Nigeria: Nigeria Revises Foreign Exchange Policy Amid Reports Of Arbitrage

Nigeria's central bank has announced a new foreign exchange policy to increase the supply of dollars to people intending to pay for overseas tuition, medicals and traveling.

Under the new arrangements, the Central Bank of Nigeria (CBN) will sell dollars to deposit banks who will then resell to buyers for those specific purposes at rates not more than 20% beyond the official rate of NGN305 per dollar.

A previous requirement that banks allocate 60% of dollar sales to manufacturers has also been cancelled. Despite this, the central bank has said its prioritization of manufacturing continues – suggesting additional palliatives for that industry may follow.

A Partial, Partial Float

In June 2016, after more than a year of operating a hard currency peg at USD1:NGN200, the CBN introduced a new more flexible foreign exchange policy1. However, the CBN's rules of determining who gets dollars and at what rate have prevented a true float and facilitated a multiple exchange rate system. For instance, in 2016 it sold dollars to government-sponsored pilgrims at NGN197 while the official rate was at NGN305, and directed banks to sell 60% of their dollar supply exclusively to manufacturers. Later that year, the Department of State Security, supported by the central bank, raided currency dealerships to compel them to bring their rates down.

Political football

The exchange rate has been a political football in Nigeria for decades. During the 2015 presidential campaign, the then opposition All Progressives Congress criticized the Jonathan government's economic policies by pointing to the exchange rate of NGN165 per dollar. It also promised voters that its candidate Muhammadu Buhari would bring the rate down to NGN1 per dollar if elected president.

Today, the exchange rate is officially NGN305 per dollar, but at the insistence of President Buhari, the CBN has resisted calls for the devaluation of the naira on grounds that it would drive the price of up—this has happened anyway. The inflation rate is officially 18.72%, but our analyst based in the economic capital Lagos explains that certain core prices have typically doubled in the past year, from milk to furniture, and this has taken a heavy toll on businesses as well.

This week there were reports that US fast-food franchise KFC was planning to shut two of its restaurants in Lagos due to rising costs and low profits. In aviation, the government recently took over the country's biggest airline Arik due to insolvency. Arik, like other airlines, had seen their maintenance costs increase steadily due to the naira depreciation and the price of aviation fuel had also risen sharply. But while the price of aviation fuel and other commodities have been rising, petrol has experienced relative stability.

Why petrol?

Much like the exchange rate, the price of petrol is a major political issue in Nigeria and has often been a yardstick for evaluating the government, which sets the pump price and subsidizes the product. Nigeria is the top oil producer on the continent with an output of over two million barrels per day on optimum, but it imports nearly all the petrol it consumes because its refineries are largely in disrepair, and so the government pays subsidies to petrol importers in order to keep the costs down.

In March 2016 there was a severe petrol scarcity in the country because importers were reluctant to bring in the product due to rising costs. So the government raised the pump price by NGN60 as an incentive to importers, and the scarcity soon ended. Having hiked the petrol price once already at a time of relative popularity, the government has avoided repeating this to prevent unrest and has since tried to maintain it at the fixed price of NGN145 even though the price would be higher given the rate of naira depreciation.

The petrol factor

To do this, the government was initially subsidizing dollars to petrol importers through the central bank in order to cushion their costs, but the bank stopped doing this around June 2016 due to pressure on its reserves. It then directed oil multinationals in the country, who earn dollars from selling their crude in the global market, to start selling dollars directly to petrol importers. The multinationals previously auctioned their dollars to deposit banks and this was a major source of supply for the interbank market. Diverting this supply forced banks to tighten up on their own dollar sales, and so more people turned to the parallel market where the rate was constantly rising because of demand.

The petrol importers stopped purchasing foreign exchange from the oil majors at a point; purportedly due to disputes about terms of transaction. Then the central bank began buying it from the oil majors and selling to the petrol importers by itself at subsidised rates.

This month, a parliamentary committee found that the central bank had sold around US$34 billion in all sales since late 2015, and about 30% of that sum had gone to petrol importers alone. When asked by the committee, the bank's Director of Financial Markets, Alvan Ikoku, could not account for any mechanisms in place to prevent the recipients from engaging in arbitrage.

Leeway

The leeway for arbitrage in the foreign exchange policy environment was publicized in August 2016 by the former central bank governor Lamido Sanusi (now Emir of Sokoto). He claimed in a speech that people with connections in government were getting dollars from the central bank at lower rates and selling in the parallel market where rates were higher.

He said, "Would you import and manufacture [if you could arbitrage]? You have an automatic guaranteed 50% return immediately for no labor. With this, every manufacturer abandoned production and started looking for forex. I had people who would come to me or telephone me and book an appointment only to ask me, 'Your Highness, I want you to help me get dollars.'"

Reports about forex arbitrage involving the central bank are more widespread today, and this month another parliamentary committee asked the Economic and Financial Crimes Commission (EFCC) to investigate the bank's forex allocations.

Outlook

Any reduction of rigidity in the rules will be well received. Further, looking to the fundamentals –  Nigeria's currency crisis developed from falling crude prices and a slump in its oil sector largely due to the militancy in the Niger Delta, but today the indices have improved to an extent. Crude prices have firmed at US$50 per barrel compared to below US$40 a year ago. The unrest disrupting output in the Niger Delta has also waned and this month, oil minister Ibe Kachikwu said output had risen to two million barrels per day, almost the benchmark for the 2017 budget.

President Buhari has chiefly influenced the policy-making, but he has been away from the country for over a month now to receive medical attention and has told parliament he will not return from the UK until he gets clearance from his doctors. His medical condition will likely limit his activeness upon return and could leave policymaking (e.g. probing the central bank's forex allocations) to those in his inner circle, but Vice President Yemi Osinbajo has been acting as president in the interim and there is a possibility that he might finish Buhari's tenure considering the president's condition.

An Osinbajo presidency would be more disposed to an independent central bank and a currency devaluation. However, political exigencies pertaining to the 2019 campaign season, which begins next year, might restrain his administration's impact. 2019 presents better prospects for a new administration and a chance for Nigeria to implement long-term monetary reform.  

Footnotes

1 https://www.cbn.gov.ng/out/2016/ccd/revised%20guidelines%20for%20flexible%20exchange%20rate%20marketjune%202016%20v1.pdf

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