Three weeks after the Monetary Policy Committee’s (MPC) consensus decision to adopt a flexible exchange rate system, the Governor of the Central Bank of Nigeria (CBN) - Godwin Emefiele - at a press briefing on Wednesday, 15th June, 2016 announced the re-introduction of a market driven two-way quote single Interbank Foreign Exchange (FX) Market. Though ultimately inevitable, reneging of the CBN represents a policy backflip against the long-held stance of maintaining NGN/USD peg at N197.00/US$1.00.
Afrinvest Research has in recent reports –notably “Price Modulation” of the Downstream Sector …Taking the Bull by the Legs” of 17/05/2016 and “A Change in Market Sentiments... 5 Signs to Watch!” of 08/12/2015 –consistently noted that the erstwhile pegged exchange rate regime adopted by the CBN had a debilitating effect on major sectors of the economy, was unsustainable and was growth inhibiting. We had also argued that a flexible exchange rate regime, together with a devaluation of the currency or the introduction of a Two-Tiered market would bode well for the capital market and the economy.
The CBN surpassed our expectations by not only adopting a single FX market structure without trading limits but also introducing derivative hedging products – Forwards, Futures, Swaps and Options – to ensure orderly transition to a market-based mechanism. Whilst we laud the bold move by the CBN in instituting a flexible FX market structure, we reiterate our position on the restricted 41 items that are still termed “inadmissible” in the new market framework. We think that perhaps the CBN should not use monetary policy tools to tackle issues that are better dealt with using fiscal policy tools. We believe as the system becomes more sophisticated through the depth and breadth introduced, market efficiency might convince the CBN to free the excluded items.
Given the above, we expect the financial market to pick up on the back of increased global funds inflow into the system and as investor sentiments favour investible assets in the money and capital market.
As part of the new guidelines for the workings of the new interbank FX market, the CBN is introducing Foreign Exchange Primary Dealers (FXPDs) who will serve as the bulk traders dealing directly with the CBN. The somewhat stringent conditions (40.0% liquidity ratio, N200.0bn shareholders’ funds and N400.0bn foreign currency assets) for qualification as an FXPD will establish a new category in the banking industry. Based on FY: 2015 and Q1:2016 data, only the Systematically Important Banks (SIBs) excluding Skye Bank would qualify. This imposes a new element to banking industry’s fundamental competitiveness.
In the subsequent sections, we present our thoughts on the new arrangement while reviewing the major highlights of the policy and how the system could work. We then conclude with the potential impact of this new FX paradigm on the economy and financial markets...