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IMF, NEC welcome decision to end currency peg

By on June 18, 2016

The International Monetary Fund (MF) and National Economic Council (NEC) both endorsed the decision by the Central Bank of Nigeria (CBN) to abandon its currency peg and adopt a flexible exchange rate policy, saying this was important to reduce fiscal and external imbalances.

Reuters quoted IMF spokesman Gerry Rice to have told a weekly news briefing that the fund wants to see how effectively the naira exchange market functions once the new float system is put into effect next Monday.

“I think the announcement yesterday to revise the guidelines for the operation of the Nigerian interbank foreign exchange market is an important and welcome step,” Rice told reporters. “It will provide greater flexibility in that market, the foreign exchange market.”

Senior IMF officials, including Managing Director Christine Lagarde, had urged Nigerian officials to allow the naira to fall to absorb some of the shocks to the economy from a plunge in oil prices and revenues.
IMF officials have said that Nigeria has not requested IMF financial assistance, but has been in consultation with the fund on dealing with budget shortfalls.

“As we have said before, a significant macroeconomic adjustment that Nigeria urgently needs to eliminate existing imbalances and support the competitiveness of the economy is best achieved through a credible package of policies involving fiscal discipline, monetary tightening, a flexible exchange rate regime and structural reform,” Rice said.
“Allowing the exchange rate to better reflect market forces is an integral part of that.”

In addition, NEC yesterday approved the new foreign exchange policy announced by the CBN.
Akwa Ibom State Governor, Mr. Udom Emmanuel said this in Abuja while briefing State House correspondents on the outcome of the NEC meeting presided over by Vice-President Yemi Osinbajo, reported the News Agency of Nigeria (NAN).

According to Emmanuel, the CBN Governor Mr. Godwin Emefiele told the council that the foreign exchange policy would be determined by total interplay of the market forces based on demand and supply.
“Certainly, it is a welcome development. (There are) two areas that we needed to really take headlong and one is this flexible foreign exchange policy.

“And to make it a little bit more flexible right now, I think it is a welcome development.
“That is the opinion of almost everybody today who knows the advantages of having a flexible exchange policy.

“It is going to help the economy, it is going to help ease of access.
“And if you also listen to the details of what he (the CBN governor) gave, so that I don’t actually repeat what he has said, I am sure at
the end of the day, head or tail, we should be better off for it.”

Naira Expected to Settle at N250/$

Meanwhile, the central bank is “reasonably optimistic” that the naira will settle at around N250 to the dollar after an initial period of weakness following a floatation on Monday, Emefiele has said in a letter to President Muhammadu Buhari.
The naira is expected to fall sharply when interbank trading begins on Monday, but the central bank said it did not have a target for the currency and the price would be “purely” market-driven. The naira traded on the black market at around 360 to the dollar yesterday.

According to Reuters, giving the first indication of a target, Emefiele said in a June 3 letter to Buhari that the central bank hopes the naira will eventually trade at around N250 per dollar, a level the president has “approved”.
“I must assure Your Excellency that we are indeed reasonably optimistic that at some point the rate will settle around 250 naira,” Emefiele said in the letter.

The letter, which briefed Buhari on the foreign exchange plan announced on Wednesday, said it could take three to four weeks to clear a $4 billion backlog of foreign exchange demand.
Buhari for months said that he did not want the naira to be devalued, but backed a more flexible exchange rate policy when the central bank outlined its plans in May, without elaborating.

The presidency has not commented on the new regime, with Buhari’s spokesman declining to comment when Reuters called on Wednesday.
The central bank could not be immediately reached for comment.
Africa’s biggest economy, which contracted by 0.4 per cent in the first quarter, faces its worst crisis in decades after the decline in oil prices since 2014 and last year’s introduction of a currency peg, which prompted a large-scale capital flight.

With a likely sharp fall for the naira, Nigerian products will become relatively cheap and imports more expensive, which should stimulate the domestic economy but also lift inflation.
Buhari had previously raised concerns about the inflationary impact that a weaker currency will have on Nigeria’s poor.
Nigeria, Africa’s largest crude exporter, has resisted devaluing its currency for more than a year despite other major oil producers, including Russia, Kazakhstan and Angola, allowing currencies to fall after crude prices collapsed.

Equities Sustain Rally, Naira Appreciates

However, buoyed by the excitement that trailed the decision by the CBN to remove the peg on the naira and float the Nigerian currency, the stock market sustained its bull run yesterday, with the benchmark index, Nigerian Stock Exchange All-Share Index (NSE-ASI) appreciating by 2.14 per cent from 27,891.96 to close at 28,489.87, while market capitalisation added N205 billion to be at N9.785 trillion.

