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CBN steps up rescue package for naira, closes RDAS/WDAS Forex window

By on February 23, 2015

At last, the Central Bank of Nigeria (CBN) in a move to avert the emergence of a multiple exchange rate regime and preserve the country’s foreign exchange reserves announced the closure of Retail Dutch Auction System (RDAS) and Wholesale Dutch Auction (WDAS). Festus Akanbi harnesses the views of financial experts on the cocktail of policies of the apex bank to stabilise the local currency in the face of the oil price shocks
After a cocktail of measures aimed at arresting the sustained fall in naira value, the Central Bank of Nigeria last week announced the closure of the Retail Dutch Auction System (RDAS) and Wholesale Dutch Auction System (WDAS) foreign exchange window, thereby leaving the interbank foreign exchange market as the only official foreign exchange market.

The decision became necessary given the wide gap between the rates at the CBN official exchange market and the interbank market; a development which analysts said largely fuelled the current speculative activities in the foreign exchange market in the country. For instance, why naira was exchanged for N168-N174 at the CBN official market, the rate hovered around N198-N199 at the interbank market last week.

The apex bank, in a statement signed by Director, Corporate Communications Department, Ibrahim Mu’azu, also admitted this, saying that “the Bank has observed a widening margin between the rates in the interbank and the rDAS window, thus engendering undesirable practices including round-tripping, speculative demand, rent-seeking, spurious demand, and inefficient use of scarce foreign exchange resources by economic agents. This has continued to put pressure on the nation’s foreign exchange reserves with no visible economic benefits to the productive sector of the economy and the general public.”

The bank therefore said the closure of the official window was to avert the emergence of a multiple exchange rate regime and preserve the country’s foreign exchange reserves.

According to the CBN, henceforth, all demand for foreign exchange should be channeled to the interbank foreign exchange market, while it maintained that it will continue to intervene in the interbank foreign exchange market to meet genuine/legitimate demands.

Exploring All Options
Although the pressure to devalue the naira again became manifest shortly after he came on board, the CBN Governor, Godwin Emefiele has never left anyone in doubt about his commitment to navigate the nation’s financial sector away from the current instability largely precipitated by the fall of oil price in recent times.

Until last week’s appreciation of crude oil price at the international market, quite a number of economic watchers had almost given up on Nigeria’s ability to weather the storm, no thanks to the depreciation of the nation’s foreign reserves, the sustained exit of portfolio investors and the attendant fall in the value of naira in exchange for foreign currencies, especially the United States dollar.

The Pressure
One primary cause of speculative attacks on the currency has been the window of arbitrage that exists between the different foreign exchange markets – the official, the interbank, and the parallel. While the official rate stands at N168/$, the interbank and the parallel markets hover around N200/$. Calls have come from several quarters to unify the exchange rate markets to put an end to volatility and speculation. But preferring the policy option of price stability above all else, the current monetary policy regime has maintained an artificial or managed ‘official’ exchange rate while the other two markets, driven by demand and supply factors, have reasonably adjusted to new realities.

The rationale of the policy is to protect the economy from an exchange rate engendered inflation by protecting the key value adding segments (raw material imports), as well as energy input, from the high cost of forex. The policy is no doubt noble in its intentions, but it engenders a distorted system, which the markets will ceaselessly seek to exploit until loopholes are sealed.

Since the devaluation late last year, the naira has continued to trade outside the official threshold of N160 to N176 at the interbank foreign exchange market, with the exchange going for as high as N213 to the dollar. With the free fall of the naira against the dollar, there is pressure on the CBN to devalue the currency once again.

In spite of the pressure on the apex bank to devalue the naira, Emefiele insisted doing so will cause further harm to the economy which is largely import-dependent.

However, as the naira continued to receive bashing both at interbank and parallel markets, financial experts said there is need to review previous interventionist policies rolled out by the Central Bank, since according to them, these policies have not sufficiently brought about the desired relief to the foreign exchange market.

For instance, while officially, the CBN is holding to an exchange rate of N168, a dollar was on February 17 sold at N198 at the interbank market while there were reports that dollars were sold at some parallel markets in Lagos at the rate of N213 to a dollar.

The arbitrage situation is said to be one major reason why speculation is rife in the nation’s currency market.

Cocktail of Policies
Towards the end of last year, the CBN decided to bar commercial banks from holding any part of their funds in United State dollars at the close of each business day as it stepped up efforts to reduce pressure on the naira.

However, the CBN had to review the policy twice later, pegging the exposure at 0.1 per cent and after much persuasion, went ahead to move the limit to 0.5 per cent.

In addition, the CBN, in November last year went ahead to devalue the naira as it moved the midpoint of the official window of the foreign exchange market from N155 to N168 to one US Dollar. This means that the naira will exchange between N168 and N174 to the dollar at the foreign exchange market.

The explanation given was that official devaluation of the naira became inevitable as a result of reduction in government revenue from oil production and sales. The devaluation will increase the volume of naira available to the federation account and to various levels of government to prosecute their local programmes.

