March 3, 2014

Forex: CBN intervention fuels boom in interbank market

CBN building

  • Banks make brisk profit short-selling Naira


The Intervention of the Central Bank of Nigeria in the foreign exchange market through special foreign exchange sales to banks has created a boom in the interbank foreign exchange market.

cbnVanguard investigations revealed that banks are making huge profits short-selling the naira in the interbank market.

Meanwhile, the interbank foreign exchange rate has refused to return to pre-suspension of Sanusi level, thus generating pessimism over the effectiveness of the CBN intervention.

Since February 20, when the Governor of the Central Bank of Nigeria (CBN) was suspended, the apex bank had been conducting special foreign exchange sales with the aim of taming the interbank foreign exchange rate which shot upwards to N169 per dollar on February 20.

But the impact of the intervention has been momentary due to increased anxiety among foreign investors and dealers. On a daily basis, the interbank exchange rate rose until it got to about N167 per dollar and fell as soon as the apex bank intervened.

Investigation further revealed that some foreign exchange dealers, especially in the big banks, have been taking advantage of this situation, buying from the apex bank at the official exchange rate and selling in the interbank market.

“It is called short-selling,” an insider, who preferred to be anonymous told Vanguard. The dealers deliberately offer to sell dollars when the market rate is high, in anticipation of cheaper dollars that the apex bank would pump into the market that day.

Meanwhile, because settlement in the interbank market is T+2, the dealers have enough time to use the cheap CBN dollars to settle the sales made at the high exchange rate.

“They are praying that the crises should continue, so that they can meet their target for the year in the first quarter. In some instances, the dealers deliberately bid up the interbank rate so as to prompt the apex bank to intervene, “a currency analyst, who does not want to be named, told Vanguard.

Intervention not effective

Meanwhile, the interbank foreign exchange rate has defied the intervention of the apex bank, closing at N165.32 per dollar. According to data from the Financial Market Dealers Quote (FMDQ), this is N1.37 higher than the N163.75 per dollar interbank rate on February 19.

“The general belief is that the intervention is not effective in returning the interbank rate to the pre-suspension level,” said a banker, adding that this belief is fuelling increased speculation against the naira.

Apparently aware of this development, the Acting Governor, CBN, Dr (Mrs.) Sarah Alade on Monday held a conference call with dealers and foreign investors.

A senior foreign exchange analyst who participated in the conference but does not want his name to be mentioned, told Vanguard that Alade told participants, which included global financial firms like J.P Morgan, that the CBN will defend the naira with the external reserves. She said that the apex bank does not plan or intend to devalue the naira.

It was gathered that most of the participants expressed apprehension that the CBN might eventually devalue the naira, given the continued decline in the nation’s external reserves. Some of them wanted to know if the CBN would maintain or reverse the recent increase in Cash Reserve Ratio (CRR) on public sector deposit.

External Reserves continue to fall

But with the nation’s external reserves declining persistently, market participants and analysts believe that the apex bank is fighting a lost battle trying to defend the naira.

“If the CBN continues this way, they will soon run out of reserves,” a bank Chief Executive, told his staff.

Last week, the external reserves fell by another $790 million to $40.26 billion. Cumulatively, the external reserves have declined by $3.35 billion. If this trend continues, the general belief is that the reserves might fall below $35 billion by the time a new CBN Governor takes office, and the apex bank might be compelled to stop defending the naira with the reserves.

This view is aptly expressed by the Economist Intelligence Unit’s (EIU) Medium-term prospects which are unfavourable.  However, whereas short-term currency stability seems likely to return, we have more serious doubts about the naira’s medium-term prospects,” it said.

In a commentary titled, Nigeria economy: The naira is safe, for now, the EIU said, “Whereas short-term currency stability seems likely to return, we have more serious doubts about the naira’s medium-term prospects.

The CBN does allow periodic adjustments to avoid any rapid running-down of foreign reserves, a move that seems increasingly likely later in 2014 or 2015. The last such adjustment took place in 2011 when the marker was shifted slightly from N150 per dollar to N155 per dollar.

Larger revaluations were carried out at the height of the global financial crisis in 2008‑ 09, when the naira target was moved from N120 per dollar to N150 per dollar. Although the 2011 devaluation helped Nigeria’s reserves to recover over the next year, they fell from US$48bn in the first quarter of 2013 to US$43 billion   in January 2014.

“ The timing of a readjustment is less certain. Although we are convinced that a naira adjustment will take place during the next 18 months, predicting the timing of it is trickier.

There are two main scenarios: The new CBN governor, who will formally take office from June at the expiration of Mr Sanusi’s term, allows a one off depreciation. He or she (but expected to be Godwin Emefiele, who was nominated by Mr Jonathan within hours of Mr Sanusi’s suspension) is likely to be concerned by the erosion of reserves and could blame the need for a readjustment on events before his time in office.

There would not be a need for a very large depreciation, perhaps to N165 or N170 per dollar, but such a move would head-off market speculation and give the new governor time to settle in.

“A depreciation before the 2015 elections could be considered politically unpalatable, given that it would be unpopular with the electorate, both by raising import prices and as a sign of weakness in the administration’s economic management.

The new CBN governor, put forward by the president (albeit subject to parliamentary approval), may decide that it would be prudent to delay a devaluation until after the conclusion of the elections due next February. Such devaluation might need to be larger in magnitude, given that reserves would have fallen further in the meantime.

A fractious election period and our expectation of outbreaks of unrest would also further undermine market confidence in the currency.

“On balance, we believe that the first scenario is slightly more likely, but would not be surprised to see the second come to fruition.

Under either situation, Nigeria’s position as a key frontier market is set to wane over the next 18 months. Although bullish pronouncements—such as Nigeria’s recent inclusion in the “MINT” (Mexico, Indonesia, Nigeria and Turkey) list of future economic giants by a prominent economist, Jim O’Neill—have some merit, recent events highlight the need for extreme caution when analysing the prospects of a country as complex and turbulent as Nigeria.

A country with enormous economic potential also brings with it enormous risks.”