The volume of trading similarly rose to 618.248 million shares valued at N5.410 billion, exchanged in 6,757 deals, compared with 588.427 million shares valued at N3.477 billion in 5,088 deals the previous day.
Market analysts at Cordros Capital Limited said stocks would continue to record gains  in the market  as investor appetite remains strengthened by the new flexible foreign exchange policy.
On the parallel market, the naira also appreciated by N10 yesterday to close at N360 to the dollar, stronger than the N370 to a dollar it closed the previous day.

Analysts had predicted that the new forex policy, which allows the exchange rate of the naira to be market-determined, would help strengthen the value of the naira exchange rate.
Speaking to journalists in Abuja on Wednesday, Emefiele said the central bank had resolved to henceforth deal with FX Primary Dealers (FXPDs) under the new arrangement. He also said the existing ban of 41 items from accessing forex from the official window would remain in place.

He said part of the objectives of the new framework, which included the introduction of the Naira-settled Over-the-Counter (OTC) FX Futures market, was to discourage people from front-loading or hoarding forex due to uncertainty.
He also assured the markets that the backlog of matured letters of credit would be cleared.
However, yields on Nigerian naira-denominated bonds rose across the board during auction on Wednesday, which was a reflection of a drop in bond prices.

The Debt Management Office (DMO) sold N112 billion worth of paper maturing in 2036, 2026 and 2020. A breakdown of this showed that the debt office sold N50 billion debt maturing in 2036 at 14.98 per cent at Wednesday’s auction, compared with 13.90 per cent at last month’s auction.
It also sold N40 billion of 2026 debt at 14.40 per cent, against 13.74 percent, and N22 billion of the 2020 debt at 14.20 per cent against 13.24 percent. The rise in yields was a reflection of the rise in inflation, which climbed to a six-year high of 15.56 per cent in May.

Commenting on the appreciation recorded by the naira yesterday, the President, Association of Bureau De Change Operators, Mr. Aminu Gwadabe blamed it on uncertainly in the informal market.
“There is a lot of fear in the market. Those holding dollars are selling because of the fear of the unknown,” he said.
Nonetheless, the Group Managing Director of the United Bank for Africa Plc, Mr. Philips Oduoza, described the move to a flexible exchange rate regime as positive for the economy.

“This is one of the best monetary policy decisions in recent months and a very big commendation to CBN governor for this. It will turnaround the economy rapidly,” Oduoza said in response to THISDAY’s enquiry.
But London-based Managing Director/Chief Economist, Africa, Standard Chartered Bank, Razia Khan, pointed out that while the CBN’s apparent embrace of currency flexibility was positive, macroeconomic concerns were likely to persist.

According to her, how the country plans to settle accumulated backlog of forex demand was still unclear.
“The risk is that if all of this demand is brought to the newly established interbank market at the outset, the Dollar-Naira FX rate would come under significant pressure.

“By establishing guidelines for a futures market, the authorities may hope to settle some of this backlog gradually over time. With May inflation reaching 15.6 per cent year-on-year, there is likely to be limited desire for further significant FX volatility, even as the CBN embraces currency flexibility.

“A second concern is the lack of monetary tightening accompanying the move towards FX flexibility. With Nigeria’s FX reserves already pressured by deteriorating fundamentals, and oil output threatened by a new wave of Niger Delta militancy, raising the policy rate and sterilising excess liquidity in the money market may have provided a better defence of the currency.

“As things stand, Nigeria’s entire bond yield curve is currently negative with respect to headline inflation. This may make it more difficult for Nigeria to attract meaningful offshore portfolio inflows. It may also weaken domestic confidence in policy, eroding trust in the naira.
“In the absence of accompanying tightening of monetary conditions, the move to FX flexibility – with a properly market-determined FX rate – might risk further currency overshooting,” Khan added.
She also held the view that a weaker FX rate will likely boost Nigeria’s receipts from oil revenue, and help contain the overall fiscal deficit.

She added: “However, there are potentially negative implications. The foreign exchange exposure of the Nigerian banking system, given the preference for dollar-lending in previous years, remains a key concern.
“A much weaker FX rate may initially bring loan deterioration, with higher system NPLs. Even in the presence of accommodative monetary policy, appetite for new bank lending may take some time to recover.

“The benefits of this policy accommodation, and hopes for an imminent resurgence in lending, may not be realised.
“Our projection is for Nigeria’s current account deficit to widen further near-term. Falling oil output will be a key source of stress on C/A receipts.

