Our nation is currently submerged in a
currency crisis. The value of our national currency is tumbling against
the dollar on a daily basis, and our foreign exchange reserves continue
to dwindle as a result of the continuous fall in the price of crude oil.
In recent months, there has been a rigorous debate as to whether the
devaluation of our currency is the answer to these problems, and what
specific measures need to be put in place to stabilize our currency and
prevent further damage to our fragile economy. As the debate rages on,
the damage to the naira, the economy, and the psyche of our people has
intensified. The Central Bank of Nigeria (CBN) appears
to have lost significant control of the situation, and speculators,
currency traffickers and perpetrators of arbitrage have seized the
initiative in the parallel market.
It is fair to say that under President Muhammadu Buhari’s tenure, the Nigerian Financial Sector has endured its reasonable share of activity and critical scrutiny. Three
major incidents have stood out, and these incidents are intertwined in
terms of the collective impact they have all had on the sustained call
to devalue the Naira. First, in the past year alone (dating
back to the previous administration), the Central Bank of Nigeria (CBN)
has reeled out a series of policy reforms on the foreign exchange market
that has sent panic to the market. Leading up to the general elections
conducted last year, the market began to experience a significant
shortage of dollars. This dwindling of our reserves was caused by
falling oil prices, while the huge demand was fuelled by election
spending and the accompanying market nervousness in the aftermath of the
change of government. Secondly, the Federal Government issued a
directive on the consolidation of Government revenues into a single
treasury account (TSA), a bold policy currently being implemented at its
infancy stages by the CBN. The immediate effect of this policy has been
the estimated movement of over N2 trillion from private banks to the
CBN, which has dipped liquidity and spiked interbank and other interest
rates. Thirdly, and probably as a result of the first two points, we received the curious news sometime in 2015 that JP Morgan
Chase-an American-based International
Financial Service Firm- would be delisting Nigeria from its Government
Bond Index for Emerging Markets (GBI-EM) in what they called “a
phased-out process” between September and October this year. JP Morgan
cited a lack of transparency and liquidity in our foreign exchange
market as the primary reason for its decision. The significance of this
announcement cannot be understated, because JP Morgan Chase provides the
pricing and trading platform for foreign investors who hold or are
planning to hold Nigerian Government-issued bonds, and they also create
and sustain an active market for these bonds.
The impact of these incidents
collectively has resulted in a panic sell-off at the Nigerian Stock
Exchange (NSE) by foreign investors in the market. The NSE market
capitalization of listed equities instantly lost about N311 billion or
2.98%. In addition, the announcement threatened the stability of the
Nigerian Bond market and the ability of the Government to use the market
to raise funds in the near future. The CBN was forced into
damage-control by issuing a public statement to the effect that it
disagrees with the expulsion, and denied the claim of a lack of
transparency and liquidity in the market. Some industry analysts have
joined in supporting the CBN’s statement, while downplaying the possible
negative effects on foreign investment and the Nigerian economy.
You see, JP Morgan’s argument has been
fairly straightforward: “We know the level of your reserve and we know
it is dwindling. We know why you have been tinkering with your foreign
exchange policy in recent times: because you are protecting your naira
and keeping the value low. We know that your currency is overvalued and
underpriced. So, release your hold on pricing mechanisms and let the
forces of ‘demand and supply’ determine price”. Of course, JP Morgan’s
primary interest is the protection of its clients- the foreign investors
playing in the bond market- because that is its main responsibility.
These major action points, alongside
some of the uncertainties that have arisen as the Federal Government
grapples with how to articulate its holistic fiscal policy and
medium-term Economic framework, have created deep-rooted cracks on the
naira exchange rate. The cumulative effect has been the sustained
pressure (both locally and internationally) carefully mounted on the CBN
to devalue the naira to reflect its ‘true’ value at the parallel
market. The pressure is on the government to remove its hold on the
official rate by moving the rate closer to the parallel market rate,
with the expectation that a higher official rate would price the scarce
foreign exchange appropriately and attract players back to the official
market, thereby improving supply and increasing market stability. If
historical antecedents are anything to go by, this devaluation
proposition is unlikely to have the desired effect.
