The Central Bank announced a new policy with a view of increasing forex liquidity hoping that the policy will help bring down price subsequently. The question to begin with is the nature
of the new forex market.

It is a general microeconomics misconception and miscalculation to use characteristic of a perfect market to describe a monopolistic one, and sometimes deliberate gimmicks by capitalists to exploit the market in the name of giving the buyer a better deal due to competition.

If assuming the forex market is at least approximately perfect then a better deal can be guaranteed. Typical example of this perfection is the pure water market whose price neither a single buyer nor a single seller can control under normal circumstances.

In the true sense of our new forex deal supply will be determined by CBN on one hand and a very few financial institutions on the other hand. Two things here can protect the buyer from
exploitation;

1. The market rules made by policy makers, here mainly by CBN who is now a competitive player in the market.

2. The size of demand and supply by the CBN which should be able to displace market control by the financial institutions.

If this deal come to work perfectly, the financial institutions are likely to have more dollars than the CBN, likely to have more demand and more supply of dollars. At this time, the CBN would have lost control of the market. The risk here is not only that the buyer is no more protected from exploitation but also that the CBN would have lost the control of a basic macroeconomic tool (monetary policy).

Let us take two simple analogies of how this can hurt policy making; remember that like our two other important markets, oil market and stock market, about 50% or more of the forex market will likely be controlled by foreign interests directly or indirectly;

1. The forex dealers can raise the value of the naira whenever they want to bring in their money for investments (hence getting a lot more of naira for their dollar) and bring the
value of the naira down whenever they want to repatriate their money (hence getting a lot more of dollars for their naira), by playing this market game foreign investors can be sure of profit without doing anything, simply by bringing their money to an economy run by crazy people; all they will need is a simple mathematics of when to come and when to leave.

2. By controlling forex rates the ‘forex gangstars’ will automatically have some level of control on interest rates, FG bonds and other indices, hence the ability to manipulate debt repayments and monetary policies. These gangstars are owners of a few banks in Nigeria, and without even elaborating the danger may be easily understood.

Let us look at some key highlights of the new policy.

i. Forex Market moving to single market through interbank via a Reuters / FMDQ order matching system with 10 primary dealers (2 way quote mechanism) and other secondary dealers.

ii. Primary dealers will operate the interbank market. CBN may intervene from time to time.

iii. Proceeds of Foreign Investment Inflows and International Money Transfers shall be purchased by Authorized Dealers at the inter-bank rate.

iv. Non-oil exporters are allowed unfettered access to export proceeds via the interbank rates.

v. 41 items formerly constrained by CBN will still not be eligible for trade on interbank.

vi. The official rate of N199 per dollar or where about will be retained for what the CBN governor hinted as ‘critical rate for critical people’.

vii. To further deepen the FX market, in addition to the already approved hedging products referenced in the CBN “Guidelines for FX Derivatives and Modalities for CBN FX Forwards”, Authorised Dealers are now permitted to offer

Naira-settled non-deliverable over the-counter (OTC) FX Futures.

viii. To enhance liquidity, CBN may offer long dated 6 – 12 months forwards to authorized dealers. Forwards must be traded-backed with no authorized spreads.

ix. The market on Monday June 20 th opened with an exchange rate of N255 per dollar and projected to continue rising rapidly before stabilizing and decreasing much later.

Some good implications of the new policy

a. The new policy may allow the dollar to find its equilibrium and without the impact of a sudden price change, it will also do away with the need for devaluations and revaluations of the naira and avoid negative speculations.

b. Improved forex liquidity may discourage rent-seeking and do away with the wide parallel market margin that has been hurting the economy seriously.

c. Allowing foreign investors to exchange their dollars for naira at market rate will encourage investors to come in, improving forex liquidity and supporting the economy generally.

d. The ‘Future Funds’ will give investors the opportunity to hedge against exchange risk and have a more realistic portfolio plan (from (viii) above, an investor can transact forex at today’s rate to receive the naira equivalent at a future date).

