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LAGOS (Capital Markets in Africa) – There have been a few of the adjectives that have been used to describe the recent foreign exchange (‘FX’) policies emanating from the Central Bank of Nigeria (CBN’) over the past 2 years and while opinion remains sharply divided it is clear that debate on these policies have assumed a life of their own. Unquestionably, the main statutory objectives of CBN’s exchange rate policy are to preserve the value of the domestic currency, maintain a favourable external reserves position and ensure macroeconomic stability, in reality, though, nothing could be further from the truth in light of the effect of these CBN policies in recent times. It is, however, impossible to investigate the effect of these policies without a thorough understanding and appreciation of the macroeconomic anomalies that have significantly impacted CBN’s policy trajectory in the recent years which then leads to the obvious question, ‘how did we get here’?.
In this article, the immediate and remote factors of the current FX malaise are examined, the substantive policy trajectory of CBN is considered over the past few years and then we dimension the impact of these policies from diverse perspectives ranging from the economic to legal implications.
Understanding the ‘HOW’
After a period of relative stability in the exchange rate regime both in terms of FX rates and exchange rates system, the plunge in commodity prices had a cataclysmic impact on the Nigerian economy as a whole and spurned the proliferation of FX policies in a bid by CBN to curb volatility, inflation, and arbitrage. In spite of CBN’s best endeavours to achieve a semblance of sanity in the otherwise highly volatile and speculative FX Market, the opposite effect has been the case as evidenced by the widening gap between the official market and parallel market, FX illiquidity, FX rationing, reserves attrition, price instability, multiple rate regimes and increased delinquency by those with foreign denominated liabilities; all of which are representative of a dysfunctional FX market.
Since September 2014, CBN has released circa 30 circulars, guidelines, directives and press releases with respects to the foreign exchange market. This explains the spike in Fig.1 below with different policies emanating at an alarming rate over 24 months period.
Whilst it may be true that the immediate cause of the instability in the exchange rate was as a direct result of the massive sharp dip in global oil commodity prices due to the supply glut in the oil industry (as a result of lifting of Iran’s embargo as well as intense competition by some OPEC members to maintain market share), there were other germane contributory root factors that precipitated this instability.
Despite repeated attempts to diversify the economy, there was a lack of consistent policy implementation to rapidly grow other sectors and make the country more efficient in terms of having a net positive balance of trade hence diversified sources of foreign earnings. Therefore, though the economy was diversified by Gross Domestic Product (‘GDP’) (the GDP rebasing affirmed this economic diversification), it became apparent that there remained an over-dependence on hydrocarbons for foreign earnings and revenue. The over-exposure to this single source of foreign earnings meant that the economy was significantly sensitive to global oil commodity prices.
Another immediate contributory factor was the over-bloated Government recurrent expenditure profile over the years. The indiscipline in spending public funds, or more appropriately the lack of fiscal discipline affected and continues to affect the macroeconomic stability of the country leading to reduced savings, fiscal imbalances, increased inefficiencies and also increased chances of inflation.
The consequential effect of trying to manage the issues discussed above explains the surge in CBN’s policies which were targeted at reducing the money supply, curbing inflation, rationing FX reserves, preserving currency value and maintaining stability. Below are some of those policies that defined their respective fiscal years.
The Real Impact of CBN’s FX Policies
Before analysing the impact of the CBN’s FX policies it is essential that these policies are, at the very least, measured on an aggregate basis against the objectives that they sought to achieve. While we have identified some of those objectives above, it is clear that the bulk of the policies can be classified into two broad categories. The first category is those policies that were primarily aimed at ensuring price stability hence mitigating volatility and reducing speculative forces and the second category were those aimed at price discovery with the intention to ensure transparency, boost investor confidence and ultimately improve liquidity.
It can be argued that until the introduction of the managed float exchange rate regime, most of the CBN policies significantly tilted towards achieving price stability especially as the gap between the official and parallel market widened driven on the back of speculative forces and arbitrage opportunities. Hence the bulk of CBN policies under this category were capital control tightening in nature and also FX rationing in character.
When it became apparent that these policies were not achieving their objective especially in the face of deep-seated concerns about the ability of the monetary authority to use administrative measures to continue to keep the exchange rate at its artificial levels without burning through the country’s reserves, the policies shifted towards ensuring proper price discovery. Hence after 40 years of officially determined exchange rate regime, often repeated and inadequate devaluation, official allocation of FX leading to unproductive and speculative arbitrage opportunities, the monetary authorities decided to adopt its own form of market determined exchange rate regime i.e. the managed float exchange rate regime.
Even though the debate rages on the impracticability of managed float exchange rate regime and how it achieved anything but price discovery, the incontrovertible truth is that there is a lack of confidence in the pricing, insufficient illiquidity and multiple price regime fostered by CBN.
Notwithstanding the above, the effects of these policies are discussed under the following aggregated headings.
In terms of dire effects of the CBN policies, it is clear that the Nigerian economy has been the most severely impacted with all economic indices recording negative growth. Foreign Direct Investment and Foreign Portfolio Investment dwindled, inflation significantly increased, Naira devaluation, negative balance of trade, a significant increase in unemployment rate, a spike in interest rates and of course consecutive quarters of negative GDP growth. The CBN policies have been in sharp variance with fiscal policies of the government which has further exacerbated the effect of these policies on the economy.
While Nigeria is still not out of the woods, it is hoped that the combination of improved global oil prices, stable oil production and successful debut of the $1billion Eurobond will improve external reserves accretion, improve dollar liquidity and alleviate some of the harsh economic conditions.
Generally, the inability of firms to procure FX has impacted on businesses tremendously in Nigeria because of our import-dependent nature. Whilst different sectors have responded differently depending on nature of their business and level of exposure to FX needs, the clear and ever present reality is the contraction in activities of firms both on the supply and demand side. The result of these policies has led to reduced earnings, significant erosion of value, increased costs of production and sales, difficulty in the repatriation of interests/ dividends and reduced FX inflows into businesses.
The contraction has however forced firms to innovate on certain levels as evident in the increased resort to commercial paper as a means of raising capital, use of OTC FX futures and forwards to mitigate exchange rate volatility, sourcing of raw materials locally and resort to backward integration.
With oil prices hovering above $100, exchange rate pegged at $155 and significantly liquid financial institutions, all pre-2015, firms especially large corporates, manufacturers, oil, gas, power, aviation, and hospitality firms became generally more aggressive in incurring dollar denominated liabilities. Servicing these obligations at inception was relatively easy because of significant liquidity, predictable exchange rates, and relaxed exchange controls; however, the FX volatility exposed the obvious risks associated with incurring dollar denominated liabilities without having the appropriate business model or risk mitigants embedded into such commercial arrangements.
This situation has led to increased contractual delinquencies and results to both restructuring and recovery actions against firms. Additionally, reduced earnings have meant an increase in cost-cutting measures and more redundancies hence there has been a steady rise of contractual disputes and resort to litigation as a means of dispute resolution.
The widening gap between the official and parallel market continues to remain a cause for concern and a clear and present danger factor under each of the aggregated headings above. Nonetheless, it is undeniable that this is the most difficult economic situation Nigeria has faced since the structural adjustment programme of 1986 and it is apparent that overcoming these issues would take more of proactive and coherent CBN policies combined with cohesive fiscal policies and less of rhetoric and inconsistent actions or inactions.
This article is featured in the March 2017 edition of INTO AFRICA Magazine, Africa’s Lions: Trust in Fundamentals.
Abayomi Adebanjo is a Managing Associate in Jackson, Etti & Edu and holds an MBA from the prestigious Lagos Business School.