CBN Governor, Mr Godwin Emefiele
By Emeka Anaeto, Economy Editor, Emma Ujah, Babajide Komolafe, Peter Egwuatu & Nkiru Nnorom
LAGOS — The Nigeria stock market, yesterday, gained N294 billion in reaction to the decision of the Central Bank of Nigeria, CBN, to allow market forces determine the Naira exchange rate in a new single structured foreign exchange market.
CBN Governor, Godwin Emefiele, yesterday, announced the introduction of a new foreign exchange policy, termed the “automatic adjustment mechanism of the exchange rate” in a flexible foreign exchange regime. The new regime is aimed at boosting supply of foreign exchange and reducing the pressure on the Naira.
CBN had been under pressure to devalue the Naira for over a year now, which had been resisted by monetary and fiscal authorities, claiming that past devaluations did not benefit the economy, being import dependent. Instead, the apex bank had adopted a controlled market with pre-determined supply and exchange rate.
Announcing the major policy shift, Emefiele said: “The Central Bank of Nigeria has always maintained that it would continue to monitor situations on ground and ensure that the bank’s policies reflect these facts and developments rather than the sentiments of any groups or sectors.
“It is in the light of this principle that we now believe that the time is right to restore the automatic adjustment mechanism of the exchange rate with the re-introduction of a flexible inter-bank exchange rate market.
“The workings of this market will be consistent with the bank’s objectives of enhancing efficiency and facilitating a liquid and transparent foreign exchange market.”
Highlights of the flexible regime
The new regime would operate as a single market structure through the inter-bank/autonomous window.
- The exchange rate would be purely market-driven, using the Thomson-Reuters Order Matching System as well as the Conversational Dealing Book;
- The CBN would participate in the market through periodic interventions to either buy or sell foreign exchange as the need arises;
- To improve the dynamics of the market, the apex bank will introduce Foreign Exchange Primary Dealers (FXPD), who would be registered with the CBN to deal directly with the apex bank for large trade sizes on a two-way quotes basis;
- These primary dealers shall operate with other dealers in the inter-bank market, among other obligations that will be stipulated in the Foreign Exchange Primary Dealers (FXPD) guidelines;
- There will be no predetermined spread on foreign exchange spot transactions executed through the CBN intervention with primary dealers, while all foreign exchange spot purchased by the authorized dealers are transferable in the inter-bank foreign exchange market;
- The 41 items classified as “Not Valid for Foreign Exchange” as detailed in a previous CBN circular shall remain inadmissible in the Nigerian foreign exchange market;
- To enhance liquidity in the market, the CBN may also offer long-tenored foreign exchange Forwards Contract of six to 12 months or any tenor to authorized dealers;
- Sale of foreign exchange Forwards Contract by authorized dealers to end-users must be trade-backed, with no predetermined spreads;
- CBN shall introduce non-deliverable over-the-counter (OTC) naira-settled Futures, with daily rates on the CBN-approved FMDQ Trading and Reporting System.
- This is an entirely new product in the Nigerian foreign exchange market, which would help moderate volatility in the exchange rate by moving non-urgent foreign exchange demand from the Spot to the Futures market;
- The OTC FX Futures shall be in non-standardized amounts and different fixed tenors, which may be sold on any date, thereby ensuring bespoke maturity dates;
- Proceeds of foreign investment inflows and international money transfers shall be purchased by authorized dealers at the daily inter-bank rate; and
- Non-oil exporters are now allowed unfettered access to their foreign exchange proceeds, which shall be sold in the inter-bank market.
Emefiele said the primary dealers would be about eight or 10 banks with the capacity to go to the market with as much as $10 million.
- Selected foreign exchange primary dealers would be notified by Friday, June 17, 2016. All other non-primary dealers would remain valid and eligible to participate in the market;
- Inter-bank trading under the new guidelines will begin on Monday, June 20, 2016; and
- The tenors and rates for the OTC naira-settled FX Futures will be announced on Monday, June 27, 2016.
Why CBN introduced new policy
Emefiele said CBN had to take the measures as the nation “witnessed a significant decline in our foreign exchange reserves from about US$42.8 billion in January 2014 to about US$26.7 billion as of June 10, 2016.
“In terms of inflows, the bank’s foreign exchange earnings have fallen from about US$3.2 billion monthly to current levels of below a billion dollars per month.”
He blamed the poor foreign exchange receipts on the over 70 per cent drop in the price of crude oil, which contributes the largest share of our foreign exchange reserves; Global growth slowdown and geopolitical tensions along critical trading routes in the world; and normalization of monetary policy by the United States’ Federal Reserve.
According to Emefiele, “the interplay between reduced foreign exchange supply and rising demand accounted for a substantial reduction in our foreign exchange reserves.”
