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The Central Bank of Nigeria

Cbn: Winning the forex market battle

The importance of foreign exchange (FOREX) as the backbone of International Trade cannot be overemphasized.  FOREX is also a key determinant of some critical  economic parameters such as the rate of return on investment, the price we pay, interest rate on our loans and so on and so on, and  the global FOREX  market is noted as the world’s biggest financial market, trading about $1. 5trillion per day.

Britain, as the world’s financial capital has the largest share of the FOREX market with about 40 per cent of all  FOREX transactions taking place in London where FOREX ‘fixes’ are determined at 11am and 4pm every day. A ‘fix’ is defined as ‘’a single rate that reflects the value of one currency relative to others at a particular point in time and is used for risk management, hedging, performance evaluation and speculation’’.

According to experts, global FOREX market  poses a danger because it is unregulated and free for all, and is prone to manipulations by the operators which consist of banks, commercial companies, investment management firms, hedge fund, retail FOREX brokers and investors. Currency trading, they say, is a ‘’zero-sum game’’-  ‘’a situation where one or more participants’ gain(loss) equals the loss(gain) of other participants, thus, a gain(loss) for one must result in a loss(gain) for one or more other.’’

Foreign investors,  especially foreign portfolio investors (FPIs)  with hot money( short-term, volatile speculative funds), track exchange rates and gravitate to geographical borders with favourable rates.  According to experts, a volatile, high and stable exchange rates discourages foreign investors, while a low, stable exchange rate attracts foreign investments but at the expense of the home economy.  Unlike  ‘patient capital’ which comes through Foreign Direct Investments (FDIs) and reside in a local economy, hot money  has no allegiance to local economies  as it is often in a  flux. It can exit any time at the drop of a hat and the exit which  is often en masse can be destructive to host markets and economies.

FOREX management is one of the three components of the ‘’Inconsistent trinity’, also known as The policy trilemma, which  challenges the dexterity of  central banks in the formulation of  monetary policies. The other components  are interest rate and free capital mobility. The policy trilemma’ posit that central banks can only pursue two of the following three policy combination options: 1, a stable exchange rate and free capital flows(but not an independent monetary policy because setting a domestic interest rate that is different from the world interest rate would undermine a stable exchange rate due to appreciation or depreciation pressure on the domestic currency; 2, an independent monetary policy(but not a stable exchange rate, and, 3, a stable exchange rate and independent monetary policy(but no free capital flows which would require the use of capital controls).

A violation of The policy trilemma, it has been noted, leads to financial crisis as exemplified in  the Asian financial crisis(1997-1998) which collapsed the economy of Thailand. According to Wikipedia, ‘’the East Asian countries were taking a de facto dollar peg(fixed exchange rate), promoting the free movement of capital(free capital flow) and making independent monetary policy at the same time. First, because of the de facto dollar peg, foreign investors could invest in Asian countries without the risk of exchange rate fluctuation. Second, the free flow of capital kept foreign investment uninhibited. Third, the short- term rates of Asian countries were higher than the short-term rates of   the United States from 1990-99.While the Asian countries’ trade balance was favourable, the investment was pro-cyclical for the countries.

FOREX management in Nigeria has always been a battle because  of the intense and un-abating demand for FOREX  due to the high  import-dependent nature of the economy. Due to changing perspectives in the market and economy, CBN, since  the mid-1980s,  had had to creatively  evolve multiple policy options in an effort to effectively manage the FOREX conundrum. The apex bank introduced the Second-tier Foreign Exchange Market (SFEM) in September 1986 as a transitory dual exchange rate to operate alongside the First-Tier market. The two markets were later merged into the Foreign Exchange Market(FEM) in 1987.

In 1989, Bureaux de Change were licensed  for the benefit of small users of FOREX, and in March, 1992, the Floating Rate policy was adopted.  There was a policy reversal in 1995, to ‘’Guided deregulation’’, which led to the Autonomous Foreign Exchange Market(AFEM). AFEM  was expected to ‘’broaden and deepen the FOREX market on daily basis and discourage speculative activities.’’

Fast forward 2016, dollar became scarce and more valuable in the thick of economic recession, caused primarily by a drastic fall in global oil price which led to the depletion of the external reserves. Dollar scarcity  led to the gyration and weakening of the naira to an all time low exchange rate of N530/US$1, a development which challenged and put CBN on the spot, but the apex Bank’s Governor, Godwin Emefiele, identified three underlying factors for the negative trend, namely,  those hiding illegal money, people desperate to transfer illicit gains out of the country at any cost and acts of sabotage by speculators.

Speculators are noted to ruthlessly exploit the weakness of currencies and create a destabilizing impact when they sell a currency when it is weak and expect it to get weaker, or buy it when the price rises in anticipation that it will rise more. Speculation(act of buying and selling foreign currency under uncertain conditions) undermine real economic growth, because, unlike a commercial transaction, it  is not backed by an underlying activity, but solely driven by the motive to make huge gains from currency moves.

With a robust FOREX policy, CBN seems determined to win the FOREX market battle. In defence of the naira and to checkmate speculative dollar trading , the Bank started  a sustained injection of dollars into the  market, made possible by the increase in external reserves and the conservation of FOREX through its policy which excluded  41 items from the inter-bank foreign exchange market. 

For six months spanning February 21 to August 21, 2017, CBN pumped in a total of $9.964billion into the FOREX market. The first tranche of $680million was in February 21, 2017 and subsequently as follows: March- $1.542billion, April-$1.616billion, May- $2.102billion, June-$1.631billion, July- $1.639billion and August 21- $754million.

The interventions have continued thereafter and dollar has become readily available and less valuable, while the naira has strengthened. From a historic low of N530/US$1,  it now exchanges  for N360/US$1 in the Inter-bank market and N361/US$1 in the parallel market.  Foreign capital inflows have also resumed, though with more of foreign portfolio investments (FPIs), and  the economy, according to the National Bureau of Statistics (NBS), has exited  recession and started kicking.  Some key economic indicators including the Purchasing Managers’ Index (PMI) are looking up.

PMI reflects the wellness of the real sector. As at September, 2017, it stood at 55.3 index points, reportedly, which indicates expansion in the sector for the sixth consecutive month.  It is expected that there will be more energetic inflows into  the economy  through further creative policies by both CBN and the fiscal authorities  to spur  growth momentum.

Arize Nwobu, is a Chartered Stockbroker and Business Journalist. He wrote via [email protected] Tel 08033021230


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