Economists Spot Inconsistencies in Central Bank Foreign Exchange Policy
Godwin Emefiele, Governor, Central Bank of Nigeria

Economists Spot Inconsistencies in Central Bank Foreign Exchange Policy

Nigeria’s central bank has done more to confuse than clarify over its exchange rate policy and sterilisation bill sales, Capital Economics –a leading independent economic research companies – said in a statement.

According to the firm, for a second time last week, the officials at the Central Bank of Nigeria did more to confuse investors than provide clarity.

Economists recalled the CBN Governor Godwin Emefiele suggested that the official naira exchange rate has been devalued by about 7%; but the move remains unconfirmed.

The firm said uncertainty is now “prevailing” in relation to another policy area as a senior CBN official was quoted by Bloomberg that sales of Open Market Operations (OMO) bills to non-residents will be wound down.

Non-resident OMO Bill was introduced in 2015 to shore up foreign currencies inflow into the country, and Capital Economics said it is usually used to sterilise the banking sector’s liquidity surplus.

On Thursday, again Capital Economics expressed view that there are inconsistencies in decision after Godwin Emefiele, the CBN Governor denied the change in policy.

FX Convergence Key to Restoring Foreign Investors’ Confidence –Analysts

“For context, the OMO bills in question have been open to foreigners since 2015, which has bolstered FX reserves but with a cost”, Capital Economics noted.

However, the firm explained in its report that CBN’s cost of attracting FX inflow has been the interest rate paid on the OMO bill, much higher than the return on FX assets.

“It follows that phasing out OMO-sales to foreigners would cut such costs but reduce the country’s reserves”, experts said.

As of September, Capital Economics said non-residents held about $13 billion-worth of OMO bills which, if wound down, would bring down Nigerian FX reserves to about $22 billion.

“This would represent just 50-55% of the IMF’s reserve adequacy measure and might raise further concerns about the naira”, it added.

FX Adjustment

In a recent statement, the CBN has indicated that it has devalued the local currency at the Investors window as rate peaked at N410 to a dollar.

In a commentary, Capital Economics said the devaluation of one of Nigeria’s exchange rates would help to improve the public finances, but it would keep already strong price pressures elevated.

“We doubt that the latest tweak in Nigeria’s FX market will culminate in a fully flexible, unified naira any time soon”, the firm added.

Godwin Emefiele, the governor of the Central Bank of Nigeria (CBN), suggested in a conference speech that the official naira exchange rate has been devalued by 7% against the dollar, from 381/$ to 410/$.

Analysts said this will close the gap between the official rate (used for government transactions) and the Nigeria autonomous foreign exchange rate -used by commercial entities including investors and exporters.

But it would still leave both rates about 17% stronger compared to the latest parallel market quotes of 480/$, Capital Economics said in a statement.

“If confirmed, the move would simplify Nigeria’s multiple exchange rate system by essentially merging the official and NAFEX rates, although we suspect some degree of fragmentation would remain.

“It is worth noting that the devaluation has not been confirmed. For example, the website of the CBN continues to quote the official exchange rate at 379/$. And so far at least, there is no anecdotal evidence of the CBN’s FX sales rate to confirm or deny the move”.

In a report, Capital Economics said at face value, it seems unusual that the central bank is undertaking the devaluation given the rise in oil prices.

The key, however, is that the official and NAFEX rates are far stronger than our estimate of the fair value of the naira, which is closer to the parallel market rate.

“One explanation for the move is pressure from multilateral institutions, which have urged Nigeria to take steps towards a freely-floating, unified naira for some time.

“Insufficient progress on currency reforms appears to be holding up a $1.5bn loan from the World Bank, which Nigerian policymakers may be hoping that the latest FX tweaks will help to get over the line”, the report stated.

Economists said other explanations could be at play too. Devaluing the official rate would improve the public finances.

“A weaker official exchange rate would push up the local currency value of key oil exports, and with it, the government’s oil revenues.

“Indeed, we estimate that, all else equal, a 7% devaluation of the naira would increase government revenues by around 0.2%-points of GDP.

“This would make Finance Minister Zainab Ahmed’s job of preparing a supplementary budget to finance the country’s vaccine roll-out easier”, Capital Economics highlighted.

