Three months ago, the U.S. Dollar was one of Nigeria’s scarcest commodities, priced at ₦500 in the black market. Today, it trades below ₦400/$1, a drop initiated by aggressive dollar sales by the Central Bank of Nigeria (CBN) in the past two months.

These foreign exchange (FX) sales have been done via an unending series of auctions, or “special windows”, as opposed to a general market sale. Most recently, the CBN opened such a window for “Investors & Exporters” transacting in invisibles (non-physical goods), with the aim of further boosting liquidity in Nigeria’s fragmented FX market. Unlike previous windows for Personal Travel Allowances, etc., this “NAFEX” window covers invisible transactions like loan repayments, dividend remittance, and capital repatriation. In short, the primary beneficiaries will be foreign portfolio investors i.e. foreigners participating in Nigeria’s financial markets. Understandably, the culmination of these moves has triggered international attention.

With dollars now readily available for most – to the point that banks are scrambling for naira to fund their dollar purchases – we can ask the question: Are Nigeria’s FX market woes over?


Hold the currency, no matter what?

To answer this, we must first understand how we got here. After the 2014 oil price collapse that decimated our export revenues and government finances, the CBN resisted calls to allow the naira weaken. The apex bank decided to peg the naira at artificial levels to deter inflation. Despite two forced devaluations, the apex bank kept pegging the currency and imposed various controls to restrict who could buy dollars and for how much.

As textbooks would prescribe, capital fled from Nigeria. This merely dried up supply in the FX market. The situation persisted through Nigeria’s recession until the OPEC oil deal and rebound in our oil production increased dollar earnings. Then the CBN started selling dollars again.

So, for a long time, the FX market was the scourge of Nigeria’s economy. The exchange rate became a national obsession, and it was all international partners wanted to talk about too. And for critics of the CBN, the chosen policy stance merely deepened Nigeria's recession. By their accounts, the recent loosening of dollar liquidity is either unsustainable if oil prices fall, or simply too little, too late. Regardless of your thoughts towards Emperor Emefiele, it is worth assessing the state of the FX market now. Does the Emperor really have new clothes?


The merits of the CBN's choices

Looking at where we are now, it is easy to understand why CBN Governor Godwin Emefiele could be satisfied. He has managed to avert another devaluation and in doing so, stop further inflation. Egypt, often used in comparison after they floated their currency in November 2016, experienced 31% inflation in March 2017. Pre-float, inflation was 14%. The comparison is crude but shows the potential inflationary effect of a weakened currency. Nigeria also experienced imported inflation in 2016 but to a significantly smaller degree: Inflation pre-devaluation was 16%. By the turn of the year, it was 19%. Considering the hardship caused by even this rise – inflation was 9% in 2015 – it would be churlish to discount the “deflationary” benefits of the CBN’s policies.

Meanwhile, it's hard to assess the CBN’s FX policies without accounting for the Federal Government’s (FG) long-term economic plans. As the Economic Recovery & Growth Plan suggests, the FG hopes to reduce Nigeria’s import dependency and to develop self-sufficiency in essential foods and petroleum products. Doing this will require a mix of FX demand management – like the 41 banned items – and industrialisation. And though till recent dollars have been scarce, the CBN prioritised industries that would most serve this agenda.

Despite these admissions, we will find that the FX conundrum is far from settled.  


More windows. Same problems

Crucially, the FX market remains fragmented. Previously, Nigeria was rumoured to have as many as six different exchange rates. Now, the CBN itself has created a range of sub-markets through “Special Windows”.  Apart from this new NAFEX window, there are windows for nearly every other reason for FX demand – personal travel, importing raw materials, and even importing petroleum products. Besides, these sub-markets are all still controlled or heavily influenced by the CBN, mainly because it is the primary supplier of dollars in those windows.

With all these markets – none of them “free” – it is difficult to ascertain the fair value of the currency. This means that some devaluation risk persists. At the same time, arbitrage is a major concern when multiple markets exist. The combination of all these erodes confidence in the market, a precursor for the reentrance of foreign investors.

And make no mistake about it, for Nigeria’s FX woes to end, we need these autonomous dollar suppliers. Foreign Portfolio Investors (FPIs) are the obvious source and incidentally, are the presumed targets of this new NAFEX window. But an additional window will not be enough to entice them. They will likely wait on the sidelines and observe trading activity at this window, gauging liquidity levels and price discovery. Short of a full currency liberalisation, the success of the NAFEX window may be our best hope of attracting more. Only then, when the CBN is not the only relevant FX supplier in the market, can we consider the FX debacle to be near its end. Nigeria still needs an FX market, not a bunch of windows. 


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