Monday, August 03, 2015 1:42 PM / ARM Research
Over the weekend, the naira appreciated at the parallel market to
N210-220/$ from N240/$ in the prior week, after several banks sent out notifications to customers informing them that they would no longer receive foreign currency (FCY) deposits in cash.
Following discussions with currency traders this morning, we understand that recent developments on the CBN front have created bottlenecks around the procedure for converting cash FCY deposits into the electronic ‘telex’ form. In particular, the apex bank has tightened restrictions around the process for granting approvals to telex transfers.
Previously banks holding cash FCY deposits obtained approvals from the CBN for exporting cash FCY deposits via Travelex offshore to correspondent banks for onward conversion to electronic FCY deposits. However, post the 2015 general elections, banks continued to report elevated FCY cash deposits which the CBN believes stems from currency substitution and illicit wealth transfers.
Thus, CBN’s belief that the currency substitution demand mainly stemmed from speculation informed the more stringent documentation and cost hurdles imposed on the approval process for cash-to-wire transfers.
Thus, facing rising insurance premiums on growing cash FCY holdings in vaults and the fact that these deposits earned zero interest, banks were hard pressed to stop accepting cash FCY deposits, in the interim.
Consequently, with no inroads into the banking system, the rejected cash FCY deposits flooded the parallel market towards the end of last week, creating a glut which is driving naira appreciation at the segment.
Figure 1: Foreign currency deposits in financial system
In our view, taken together with recent CBN circular requesting that banks and BDCs track FX transactions with customers’ BVNs, the development raises the cost of naira speculation, which is largely cash driven, and should drive down the parallel market premium over the official, as participants rush to dislodge the risk associated with holding large cash FCY holdings. More importantly, the volatile swings, provide ammunition to the CBN’s position that dominance of speculators in the parallel market renders segment’s exchange rate a poor reflection of the naira.
Whilst most market participants especially foreign investors, would differ from that official view, the speed of the adjustment of the parallel USDNGN, at the very least, questions whether the previous rate (
N240/$) was a fair reflection of the naira and undermines expectations for further significant naira devaluation. In terms of fundamentals, whilst softness in oil prices and current account deficit in Q1 suggest naira pressures, sizable real exchange rate depreciation already taken and recent uptick in FX reserves already dim scope for sizable down-leg in interbank USDNGN.
For us, the development is positive insofar as it represents the first direct attempt by the CBN to tackle the cash base of the naira speculation the current administration had long identified.
However, whilst the policy change puts some curbs on the unregulated cash FX market it is unclear how it improves on overall market architecture, deficiencies in which, to our thinking, continue to facilitate the speculation and underpin the pervasive expectations for depreciation.
In our view, the reforms started by the OB2WQ system need to be completed such that, in particular, the moral hazard problem implied by CBN dominance of dollar supply is removed and there’s a framework for forex market liquidity to flow, independent of official influence.