It added that positive implications for the country’s balance of payments position may not be as large.

Non-oil exports that would benefit from a weaker currency make up less than a third of Nigeria’s total exports -with oil, which is priced in US dollars, accounting for the remainder.

Meanwhile, experts hint that a weaker exchange rate would probably do little to encourage import substitution, as various exchange rate windows are used by importers – including the NAFEX and the parallel rates that have not fallen as much as the official exchange rate.

Even so, prices of imported goods are likely to rise, keeping inflation elevated, Economists explained.

According to Bureau of Statistics, the nation’s headline inflation stood at a nearly four-year high of 16.4% year on year in January after 17 month consecutive rise.

“We expect it to stay around this level until the tail end of this year”, Capital Economics projected.

The firm said, “Taking a step back, we doubt that the latest devaluation of the naira will mark a meaningful shift in Nigeria’s exchange rate policy.

“We’ve flagged before that Nigerian policymakers appear reluctant to loosen their grip on the currency”.

In its latest Article IV report, released last month, the IMF noted that the Nigerian authorities did not agree with the need for additional exchange rate adjustment”.

“A lack of official confirmation of the devaluation hardly inspires confidence.

“Worse still, Governor Emefiele reportedly outlined plans to strengthen the currency just a day after his comments about the weakening of the official exchange rate.

“A multitude of FX restrictions aimed at defending the currency’s value remain in place, including prohibiting exporters who fail to repatriate proceeds from banking services.

“The upshot is that Nigeria’s heavily managed exchange rate regime is here to stay.

“We remain comfortable with our view that policymakers will continue with their piecemeal approach to the currency, only letting the naira weaken when pressure mounts.

“Our end-2021 forecast for the NAFEX rate remains at 425/$, and we have now revised our official exchange rate forecast to 425/$ as well (from 400/$)”, the firm explained.

It also said evidence is growing that this FX policy has failed to keep inflation stable, which policymakers pin their support on.

“Nigeria will probably be stuck with high inflation for the foreseeable future. And, so long as the threat of further devaluations is present, investors will be wary of putting their money into Nigeria.

“As a result, the authorities will continue to rely on capital controls and import restrictions to sustain the balance of payments position at the expense of disruptions to activity and weak economic growth”, Capital Economics explained.

Naira 4 Dollar Scheme

Elsewhere, following the effort to increase foreign currencies inflow, the CBN announced to give N5 per dollar receives from diaspora remittance starting from Monday.

The incentive, tagged “Naira 4 Dollar Scheme”, was announced in a circular signed by Saleh Jibrin, CBN‘s Director, Trade and Exchange Department.

The scheme was developed in a bid to increase inflow of the greenback into the Nigerian economy amidst foreign exchange scarcity.

Jibrin said that the scheme, which would run between March and May, would allow all recipients of diaspora remittances to be paid N5 for every one dollar received.

He said that beneficiaries would get the incentive, whether they collect the remitted dollars as cash across the counter or through their domiciliary accounts.

He instructed all commercial banks and International Money Transfer Operators (IMTOs) to ensure that the scheme takes effect from Monday.

“In an effort to sustain the encouraging inflows of diaspora remittances into the country, the CBN hereby announces this scheme as an incentive for senders and recipients of international Money Transfers.

“All recipients of diaspora remittances through CBN licensed IMTOs shall henceforth get N5 for every one US dollar received.

“This incentive is to be paid to recipients whether they choose to collect the dollar as cash across the counter in a bank or transfer same into their domiciliary account.

“Having discussed with banks and IMTOs, the scheme takes effect from Monday March, 8 and ends on Saturday May, 8,” he said.

Naira Tumbled

Last week, Naira tumbled in the Investors and exporters Window. However, the CBN spot rate traded flat all week at ₦379.00/$1.00 while rate at the parallel market appreciated ₦2.00 w/w to ₦480.00.00/$1.00.

At the Investors & Exporters (I&E) Window, the Nigerian Autonomous Foreign Exchange (NAFEX) rate depreciated ₦0.75 week on week to ₦411.00/$1.00.

Afrinvest however noted that activity level in the Investors Window improved as total turnover declined 55.6% to $221.5 million from $498.8m recorded in the previous week.

Economists Spot Inconsistencies in Central Bank Foreign Exchange Policy