Also, in its bid to calm the strong volatility observed in the forex market, as well as save the naira from further depreciation, the CBN increased the weekly supply of dollars to bureau de change (BDC) operators from $15,000 per BDC, to $30,000 per BDC.

The banking sector regulator said the move was also part of measures to deepen the BDCs segment. The latest policy takes effect from Wednesday, January 28th, 2015 auction.

J.P Morgan analysts had placed Nigeria on a negative watch for the next three to five months following reservations over the country’s foreign exchange position and the bond market which was described as illiquid.

Not ready to give up on its rescue mission, the CBN, which realised that domiciliary transactions are used for round tripping by banks, had directed that banks submit details of domiciliary account holders, including name, account number and balances as at January 29, 2015.

It also required banks to present total balance of all domiciliary accounts as at the same date, list of corporate domiciliary account holders and their balances, list of individual domiciliary account holders and their balances, list of public sector institutions domiciliary account holders and their balances as well as the mode of lodgement to the account transactions (either cash or by wire transfer). Domiciliary deposits were equivalent to 21 per cent of the N17 trillion or $19.5 billion deposits in the Nigerian banking system as at half year 2014, according to data from an investment firm, Renaissance Capital.

Assessing the Policies
Assessing the various interventionist moves of Godwin Emefiele-led CBN, the head of African research at Standard Chartered, Razia Khan, said the apex bank has fared well so far.
She said, “So far, so good. The special auctions for the interbank FX market appear to have helped.  There will always be some panic, but the CBN has at least exerted some influence on the pace of depreciation.

Another analyst that gave the CBN a pass mark is a research associate with BGL Plc, Mr. Olufemi Ademola. He however believe certain contradictions are affecting the implementations of some of the policies rolled out by the CBN.

Ademola, in response to THISDAY enquiries said, “In my opinion, the interventions by the CBN are normal and expected in line with the exchange rate situation. However, the effects are not so felt because of the prevailing uncertainties and the confusion in the polity on the one hand, and the mixed messages from the CBN on the other hand. While the CBN is trying to allay fears by stating that the naira is appropriately valued and hence no panic, the interventions in the market including official currency devaluation and implied depreciation of the currency in some segments of the foreign exchange market say something else; leading to confusion and increased uncertainties.”

Ademola believes the modest appreciation of crude oil price in recent times will go a long way in boosting the nation’s buffers. He said, “Although the foreign reserves level has gone down to $32.66 billion, the fact that oil price is recovering means that there may still be an opportunity to grow the reserve. In addition, the expectation of a reversal of capital to the country after the election may also sustain a strong level of the reserves. However, a continuous haemorrhaging of the foreign reserve limits the capability of the CBN to defend the Naira and in the long run, floating of the exchange rate will be the most appropriate action to take.”

Also commenting on the potency of the CBN’s rescue arrangement, Khan said stakeholders were still studying the approach being used by the apex bank. “It is not known what the CBN’s ‘line in the sand is’.  If it wants to send a strong message that it will support the NGN, it might be willing to draw down reserves to much lower levels. The problem is, as FX reserves come under greater pressure, more market participants are likely to start doubting that the current level of FX can be sustained.  Given this, the best strategy might be for the CBN to try to control the pace of the depreciation, rather than to fight it entirely,” the Standard Chartered chief said.

Expectations from CBN
Should the attacks from speculative activities from the foreign exchange market continue to take its toll on the naira, what are the immediate steps expected of the CBN?
Khan said that “Some sort of remedial action from the CBN is expected – maybe a closer look at the FX trades that are getting filled.

But the BGL official said there is need for the CBN to adjust the official midpoint managed float to give room for appropriate controls. He said, “Unfortunately, no country (using an exchange rate peg) has ever won a currency war. Therefore, if the exchange rate volatility continues, the most likely action of the CBN would be to adjust the official mid-point managed float and allow a corridor to cover all the market segments. However, if as stated by the CBN, the outlook for the Naira is stable (appropriately valued) and that the volatility is time-bound, there may not be a need to do anything until that outlook changes.”

Ademola believes that “The implication of deteriorating foreign exchange on the economy is felt more on terms of trade. With the declining naira value, there will be a significant depression in dollar value of exports (which would make our exports more competitive in global market); however the high import content of the economy would transmit the foreign exchange volatility effect into higher domestic prices and hence higher inflation. This could translate into weaker consumption and investments and ultimately a contraction in growth and increase in misery index.”

Khan, on the other hand said “Much of the demand for FX now seen in local demand is driven by the expectation that the NGN will weaken further. Because FX reserves are finite, sustained pressure on FX reserves may see expectations of further NGN weakness become self-fulfilling.  Oil prices have started to recover. Brent has touched USD 61/bbl. on a falling rig count in the US, but it seems to be having little impact on the NGN.  Unless the CBN can restore faith in the currency, a sustained depreciation risks eventually feed through into higher inflation.  It also unnecessarily adds to the debt burden of those who have borrowed in USD, and makes capital goods imports for infrastructure projects more expensive.”