Those who fail to learn from history are
doomed to repeat it, so in our attempt to adopting bold, decisive and
creative solutions to stop the economic bleeding, we must properly
educate ourselves on our current situation, and how we got here in the
first place. It is a situation that has played itself out in countries
like Brazil, Argentina, Greece and Venezuela. Some of these countries
survived their currency quagmire by taking bold, decisive and creative
steps to limit the damage to their economy and return their currency
back to normalcy. In actual fact, this is not a situation that is
completely unfamiliar to us.
The rapid evolution of the Nigerian
foreign exchange market began in 1982, when comprehensive foreign
exchange controls were enacted to manage the monetary crises that ensued
that year. We subsequently moved to the era of Second-tier Foreign
Exchange Market (SFEM), introduced in 1986 to manage the fall-out of the
exchange control system introduced in 1982. Further liberalization
reform measures were introduced by the introduction of the
Bureau-De-Change (BDC) market to improve access to foreign exchange by
small and retail users. This particular measure, without clear
guidelines and monitoring systems, pushed the parallel market to the
forefront with full force. The resultant volatility caused by the
flourishing parallel market led to the introduction of further reforms
by way of the Foreign Exchange Market in 1994. These new reforms
included the formal pegging of the naira exchange rate, the
centralization of the market at the CBN, the restriction of the
operations of BDCs, and the discontinuation of the Open Accounts and
Bills for Collection System as a means of payment. Further measures were
implemented in 1995, with the introduction of the Autonomous Foreign
Exchange Market (AFEM) when, for the first time, the market was
liberalized with end-users able to buy and sell foreign exchange from
CBN through banks at market determined rates. By 1999, we began to
witness a further liberalization of the market by the introduction of
the Inter-bank Foreign Exchange Market (IFEM).
The current foreign exchange regime is
an off-shoot of the last major reforms between 1995 and 1999. The supply
of foreign exchange has been dwindling since the price of crude oil
started its free-fall in 2015, whilst foreign exchange demand has been
on the rise due to market confusion, its negative perception of future
supply, recent CBN measures to manage demand and an overall loss of
confidence in the market by foreign investors and speculative dealers in
foreign exchange. Indeed, the structural impediments or the 90s are
still intact today. Rather than removing the bureaucratic bottlenecks in
the system, successive CBN administrations have been focusing on
defending the naira by tinkering with the pricing mechanism, while
letting illegal operators take the initiative. The result of this is the
existence of a two-tier market: the legal (official) market, and the
illegal (parallel) market.
The official market comprises of the CBN
as the main supplier, and banks, oil companies, non-oil exporters,
Bureau de Change (BDC) licensed operators and legitimate end-users who
deal in the inter-bank and autonomous trading window within the banking
system. The CBN has kept a lid on the rate in this market at around 199
naira to the dollar. This is the only legal foreign exchange market
supported by existing laws. On the other hand, the parallel market
comprises of a collection of players including speculators, currency
traders, street currency hawkers, tourists, travellers, traders, small
and medium-sized businesses (SMEs) and migrants from the official market
attracted by the huge differentials in the rates for arbitrage
opportunities, and the ease and simplicity of the market. The problem
has been further compounded by the CBN’s conscious and deliberate
position to ignore the parallel market’s existence by pretending that
there is only one exchange rate. Its stubbornness has driven buyers and
sellers to the parallel market, making the official market more
unstable.
Of course, the primary objective has
always been the efficient management of the foreign exchange market by
determining the true price of foreign currency vis-a-vis the naira. The
reality is that nobody- including the CBN- knows the true value of the
naira. The value of a currency is its price, just like price determines
the value of goods and services. The Naira-Dollar ‘product’ is like any
other good; its price is determined by a complex interplay of demand and
supply, which forms the price at equilibrium. The real quagmire is
this: who knows the actual demand and supply? Of course, the CBN knows
how much dollars are available for sale on a weekly basis, and how much
naira is utilized to meet the demand for the dollar. The information
that the CBN possesses comes from its position as the major supplier of
both currencies, and its main function as the banker to our banks and
the custodian of the foreign exchange market. In truth however, nobody
has the authentic information on the actual volumes of Naira and Dollars
chasing each other in our economy.