“Even with currency flexibility, this is unlikely to be fully compensated for by other inflows, at least in the near term. Nigerian FX reserves will likely remain pressured.
“More will be needed to boost confidence in the new FX regime, ensuring its workability.”
In her comment, Johannesburg-based Sub-Saharan Africa Economist at Renaissance Capital (RenCap), Yvonne Mhango, said Nigeria’s new forex rules would release a pressure valve for the economy.

“We see the economy beginning to thaw and green shoots emerge possibly as soon as a year from now. Before then, we believe the macro-picture will deteriorate. Now the question is where the market will put the naira?
“We look to the Kazakh tenge (KZT) for some guidance. Investors draw parallels between it and the naira because they are both oil-exporting currencies, and have followed similar trajectories – at least until August 2015, when Kazakhstan floated the tenge, which resulted in it depreciating by almost 30 per cent against the US dollar, over a couple of days.

“If the naira were to mimic that move next week, when trading begins, we could see the FX rate at NGN260/$1, which is close to our fair value estimate of NGN255/$1. (It is likely the central bank will anchor the FX market by setting the opening rate on 20 June.)
“However, this would just be the start. It took over six months for the KZT to fall to its low, representing an additional 50% fall. If the NGN follows this path, we may see the FX rate fall to NGN390/$1 by YE16, before retracing,” she added.

But Mhango’s colleague at RenCap, Adesoji Solanke, who is the Sub-Saharan Africa Banking Analyst/Head of Research for the financial advisory firm, in a note yesterday, stated that the FX trading and revaluation gains should be the biggest positives on the profit and loss books of banks, adding that capital and NPL risks would be the biggest potential negatives.

Also, analysts at Ecobank Nigeria stated that CBN’s actions were aimed at unlocking the interbank foreign exchange market that hitherto has been inactive due to challenges arising from sustained low oil prices, low level reserves and strong import demand.
They however expressed displeasure over the continuous ban of the 41 items, saying: “While this move may help to conserve FX reserves, we believe that this policy measure is counterproductive and will continue to damage the economy via higher inflation, slower growth and FX market uncertainty given the concerns already existing about weaker oil production in the economy.

“While the CBN did not announce any exchange rate, it is our opinion that a new exchange rate will emerge from the interbank exchange market, which will likely be above the current rate of $1:N197, at which the CBN has been selling dollars to banks.
“We think this rate is initially likely to be around $1:N285-320 as pent-up demand for dollar is released onto the market.

“Over time, the move is likely to increase the supply of US$ liquidity to the interbank market as remitters and exporters are likely to be more willing to sell dollars at the interbank rate.
“Similarly, we believe that investors who have been sitting on the sidelines for fear of not being able to get dollar out of the economy will now be more willing to commit.

“Overall this greater flexibility will be positive for the economy as it will improve access to foreign exchange (albeit at a higher rate) for firms which have been struggling to buy hard currency.”
Also, Cyprus-based Research Analyst at Forex Time (FXTM), Lukman Otunuga, in a note yesterday said global markets received a pleasant surprise during trading on Wednesday following the CBN’s “unanticipated decision to de-peg the naira against the dollar in an effort to revive economic growth”.

“For an extended period, the incessant decline in oil prices have slashed the nation’s foreign exchange earnings, while the dollar peg heavily eroded reserves which simply pressured the nation further.
“With fears mounting that a recession could be pending in second quarter amid depressed oil prices, the central bank’s move to de-peg the naira may have mitigated some concerns, consequently boosting sentiment.

“Although the naira may be set to depreciate to unfathomable levels as the natural forces of supply and demand determine its true value on the free floating exchange, this could encourage domestic import substitution, while re-attracting foreign investors.

“As of now, the CBN will need to act with haste by hiking rates, as ongoing naira weakness may punish Nigerians further while causing inflation to spiral uncontrollably,” he said.
The Head, Investment Research, WSTC, Mr. Tola Oni, said the new forex policy signposts the termination of a protracted period of constriction of trade and capital flows.
“The liberalisation of the FX market will improve confidence in the CBN’s FX management and attract foreign portfolio and direct investments.

“The introduction of the FX OTC futures markets should subdue volatility in the spot market and foster appropriate planning of capital intensive projects in the real sector.
“The liberalisation of the FX market is a necessary condition for a rebound of the domestic economy. Thus, we expect improvement in economic activities.

“However, we believe that the retention of the 41 excluded items from the FX interbank market (given the inability to meet demand through domestic supply) remains an inhibiting factor to the realisation of the full economic benefits of an efficient market,” Oni stated.

 

[ThisDay]