He, however, stated that “our reserves, despite having fallen, is still robust and is able to cover about five months of Nigeria’s imports as against the international benchmark of three months.”
He said his team at the CBN would ensure transparency in the new foreign exchange market regime and that there would be no place for speculators.
His words: “Let me note that the Central Bank is strongly determined to make this market as transparent, liquid, and efficient as possible. Therefore, we would neither tolerate unscrupulous behaviour nor hesitate to bring serious sanctions on offenders.
“The CBN expects all authorized dealers, particularly, to display the highest level of professionalism. We expect them to understand the spirit and letter of this transition to a market based system. The CBN will not allow the system to be undermined by speculators and rent-seekers.
“Permit me to emphasize that any attempt to breach any aspect of this new framework will be heavily sanctioned by the CBN and this may, indeed, result in the suspension or withdrawal of the foreign exchange dealing licence of an offending authorized dealer.”
Implications of the new policy
Most questions from the public, yesterday, focused on what the role of the CBN would be in determining the exchange rate and what the rate will be like under the new regime. Emefiele said the price will be known when the market opens officially on Monday.
He also said the supply side would be market determined, while the apex bank would intervene with supply from time to time to influence market trends in the desired direction.
Emefiele’s pronouncements also indicated that the end of the black market is near as buying and selling of foreign exchange is now open to anyone at any bank or with authorized dealers at a price that is market determined.
Consequently, black market rates would drop if the CBN announces a float as individuals, investors and businesses, who had refused to import their dollars into Nigeria, can now supply their forex at a price they believe is market determined. The drop in exchange rate may take some time at the worst but the market will be flooded with liquidity in due course.
But analysts anticipate some volatility in exchange rate in the short run as the market takes shape and tracks how liquid the market will be. However, the spread rate between the interbank market and the parallel market is expected to narrow in a short while.
CBN is also expected to relax the controls currently in place such as limits to withdrawals of dollars from domiciliary accounts or spending limits when abroad as Emefiele stated that exporters were immediately granted unfettered access to use their foreign exchange in their domiciliary accounts.
Stock market reacts positively, gains N294bn
Values of shares on the Nigerian Stock Exchange, NSE, rose sharply by N294 billion as investors reacted positively to details of the new foreign exchange regime announced by the CBN.
“Nigerian equities rebounded from a three-day losing streak to close at its highest point in June 2016 as the CBN announced a new foreign exchange policy guideline with improved flexibility,” said Afrinvest Plc, a Lagos-based investment and research firm.
In its review of activities in the stock market, yesterday, the company stated: ”The market initially opened on a high note as investors anticipated the CBN’s guideline but dipped at mid-day before closing bullish subsequent to the press briefing of the CBN Governor.
“The benchmark All Shares Index (ASI) surged 3.2 per cent to close at 27,891.96 points, bringing MTD return to 0.8 per cent and paring YTD losses to -2.6 per cent. Market capitalization added N294.6 billion to N9.6 trillion while market activity was equally strong with volume and value traded advancing 244.7 per cent and 43.4 percent to 588.4 million units and N3.5 billion, respectively.
“All sector indices closed positive, yesterday, in line with the strong appetite witnessed across board. The Banking Index led advancers with a 4.0 per cent appreciation consequent on buy sentiment on Tier-1 lenders —Guaranty Trust Bank, GTBank (+7.8 per cent), Zenith Bank (+5.4 per cent ) and UBA (+6.5 per cent ) — while the Industrial Goods index (+2.8 per cent) followed at a distance with Dangote Cement (+5.0 per cent), the major mover of the index.
“The Consumer Goods index gained 2.4 per cent as investors positioned in blue-chip brewers— Nigerian Breweries (+4.5 per cent) and Guinness (+5.0 per cent ). The Oil & Gas index rallied 1.1 per cent on the back of renewed appetite towards Oando (+5.0 per cent) while the Insurance Index recorded the smallest gain (+0.6 per cent ); NEM Insurance (+9.5 per cent ) and AIICO Insurance (+3.9 per cent) drove the index.”
Naira stable at N369/$ in parallel market
However, the naira remained stable at N369 per dollar at the parallel market as operators adopted a “wait and see” attitude in anticipation of the impact of the new foreign exchange regime.
Morgan Stanley isolates Nigeria
Meanwhile, just as Emefiele was announcing the new foreign exchange regime, which came close to what foreign investors and international financial community have been clamouring for, Morgan Stanley Capital Index, MSCI, United State’s based multinational investment banker, and a leading provider of global equity indexes, announced that the MSCI Nigeria Index may be removed from the MSCI Frontier Markets Index and reclassified as a stand-alone market due to capital mobility issues.
