Sunday, August 01,
2021 / 03:00PM / Afolabi Ogunlayi, Comercio Partners Limited / Header Image
Credit: The Cable
Monetary Policy Committee (MPC) meetings in the first half of the year ended with non-dramatic and highly predictable conclusions, as policy makers wrestled with an economic reality characterized by higher prices and tepid growth; hence, resulting to the maintenance of all policy parameters at the levels we started the year. Understandably, the reasonable policy route was to maintain status quo, as anecdotal evidence suggests that interest rate loosening would not necessarily stimulate the desired economic growth, while the hawkish deployment of policy levers would not effectively tackle the supply driven inflation-type that blights the economy.
However, July's MPC meeting came with surprises. Although there were no changes in policy instruments within the ambit of the Apex Bank, other announcements were made regarding the FX market. In an apparent move to rein in the activities of Bureau de change (BDC) operators, the Governor of the Central Bank expressed his dissatisfaction with the operations of the BDCs, a group that provides intermediation between incoming tourists who have dollars but need naira and outgoing travellers who have naira but need dollars.
The CBN used these BDC operators to intervene in the FX market, as they serve as a conduit through which FX is channeled to retail buyers who have dollar needs that are deemed legitimate by the monetary authority. The CBN's concern with BDCs border around the wholesale dealings that they now engage in and the extraordinary spread that they make on FX sales, all of which are antithetical to the intent of their establishment. Accordingly, the CBN announced the cessation of FX sales to BDCs and halted the issuance of new licenses including those in the pipeline. To remedy the stoppage of FX sales to BDCs, the CBN noted that it would channel a significant portion of the weekly allocations to commercial banks who will in turn serve as a channel to meet the legitimate FX needs of retail investors.
Understanding the Why
The rationale behind the CBN's decision is clear, feeding off the existing concerns around FX speculation and the possible contribution of BDCs to the prevailing currency crisis. To better illustrate, the CBN recently used to offer FX to the BDCs at $1/N393 with stringent directives to sell with a N2 margin, but the BDCs act otherwise and sell at the prevailing parallel market rates, leaving them with a spread that is north of N100 for each dollar sale. Hence, you can easily extrapolate the concerns of an Apex Bank that has been in a losing FX battle for the better half of the last decade, and the $20,000 weekly supply to about 5,500 BDCs can be understandably interpreted as a leakage.
The Concern - A Non-Holistic Approach
Broadly speaking, the activities of the speculators undoubtedly contribute to the dilemma in the FX market, but avid critics of the CBN's decision to clamp down on the BDCs question the effectiveness of its strategy and its tendency to underestimate the root cause of the problem. Simply put, FX speculators are able to sell dollars at such high rates because of the existence of an effective demand side that is willing to pay. You would easily reject dollars offered to you at over 1$/N500 if you could get it at the official rate of $1/N410.16.
The economic reality remains the same, and the insufficiency of dollar supply sits at the center of the whole problem. To blame other factors like the activities of speculator and hoarders, oversimplifies the problem and fails to provide a holistic solutional approach to the issue at hand. By stifling black-market supply, the Apex bank believes it could effectively tame and possibly eliminate some demand, which through a very narrow policy lens, is viewed as illegitimate.
Also, the recent decision by the CBN cuts deeper for many, as it bears a striking resemblance with a policy stance witnessed just before the 2016 economic recession. The announcement to clamp down on BDCs comes off as a DÃ©jÃ vu, leaving many bothered as to whether the decision will birth an identical undesirable economic outcome.
An Historical Nostalgia
The CBN has been down this route before; hence, the recent announcement brought with it a feeling of nostalgia. In a press statement dated January 2016, the CBN expressed its dissatisfaction with the operations of the BDCs. The issues stated then were mostly the same with the ones aired at the last MPC meeting - the BDCs had morphed into wholesale FX dealers, rather than serving only the needs of retail customers with dollar needs of $5,000 or less; also, the spread on FX sales had become exorbitant, as the CBN sold dollar to them at $1/N195 while they sold to the market at c.$1/N250.
In response to an identical problem back in 2016, the CBN also deployed very similar solutions, halting the $60,000 weekly sales of FX to the 2,786 BDCs in operation then and instructing commercial banks to start receiving FX cash deposits from customers. The impact of these decisions reverberated through the country, as the consequential depreciation of the naira passed through the broad economy.
Following the CBN's decision to halt the supply of FX to BDCs in 2016, the FX market witnessed a prolonged period of depreciation at the parallel market, with the exchange rate moving from $1/N265 on the 4th of January 2016 to touch its support level at $1/N520 on the 20th of February 2017. The naira remained depressed up until the introduction of the Investors and Exporters FX Window in April 2017.
Also, the pass-through effect of the currency depreciation reflected in the rate of inflation, as the yearly headline index rose from a single digit level of 9.62% in January 2016 to a peak of 18.72% in January 2017. Inflation moderated later into 2017, due to the high base effect and the improvements in the FX rates after the introduction of the NAFEX window.
Also, the monetary policy committee instituted multiple rates hikes in 2016 to tame the fast-rising rate of inflation. The benchmark rate was hiked by 2.00% twice, in March 2016 and July 2016.
Given the uptick in inflation and the rake hikes instituted, the local fixed income market yields reprised upwards. On average, the benchmark yields on the FGN bond inched up by 4.33% from 11.89% in January 2016 to 16.23% in April 2017.
Possible Expectations - Lessons from History
Following the move of the CBN against the operations of the BDCs, we can easily infer the possible economic outcomes, by examining the macroeconomic atmosphere and drawing some similarities from the events that took place in 2016.
The immediate impact of the news will be a near-term knee-jerk reaction that worsens the position of the naira in the FX market. However, a more disturbing but possible expectation is the persistent depreciation of the Naira over an extended period, creating the threat of a 2016-type currency depreciation that resulted to the naira losing about 49.04% at the parallel market.
Currently, a repeat of such movement would take the exchange rate as low as $1/N1000. However, we do not anticipate such a massive drop, given our relatively deeper pockets of dollar reserves now. The reserve levels were comfortably below $30 billion in 2016 and they remain slightly north of $33 billion at the moment. Nonetheless, we cannot overlook the possibility of a $1/N600 exchange rate.
The yearly headline inflation managed to halt its 19-month uptrend, recording three consecutive months of moderation. However, the pass-through effect of a depreciating naira is expected to reverse this trend of disinflation, as the consequential rise in production costs is expected to be filtered through to the final consumers. In addition, a buildup of inflationary pressure should cause fixed income yields to reprise upwards in the local market, and this uptick could be exacerbated by domestic borrowings by the Federal Government to service the 2021 budget.
In our view, a move that could be deployed as a stopgap to temporarily avoid the gloomy outlook, is a massive Eurobond issuance. This would provide a significant supply of FX, translating into an improvement in the exchange rate, which in turn sponsors a moderation in inflation. Also, massive borrowings on the foreign end will reduce possible local fixed income supply, which alongside a slower rise in inflation, should help keep fixed income yields from running hot.
Related News on CBN's Directives
2. CBN Stops Sale of FX to BDCs, Holds Policy Parameters Constant- Jul 27, 2021
3. CBN Communique No. 137 of the MPC Meeting - July 26-27, 2021 - Jul 27, 2021
5. CBN Suspends FX Sales to BDCs Until Further Notice - Mar 26, 2020
6. CBN FX Sales ban to BDCs: financial and market players react - Jan 12, 2016
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