The Central Bank of Nigeria's (CBN) foreign exchange (FX) policy has been central to the country's economic fortunes since the oil price crash of summer 2014. The decision to operate a de facto fixed exchange rate – even after a public shift to a more flexible system – along with its infamous supply management policies, have cast it in the limelight.
CBN in the eye of the storm
The CBN hastily made the decision to peg the currency after the 2014 oil price crash decimated Federal Government (FG) oil earnings. By the end of 2015, the gap between the official exchange rate and the parallel market rate had widened to over 30% while Nigeria had been evicted from the primary J.P. Morgan Emerging Market Bond Index. The latter triggered a significant exit of foreign funds and deepened the FX scarcity issue.
In some ways, the CBN's stance bought Nigeria some time while sluggish political appointments created a fiscal vacuum. In particular, the refusal to devalue the naira temporarily repressed inflation, which closed 2015 at 9.6% (slightly above CBN's upper target of 9%).
Meanwhile, worried about liquidity levels in the banking sector following the implementation of the Treasury Single Account, the CBN loosened monetary policy at the end of 2015, reducing its main rate – the monetary policy rate (MPR) – to 11%, while lowering Cash Reserve Ratio (the percentage of deposits banks must keep with CBN) from 25% to 20%. At their first meeting in 2016, the CBN's Monetary Policy Committee (MPC) maintained this expansionary stance, giving support to FG efforts to arrest an economic decline that had become apparent. Essentially, CBN set the scene for FG to step in with its expansionary fiscal policy.
Inflationary Concerns and Fiscal Struggles
However, 2016 did not begin well for the FG as it grappled with a budget padding saga which put its planned expansionary budget on hold. With no resolution to this by March, the MPC changed course, marginally raising both CRR (to 22.5%) and MPR (to 12%) at its bi-monthly meeting. The rationale was clear; driven by an electricity price hike and turbulence in the petroleum market, inflation had risen to 11.4% in February.
One cause of the petroleum crisis was FX scarcity. Fuel importers struggled to access the dollars needed to maintain supply levels, and NNPC was unequipped to bridge the supply gap. In May, the FG addressed the elephant in the room by "removing" the subsidy on fuel, allowing price go up from ₦87 to a ₦135 - ₦145 band. The interesting element was that the pricing band was calculated using an exchange rate of about ₦285 to $1, over 40% higher than CBN's official rate at the time.
But the CBN still refused to budge on FX policy. Its refusal to devalue despite a significant demand and supply imbalance further widened the parallel market gap and put off investors who anticipated a devaluation. The devaluation finally came – along with a mooted switch to a flexible exchange rate system, as the CBN itself outlined. CBN's decision was met with a lot of positive feedback as it seemed the economy would now get the fillip needed for recovery. There were some concerns that CBN retained its ban on 41 items; however, it was expected this would get phased out as the new policy took hold.
Tightening the locks
With the Budget passed and a new exchange rate regime, the second half of the year looked much brighter, despite Nigeria officially entering a recession by that point.
But with inflation approaching 17% in June, the CBN made an about turn, raising the MPR to 14%, the highest level in a decade. Although the decision was partly made to support a recently floated naira, it came despite Nigeria's first recession in two decades and rising government borrowing costs.
In effect, the CBN reverted to its primary goal of price stability, leaving fiscal policy to do the heavy lifting of economic recovery. The CBN would hold this position for the rest of 2016 and inflation would rise unperturbed – hitting 18.7% in December. GDP would contract even further in the third quarter of 2016 as the CBN reneged on its decision to float the naira by pegging it at ₦305/$1 for the rest of the year. 2016 would close as tepidly as it began.
What to expect in 2017
CBN has played a central role in economic policy in recent times, even driving the economy as the new federal government found its feet in 2015. The jury is still out on the decisions taken in the last 18 months. Inflationary pressures are still around – especially on the exchange rate and fuel prices – meaning the CBN must remain alert to further inflation.
It is important that Nigeria gets back to growth in as quickly as possible and the FG will be looking to its ₦7.3 trillion budget to do so. Perhaps the CBN will be convinced to re-evaluate its stance in 2017 and loosen its grip on liquidity, focusing on growth. The apex bank persevered with its stance at its January meeting but come March, with the budget hopefully passed, it may sing an entirely different tune.
In the FX market, there are signs that the CBN is willing to tackle the issue of dollar scarcity head-on. Higher oil prices have built up the bank's dollar reserves, and Nigerians will be hoping to get a slice of that pie over the next few months.