Some not-so- good implications

a. The new policy is like running from pillar to post without reliable results, wasting one year on tightly controlled self-sanctioning policies until the economy is chocked, just to replace it with loose self-selling policies. Policy makers here are deliberately creating bubbles and bursts both of which helps widen inequality gap and weakens economic structures.

b. The ‘critical rate for critical people’ may end up being a further opportunity for critical people to continue making critical wealth.

c. The 41 items remaining on the bank list (including rice) have to

source forex from the parallel market. The new policy will make it more difficult for BDC’s to source forex since all forex available will go to the interbank market, on the other hand a significant amount of demand through BDC’s will remain due to the 41 forex-access banned items. This situation will keep the parallel-market price much higher than the interbank price and hence price volatility may not see an end soon.

d. A sudden fall in foreign earnings or a sudden civil unrest can create a huge liability for the country due to currency hedging.

Currency exchange risk should be a risk an investor has to take if he is interested in our market, at least which will make him more responsible for our economic stability.

e. Investment round tripling: ‘The Vanguard’ newspaper editors on June 20 th column among other analysts projected a peak of N390 per dollar before the exchange rate will begin to come down making reference with currency floating in Kazakhstan.

Nigerian economy is not in any way identical to Kazakhstan’s, but their projection may be true since the new policy is relying heavily on foreign investments to improve supply. The intelligent/greedy investors will not come to Nigerian market until the exchange rate is high enough to give them more Naira

for their dollars, then there will be so much liquidity and the exchange will begin to come down while the stock market will begin to rise on the other hand. Once the exchange rate reaches

a bear and the stock market reaches a bull these same greedy

players will sell their stock and exchange more dollars from their Naira for repatriation making huge profit on four different edges. Unless the country has a genuine source of forex at that time, the exchange rate will begin to rise again while the stock

market crashes. This cycle can happen every year for as long as the window remains for these foreign players.

e. Inflation: the rate of inflation is currently at 15.6% much above a 20 year average of 12.13%, and expected to rise further due to price increase of petroleum products. The sudden rise in price of forex will precipitate a further sudden rise in prices of commodities causing higher inflation; worst is that the policy

may soon force further increase in petroleum products. Since no economy is perfectly elastic, an important question here is whether or not the economy can withstand these sudden price

increases before assumed benefits of the policies begin to bring the prices down.

The key to monetary policy is exchange rate stability, however, the

new policy has already started yielding so much uncertainty which is likely to continue and worsen. The return of Dutch Auction

System or Wholesale Dutch Auction System would have been a better option, which proved effective in the past and help stabilized exchange rate for ten consecutive years from 2004 to

2014.

Some major highlights of DAS/WDAS in comparison with the new policy

A. All commercial banks were participants under DAS/WDAS

while only a few banks can participate under the new policy.

B. FDIs go through the CBN while FDIs will go through the IB Market under current policy.

C. CBN is the major supplier of forex under DAS/WDAS,

exchange rates are not fixed under DAS/WDAS but determined by forex supply from CBN, among other monetary rate policies.

D. DAS/WDAS gives CBN the flexibility to ensure exchange rate stability without compromising policy making.

The new policy can bring economic prosperity on the short term but may end up selling the little remaining economic independence we have, and expecting the new policy to develop the economy is rather chimerical.

In one of public clashes between Keynes and Cannan, Keynes wrote in his ‘Tract on Monetary Policy Reform’

” Nowhere do conservative notions consider themselves more in place than in currency; yet nowhere is the need of innovation more urgent. One is often warned that scientific treatment of

currency questions is impossible because the banking world is intellectually incapable of understanding its own problems. If this is true, the order of society, which they stand for, will decay. But I do not believe it. What we have lacked is a clear analysis of the real facts, rather than ability to understand an analysis already given. If the new ideas, now developing in many quarters, are sound and right, I do not doubt that sooner or later they will prevail. …”

Policy makers should have a rethink on implications of the new policy otherwise they will end up drowning the naira.

A.Y. Ahmad, ACE University of Porto, Portugal