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.