To make matters more complicated, this
is only a segment of the market. For example, the official exchange rate
is pegged at approximately N199 to $1 because it is based on CBN’s
information on the official demand and supply, which is supposed to be
the equilibrium price. Unfortunately, the mechanism for arriving at this
rate is largely discretionary and unscientific. The CBN may have been
right in arriving at this rate, but it very well may have been wrong in
arriving at this rate as well. The parallel market rate is hovering
around N400-$1 today because the market gets some of its supply from the
CBN and will naturally add profit to resell. It is selling mostly cash,
which always sells at a premium. Cash has a monopoly because the
traders in this market have perfected the art of rigging rates. All
these aggregately ensure that the parallel market rates will forever be
ahead of the official rates. It is wrong to use the parallel market rate
as a reference point because it is not determined by any traceable
interplay of demand and supply. The rate is rigged and illegal, and
should be ignored in its entirety.
Indeed, it is not a surprise that the
parallel market is probably bigger and more active than the official CBN
market. Nobody knows the exact volume of dollars being traded in this
unofficial market, or the naira-cash floating outside the banking system
that is being used to buy and sell dollars. We do not have accurate
estimates on the number of mallams, or the total volume being traded by
them daily. We do not know the exact volume being traded by unregistered
foreign exchange dealers all over the country. We also do not know the
exact amount of raw cash dollars imported and exported by Nigerians and
foreigners. So, how then can you determine the equilibrium price of a
market with so many unknowns!
President Buhari is correct in believing
that our currency does not need to be devalued – for the time being.
For example, no amount of devaluation will bring up the price of oil.
Devaluation will not eliminate parallel market players, nor will it
necessarily increase the supply of dollars into the market. In actual
fact, devaluation will simply push the official rate (and by extension,
the parallel rate) up, thereby compounding the currency crisis and
further driving more players to the parallel market. Inflation will
rise, impacting the cost of essential products and services within our
economy.
The sum-total of the aforementioned
points is that it is unhelpful to conclude that our naira should be
devalued, because we simply do not have any rational indices for
measuring the naira’s true value. A further devaluation will devastate
our economy because it will technically make our imports more expensive
and our exports cheaper. This is somewhat unhelpful to us because we
import practically everything and export very little except oil, whose
price is determined internationally and whose supply is quota-based.
Therefore, the gains of devaluation would be inapplicable to our
situation, while the adverse effects- higher import prices, higher rate
of inflation, more pressure on the demand for dollar, higher
unemployment and general recession- would be catastrophic to us.
Perhaps, a silver lining in all of this
can be adduced from our recent experience with petroleum importation,
pricing and marketing. The introduction of the subsidy regime by the
Obasanjo administration around 2005- whilst commendable in its intent to
maintain a low pump price on our imported petroleum products- turned
out to be a catastrophic and costly error on the part of the previous
administrations that retained it. The subsidy-era was marred by market
instability, regular fuel shortages, a thriving black market for fuel
and huge debts allegedly owed to importers. Now that the subsidy regime
is virtually non-existent, the market has gradually become stable, and
many of the associated problems have disappeared. First, there is only
one recognized market price (at the filling stations) across the
country. Secondly, there no longer exists a thriving parallel market for
petrol; there simply is no need for one, as there is no scarcity or
bottleneck in the supply chain for now. Thirdly, suppliers are motivated
to supply because the pump price has been determined by factoring all
possible costs and profit margin from point of purchase to point of
sale. In addition, this system will always adjust the pump price
mechanically, thereby guaranteeing regular supply at all times. The end
result is that consumers are invariably assured that supply will be
regular and price will continue to be market-determined. There is no
guarantee that this current solution will be permanent, but it is at
least a marked improvement from the previous uncertainty. A replication
of this way of thinking by the CBN will go a long way towards returning
normalcy to our currency market.
What then is the way forward with our
currency? First, the Federal Government has to fast-track its efforts
towards implementing a sustainable fiscal policy regime tailored towards
boosting our local industry. Curbing corruption, promoting import
substitution and the exportation of indigenous products will go a long
way in achieving this aim. Countries like India, South Africa, Malaysia,
Indonesia and Egypt have little or no oil dollars, but all have more
stable currencies and stronger liquidity than we currently do. They have
been able to successfully tap into these “other sources” and develop a
stable foreign exchange system with a thriving market to boost supply
and manage demand.
Secondly, a critical solution lies in
our ability to bring sanity to our foreign exchange system and have
better controls over the demand and supply mechanism. As a matter of
national emergency, the parallel market has to be destroyed. The Foreign
Exchange (Monitoring & Miscellaneous Provisions) act of 1995 as
amended, the Money Laundering (Prohibition) Act of 2011 and other Laws
of the Federation are some of the legal tools available to enforce the
collapse of the parallel market.
