| Monetary Policy |     3958 VIEWS  |
| Monetary Policy | |
| 3958 VIEWS | |
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Friday, February 16, 2018 /4:25 PM / FDC
The Monetary Policy Committee (MPC) voted in May 2016
to adopt greater flexibility in ex-change rate policy and held other monetary
policy parameters un-changed. This was the first in a sequence of monetary
policies aimed at salvaging a near-crisis situation in the foreign exchange
(forex) market. The situation in the forex market was occasioned by a steep
fall in global oil prices and domestic oil production shocks, and was
exacerbated by economic policy inertia.
The immediate effect of this new policy was that the
average naira exchange rate weakened at the inter-bank segment of the foreign
exchange market. Consequently, the exchange rate at the interbank market opened
at N197.00/US$ and closed at N292.90/US$. The Central Bank of Nigeria (CBN)
further supported the measure by hiking the monetary policy rate by 200 basis
points (bps) from 12.00% per annum (pa) to 14%pa at the MPC meeting in July
2016. The rationale for the decision was to attract foreign portfolio
investment into the country and stabilize the naira.
The policy seemed to have worked as
imported capital jumped by 74.84% from $1.04 billion (bn) in the second quarter
of 2016 (Q2’16) to $1.82bn in Q3’16. Foreign Portfolio Investment (FPI) accounted for 85% of the total quarterly
increase. The euphoria surrounding the flexible exchange rate and higher
interest rate was short-lived as capital imported in Q4’16 declined by 15% to
$1.55bn and was followed by a 41.36% fall in capital imported in Q1’17 to
$908.27mn. This was largely due to the skepticism about the flexible forex
policy and investors’ apprehension about the huge disparity between the
interbank forex rate and the parallel market rate. This trend continued until
the Investors Export Foreign Exchange window (IEFX) was launched in late April
2017. The IEFX boosted liquidity in the forex market, calmed the frayed nerves
of foreign investors and supported the convergence of Exchange rate.
The Investors & Exporters Foreign
Exchange window
The introduction of the IEFX window in
late April 2017 is ar-guably the most important policy implemented by the CBN
in 2017. Prior to the introduction of the IEFX, foreign portfolio investors,
particularly those repatriating funds from Nigeria, were concerned about the
multiple ex-change rates in the country. There was a huge gap be-tween the
official exchange rate and the parallel market exchange rate, plus an
opaqueness in the foreign ex-change management system (which caused
uncertainty), and the acute scarcity of hard currency. Consequently, there was
an exodus of foreign capital and little or no new investments into the country.
However, foreign portfolio investors returned with the opening of the IEFX.
Prior to this, investors were of the view that the naira was overvalued and not
at a market-determined level. The IEFX window, higher oil prices and
production, and the CBN’s consistent intervention in the forex market are the
main drivers of the stability and the convergence of exchange rates in Nige-ria
today. The graph below shows how the IEFX window has gained traction since it
was introduced.
The capital importation graph shows that
there was capital flight in Nigeria from Q2’15 which preceded the recession.
The hemorrhage was stopped briefly in Q3’17 when the CBN increased the
benchmark interest rate by 200bps to 14.00%pa. The Q3’17 figures show
investors’ response to the introduction of the IEFX. There are expectations
that the upward trend in capital im-portation will continue in Q4’17. While FPI
and other investments seem to be on an upward trend, FDI has remained
stubbornly low because of infrastructural as well as other institutional
challenges. 
Currency stability? Not yet Uhuru
The CBN Governor, Debt Management Office (DMO) Chief and other top
government officials are of the view that the forex short-age in Nigeria is
over and the naira will continue to gain traction. Data from the National
Bureau of Statistics (NBS)10 further shows that capital Defending the naira may
lead to a depletion in the external reserves and reduce the import and payments
cover of the country. On the other hand, allowing the exchange rate to float
freely after a shock could lead to sharp depreciation of the naira of which it
may or may not recover from. The optimal path of the foreign exchange after a
shock is still the subject of intense academic and policy debate. importation
is reaching pre-2015 levels and the exchange rate has been relatively stable.
However, some investors and analysts disagree. They are of the view that the
fragile stability will disappear if there is any significant oil price or
production shock or if sentiment moves against emerging market assets. (This
may happen as the US Federal Reserve [US Fed] is set to raise interest rates in
2018). With the 2019 elections coming up, there may be a new spate of attacks
on oil infrastructure. In the event of an oil price or production shock, the
CBN will have to choose between defending the naira with its reserves and
letting the naira float freely.
There are strong indications that the MPC
will shift towards an accommodative monetary policy stance in 2018. There are
also indications that the US Fed will hike interest rates this year (which may
trigger capital flight from Nigeria). Given that hot money is interest rate
sensitive, the combination of these events may trigger a reversal in capital
flows. However, with the external reserves approaching $41bn and if there are
no shocks to oil price and production, the exchange rate effect should be
minimal. Although hot money makes most central bankers cringe, it is one of the
main sources of capital flows in emerging markets and it helps countries meet
their balance of payment obligations, therefore stabilizing the exchange rate.
Apart from hot money, Nigeria needs to improve the ease of doing business and “fix”
some of its challenging infrastructural problems in order to attract cold money
which is longer term, not interest rate sensitive and more sustainable. While
Nigeria awaits an economic and political messiah to save her from the shackles
of corruption, economic backwardness and infrastructural decay, hot money will
remain the major source of foreign capital.
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