Impact of a Unified Exchange Rate and Assessment of Playing Field

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Friday, June 17, 2016 7.57PM / FDC

The Central Bank has released its guidelines for implementing a flexible exchange rate. This has been long overdue, with the CBN finally coming to terms with the need for a currency adjustment. Contrary to analysts’ expectations of a dual exchange rate regime, only one market would be at play with a unified exchange rate.

This is welcome news as the unification of rates effectively addresses the uncertainty and speculative factors that have played significant roles in determining the parallel market premium under the fixed exchange rate regime.

According to the Charles Enoch, Deputy Director, Monetary and Financial Systems Department, International Monetary Fund, the shift to exchange rate unification has been part of a broader adjustment program to enhance financial stability and growth. In others, the decision to unify exchange rates was not part of a well-defined strategy, but instead occurred in the context of a crisis; when in the absence of fundamental reforms, parallel market premiums widened significantly, making the system unsustainable.

In his paper titled “Moving to a Wholesale Dutch Auction System: Country Experiences”, a review of exchange rate unification has shown that in most cases, the trigger for unification was macro-economic instability and low growth. Foreign exchange markets were characterized by a rationed official market with a fixed exchange rate and an active black market, with the floating rate carrying a high premium.

According to Enoch, successful unification was more likely when the reforms were part of a comprehensive package, involving macro-economic adjustment (particularly fiscal discipline and credible anti-inflationary policies) and structural reforms, including trade and market liberalization. By contrast, where such policies were not followed, for instance, through continued expansionary fiscal policies, exchange rate pressures emerged, leading to the reversal of unification (Iran in 1993).

In most cases, macro-economic stability was achieved after unification, even where there had been sizeable depreciations, with lower inflation. Fiscal positions improved and gross foreign exchange reserves generally rose (e.g. in India post 1991 – see Charles Enoch: Moving to a Wholesale Dutch Auction System).


We expect the following to occur in the short to medium term:

1.       There would be no more uncertainty surrounding the exchange rate and exchange rate policy. Since the rate can move in any direction at anytime, the demand for forex would primarily be for immediate transactions rather than speculative trading.

2.      Companies and manufacturers would start carrying inventories for a shorter period as the need to front load disappears.

3.      There would be less demand at the BDCs now that the uncertainty and unavailability premium is gone, resulting in an appreciation at the parallel market.

4.      There will be a gradual convergence in rates between the unified and parallel markets.

According to a leading U.S. money centre bank in a note released today, the naira is projected to trade between N280-300 against the dollar, while the parallel market rate will stabilize. The supply of forex is also expected to increase. This implies that the new exchange rate is unlikely to depreciate lower than the parallel market rate. In anticipation of Monday’s new rate, the naira appreciated from N365/$ to N340/$ in the parallel market.

This market is a marginal and fringe segment of the total market. It is also not a true reflection of actual demand but is influenced by speculation, uncertainty and arbitrage activities. One of the expected outcomes is that price leadership will now rest squarely within the regulated market segment. This will be influenced to a large extent by the CBN. The CBN supplies over 70% of foreign exchange to the markets.


Following the recent announcement of the framework of a more flexible interbank market, Renaissance Capital hosted a conference call with Nigerian bank treasurers to get a better under-standing of the dynamics of the soon to be introduced flexible market and the implications of this for the Nigerian banks. On the call were Michael Anyimah (Head of Trading, Zenith Bank Plc), Dapo Olagunju (Group Treasurer, Access Bank Plc) and Adebayo Omogoroye (Head of Trading, GTBank Plc). As expected, the issue of a flexible interbank rate was quite topical on the minds of in-vestors, and we had over 140 participants dialed in. If you need the recording, kindly let us know.

The CBN’s decision to adopt a completely market driven FX market came as a big surprise to most market participants, as many had expected a two-tier system under some sort of managed float. It is clear from such a radical change, that the Central Bank of Nigeria could no longer sustain the Naira at the pegged level of NGN197/$.

The bank treasurers gave detailed insights on recent developments, addressing many of the concerns of investors. We summarize the key points from the call below:


The banks’ traders held a meeting yesterday to discuss the mo-dalities of the interbank market further. As guided by the CBN governor, the banks expect trading to kick off on Monday 20th of June, although there appears to be some level of uncertainty as to the exact mechanics. At this point it is difficult to determine what level the NGN will trade at, given it is dependent on a number of factors, including the quantum of CBN’s supply on the first day of trading.

The banks expect the Naira to trade anywhere between NGN270-NGN300/$, and note the likelihood of some volatility in the initial days of trading.

From the CBN guidelines, we understand that it intends to intro-duce FX Primary Dealers (FXPDs) – registered authorized dealers designated to deal with the CBN on large trade sizes on a two-way quote basis. To qualify as an FXPD, a bank is required to meet at least two of the three conditions highlighted below:

1.       Minimum shareholders fund unimpaired by losses of at least NGN200bn;

2.      Minimum of NGN400bn in total foreign currency assets; and

3.      Minimum Liquidity Ratio of 40 percent

While no official statement has been made regarding the appointments of the FXPDs, we deduce based on FY15 numbers that only seven of the Nigerian banks meet these requirements, skewed towards the larger tier 1 names. They include FBNH, Zenith, GTBank, UBA, Access, Diamond and Union Bank. Appointment of these banks as FXPDs could imply they control a relatively higher proportion of FX market volumes, which should be positive for their NIR line.

These banks can also have short positions up to 10% of shareholders’ funds at the close of each day (from 0.5% currently), implying their trading bias should be to see the Naira appreciate.

In addition, the wider short trading position of 10% vs the 0.5% long trading limit, should reduce pressure on the FXPDs to buy dollars at the close of business to close their positions and give them more room to enter forward positions when the cash isn’t immediately available.

Coincidentally, none of the international banks qualify as FXPD based on our analysis, implying they will be second leg participants in the market.

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3.      How the CBN Naira-Settled OTC FX Futures Market Will Work

4.      Exchange-rate flexibility beyond expectation

5.      The new fully Floated FX Market – In a Nutshell

6.      Implications for Markets as the CBN finally floats the Naira

7.      The Nigerian Managed Float Exchange Rate System

8.     Revised Guidelines for the Operation of the Nigerian Inter-Bank Foreign Exchange Market  

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