The CBN has to overhaul the foreign
exchange regime by bringing all legitimate buyers and sellers into the
official market. For example, the use of credit cards to make purchases
online and in foreign currencies should be re-introduced, with each
authorized dealer setting its own limit depending on capacity. The way
to do this is to simplify the buying and selling process by making
documentation easy and seamless, and accommodate all economic users of
foreign exchange. The buying and selling process could be simplified
through the authorized dealers with clear and unambiguous rules, while
CBN provides adequate supply to the market at all times.
Finally, and perhaps most crucially, the
CBN must create a buyer surcharge and seller premium system. Under this
system, buyers of foreign exchange for products and services
categorised as essential or critical to the economy would be sold
foreign exchange at the official buying rate. Rather than impose
restrictions and/or bans on other users of foreign exchange outside the
essential list, the foreign exchange could be sold to non-essential
categories at the same official buying rate (a single exchange rate
system) but with an additional fixed surcharge imposed for accessing
foreign exchange. This will be paid upfront at the point of purchase to
the coffers of government. It can be categorized as a special tax for
users of foreign exchange for purposes considered as non-essential or
non-contributory to the progress of the economy. This special tax
becomes a premium to government. It will be an immediate boost to the
national revenue, and the Government may choose to utilize this fund to
promote and boost the non-oil export sector. It will also make these
products and services more expensive, and possibly have the long term
effect of discouraging the importation of non-essential items.
Simultaneously, suppliers of foreign
exchange to the market can be incentivized into selling at the official
selling rate, while also earning an “incentive premium”. It should be
noted that the CBN is not the only supplier to the market. Other
suppliers include oil firms, exporting firms, Nigerians in diaspora,
foreign investors, foreign lenders, etc. These suppliers could provide a
much higher volume to the market than the CBN if motivated and
encouraged. For example, an incentive premium of 10% could be paid from
the surcharge proceeds to encourage and motivate suppliers to bring
their foreign exchange to the official market. This system of surcharge
and premium could be sustained until the market stabilizes. The CBN
would simply midwife the process by maintaining and aggregating adequate
supply into the market as much as possible. It would also be
responsible for posting the official daily buying and selling rates
based on market fundamentals, managing the surcharge and premium regime,
and determining the categorization of essential users on a periodic
basis. It should also put in place a regular audit and monitoring
process to ensure strict compliance and adherence.
The immediate effect of effectively
implementing the above recommendations will be a single official foreign
exchange market with all players (buyers, sellers, dealers, government)
adhering to the same set of rules and regulations. The parallel market
would die a natural death, and there will be an efficient pricing
mechanism with a single exchange rate. This in turn will lead to an
effective and efficient management of our foreign exchange reserves, and
will enhance the attraction of foreign exchange into the system from
other sources. Putting the tax and incentive mechanism in place will
have the combined effect of encouraging supply and penalizing the
frivolous use of our scarce foreign exchange. This also creates a new
source of revenue for the Government, and acts as a check on those who
would normally cheat on import-duty payments. The economic impact will
be appreciation or depreciation, but not a devaluation of the value of
the naira. There will be market and price stability, gradual confidence
restored back to the single market and demand and supply equilibrium.
It would become easier for the Federal
Government to deploy its security apparatus and other legal instruments
towards chasing away the remnant players in the illegal market when the
CBN successfully brings the legal buyers and sellers into the official
market. With regards to the parallel market operators, the Government
should apply the same vigor that it is adopting in its pursuit of
corrupt officials, because every effort to manage our foreign exchange
market will simply be like pouring water into a woven basket until the
parallel market is eliminated or reduced to insignificance.
Any attempt to devalue the currency for
the time being would amount to treating an ailment without a proper
diagnosis. In fact, many of these issues have been with us for over 35
years. They are not going away until we take a firm stance towards
rendering the underground foreign exchange market insignificant and
irrelevant. This will allow us to focus on addressing the actual value
of our currency against the dollar and other currencies.
____________________________________________________________________
Otunba Femi Pedro
is a Banker and an Economist. He is a former Deputy Governor of Lagos
State, and the former Managing Director of First Atlantic Bank (FinBank)
Plc. He can be reached via the Twitter Handle: @femipedro
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