Due to the urgent nature of this investability issue in the MSCI Nigeria Index, MSCI will announce its decision on the proposal to remove the MSCI Nigeria Index from the MSCI Frontier Markets Index by the end of September 2016.
It was not clear if the MSCI executives were informed of the latest development in Nigeria before their decision.
As at last year, a leading global investment bank, JP Morgan, had suspended Nigeria from its market index due to the foreign exchange regime it felt was anti-market.
MSCI was to follow on the same action earlier this year but moderated actions until yesterday.
Financial institutions, economists react
On the heels of the release of the long-awaited flexible foreign exchange policy, some financial institutions and economists have expressed satisfaction with the policy, saying it would eliminate uncertainty and boost inflow of foreign exchange from foreign investors and exporters.
“The immediate effect is that uncertainty will disappear,” said Mr. Bismarck Rewane, Managing Director/Chief Executive, Financial Derivatives Limited. According to him, “the policy is good, the situation is now much better. But people have to first understand it.”
According to Mr. Wale Abe, former Executive Secretary, Financial Market Dealers Quote (FMDQ), “the implication is that the exchange rate will now be market determined. It means no more foreign exchange subsidy for anybody, and this will lead to efficient allocation of foreign exchange.”
A former CBN Director, who spoke on condition of anonymity, also commended the new policy, saying: “It is a good policy. I hope it will be effectively implemented as specified. The immediate impact is that it would encourage inflow of autonomous foreign exchange, reduce sharp practices by exporters as they now have unfettered access to the interbank market.”
Financial analysts at Greenwich Trust Limited, a Lagos-based investment house, stated: “CBN has taken another step in enhancing its dovish stance on monetary policy in order to increase capital flows and drive economic growth. By adopting the free float and including currency forwards and futures, the CBN has introduced a deep and flexible market structure.
“We recall that the main reason behind Nigeria’s expulsion from the J.P. Morgan Emerging Markets Bond Index was the lack of a liquid, two-way FX market. We anticipate a significant rally in both equity and fixed income markets as investors take positions in fundamentally sound companies trading at depressed prices. We expect the Naira to appreciate in the BDC market for the rest of this week.
“We also expect the CBN to adjust the Net Open Position for Deposit Money Banks (DMBs) to ensure banks have sufficient liquidity to participate in the market.
“In the short-term, despite Emefiele’s caution, we foresee a depreciation when the inter-bank market opens on Monday as investors flood in to exercise pent up demand.
“However, we see an appreciation in the long term as forex supply improves and market participants take advantage of an efficient, broader and deeper market via trades in derivatives (forward and future contracts).
“The success of this bold monetary policy decision will be hinged on the fiscal authority’s ability to negotiate a cease-fire with the Niger Delta militant groups to enable optimal crude production and the resultant accretion in forex revenues.”
According to Mustapha Suberu, Research analyst at Eczellon Capital Limited, a Lagos-based investment banking firm, the market would react positively in the days ahead.
He said: “The news is positive for the capital market. The equity and bonds market will likely trade higher in the coming days and week as the market expects re-entry of foreign portfolio investors, that had hitherto left due to currency restrictions.”
Speaking in the same vein, Mr. Johnson Chukwu, Managing Director/CEO, Cowry Asset Management Limited, said the news was cheery to the market, saying the rally witnessed in the market, yesterday, was a result of the clarity on the forex guidelines. He stated that the FX policy would partly contribute in boosting the attractiveness of the market in the medium term.
“For now, domestic investors are positioning in anticipation of foreign investors, who had deserted the market, would come back. That is why you see the rebound in the market,” Chukwu said.
Also, in their daily market update, Cowry Asset Management Limited applauded the new Fx policy, saying the policy was complementary to the positive developments in the external sectors – the increase in crude oil prices. These policies are bound to reduce uncertainty in the markets and could help in reducing pressure on the foreign exchange reserve.
Analysts at Cowry observed that by allowing market forces to determine the exchange rate and adopting single market structure for foreign exchange supply to the market, the capital market will henceforth be attractive to investors as their earlier fears of foreign exchange illiquid/scarcity and likely devaluation would have been mitigated.
According to them, “the introduction of derivatives such as customised forward contracts should help investors further hedge against foreign exchange volatility while simultaneously being a major step towards developing this important alternative asset market.
“Furthermore, forex primary dealers will be registered to deal directly with the CBN for large ticket transactions which could favour large manufacturers as well as foreign direct investors.
“The removal of controls on non-oil exporters’ proceeds and the allowed participation of non-oil exporters in the interbank market should indirectly help spur activity of outbound transactions, thereby increasing economic output.”
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