By Babajide Komolafe

On March 26th 2006, the Central Bank of Nigeria (CBN) introduced a policy titled, “Further Measures To Liberalise the Foreign Exchange Market”. The aim of the policy was to address the widening gap between the official exchange rate and the parallel market rate.

Earlier that year the apex bank following introduction of Wholesale Dutch Auction (WDAS) had achieved convergence of the official exchange rate and the interbank exchange rate.

But while the interbank rate declined and converged with the official exchange rate at N130 per dollar, the parallel market exchange rate rose from N142 per dollar on February 20th when WDAS was introduced to N152 per dollar on March 26th. Thus the gap or premium between the official/interbank exchange rate and the parallel market rate widened to N20 from N10.

The strategy   adopted to arrest the situation was to increase supply of foreign exchange in the parallel market and at the same time reduce demand in the market.

Lamido Sanusi

To reduce demand the CBN eliminated or reduced restrictions imposed on users of official foreign exchange. This diverted patronage from  illegal currency traders or black market operators which held sway in the parallel market  to the BDC which are the officially licensed retail currency traders.

This demand strategy includes removal of restrictions on official foreign exchange for the purposes of: Business Travel Allowance/ Personal Travel Allowance (BTA/PTA), foreign borrowing for on lending, Utilisation of Certificate of Capital Importation, ECOWAS travellers cheques, Foreign Trade finance facility, Foreign Guarantees/Currency deposits and Collateral for Naira loans.

To increase foreign exchange supply into the parallel market, the CBN admitted BDCs into the official market for the purpose of purchasing foreign exchange from the CBN, via the Cash Sale of Dollar Scheme, and sell to the public at the official exchange rate (plus 2% margin allowed by the CBN).

In addition to this, BDC operators were  allowed to serve as brokers within the inter-bank frame work.

They were also empowered by allowing them to transact business with Authorised dealers. In other words, BDCs were allowed to buy foreign exchange from the official market (from and through the commercial banks).

To complement this and ensure that the policy measures were not frustrated by monopolistic tendencies by the conventional BDCs, the CBN allowed banks to apply for BDC license and operate BDC outlets in their branches.  The CBN also licensed more new BDCs to increase accessibility of foreign exchange across the country.

The effect was phenomenal. In the first month of implementation, the parallel market exchange rate dropped to N142 per dollar and by July 13th, it converged with the official and interbank rates at N130 per dollar.

Thus for the first time in the history of the nation’s foreign exchange market the elusive parallel market was arrested and the influence of the parallel market especially the black market was whittled down.

The policy was maintained and the convergence remained until December 2008, when the apex bank reduced foreign exchange sale to BDCs by 50 per cent, in response to the impact of the global financial crisis on the nation’s external reserve.

That month the total amount sold to BDCs  dropped sharply to  $486.73 million  from $1.265 billion the previous month . In response the parallel market exchange rate rose to N141 per dollar from N118.4, while the premium widened by N7.97 to N9.75 (by 5%)

Although the foreign exchange sold to BDCs in January 2009 ($559.25 million) and February ($619.09 million) 2009 rose slightly but  because the amount sold was still far below the 2008 monthly average of $822 million, the parallel market exchange rate continued to rise while the parallel premium widened.

Finally, in March 2009 the CBN suspended the conventional BDCs from the Cash Sale of Dollars scheme, selling only to bank owned BDCs and a newly created set of Class “A” BDCs.

The result was rapid depreciation of the naira in the parallel market, with the parallel exchange rate rising up N170 per dollars in March and the parallel premium widened to N24.3. The wide gap remained till July when the CBN readmitted conventional BDCs to the official market.

The lesson of this short history is that when foreign exchange supply to the retail end of the foreign exchange market served by BDCs is restricted, the gap or premium between the official and parallel market exchange rate would widened offering attractive opportunities for malpractice like round-tripping.

Apparently, the CBN had forgotten this lesson when on June 24th, it restricted to $250,000 the amount of  autonomous foreign exchange each bank could sell to BDCs.

The apex bank observed that much of the foreign exchange demand in the interbank market and causing the interbank rate to rise persistently is not consistent with economic realities.

It was informed that most of this demand was coming from BDCs. Of course the demand was actually been fuelled by politicians who have suddenly adopted the dollar as their currency of trade because of its portability. Thus the apex bank decided to restrict dollars that banks can sell to BDCs.

The restriction though caused the interbank exchange rate to fall and converged with that of the official rate and hence close the gap between the two rates, it however caused the parallel market exchange rate to rise from N158 per dollar to N167 per dollar, with the gap between the official exchange rate and the parallel market rate widening from N3.19  to N16.54 .

This triggered a boom in round-tripping of foreign exchange and  except the management of the CBN wants to feign ignorance or its staff are not doing the job would they refuse to acknowledge the policy has resulted into widespread unbelievable round-tripping in the foreign exchange market.

And who are the major beneficiaries? The banks, the oil firms and parallel market operators are the ones enjoying huge profit margins due to the N16.54   exchange rate difference.

Thus the CBN in order to solve a problem has created another one. The apex bank should have matured beyond this.

What the apex bank should do which it apparently does not want to do is to sanction any bank or BDC abusing the system and hence behind the unusual demand for foreign exchange at the interbank market.

This would have been more effective, with little or no side effect that would make round-tripping attractive and be the order of the day.

That was what the Joseph Sanusi led CBN did in 2002, when it suspended from the foreign exchange market 21 banks indicted for  foreign exchange malpractices and thereby brought sanity and stability to the market.

That is what the Lamido Sanusi CBN should do rather than create opportunities for rent seeking and arbitraging in the nation’s foreign exchange market.