expecting. It’s a pleasant surprise.”

Emefiele also said the central bank will open a foreign exchange futures market to ease demand on spot trading, reduce volatility and give businesses more certainty.

Precise guidelines will be published later on Wednesday, he said, adding that the new window would have eight to 10 primary traders handling minimum volumes of $10 million.

Africa’s biggest economy, which contracted by 0.4 percent in the first quarter, faces its worst crisis in decades after the decline in oil prices and last year’s introduction of a currency peg that prompted large-scale capital flight.

“Over the long run, a weaker currency will help Nigeria’s economy by encouraging import substitution and attracting foreign investors, who have shunned the country for fear of a devaluation,” said John Ashbourne at Capital Economics.

“But the move will be painful over the short term. Higher import prices will add to inflation … This will probably force the authorities to tighten monetary policy.”  

Other Observations

According to a Senior Research Fellow at the Centre for the Study of the Economies of Africa, Dr. Solomon Olakojo, allowing the Naira to float freely means that the government is leaving the forces of demand and supply to determine the foreign exchange rate. This means that the more people demand for the Dollar, the more they will pay for it in Naira. For instance, during the resumption of schools abroad, affected Nigerian parents will demand for Dollars thereby leading to an increase in the exchange rate of a Dollar to the Naira. During this period, banks will likely set their own exchange rate based on demand in order to sell to those willing to buy at higher rates.

Following this announcement, Nigerians will not be able to buy US Dollars at the CBN rate of 199. This means that people who want to make payments for school fees, business, tourism, medicals, holiday and other bills will not be able to buy at 199. They are now left at the mercy of the inter-bank market determined rates.

Banks, importers and individuals who also engage in round-tripping or arbitrage (buying funds from the Central Bank of Nigeria’s official market at low rate and resell in the parallel market at higher rates) – will not be able to do so anymore. 

There is no significant inflow of the Dollar to meet about 70 percent of the demand. Therefore it is still unclear whether this move will work considering the fact that Nigeria does not have the required operational framework in place to ensure that it achieves the desired result. Nigerians cannot bet on the Dollar dropping below N300 anytime soon.

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