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The naira came under intense pressure last week after the Central Bank of Nigeria (CBN) unified multiple exchange rates into the Investors’ & Exporters’ (I&E) window. The two-day market volatility ended on Friday with the local currency recording its first closing gain at the window. Improved confidence has energised investors to pump dollars into the market, with the new operational changes to the foreign exchange market expected to encourage people to channel their forex to the official market and open up Nigeria’s investment climate to domestic and global investors.

Before last Wednesday, not too many people knew or bothered about what the Investors’ and Exporters’ (I&E) window represents or how its operations affect their businesses and economy. They had several other permissible forex windows where transactions were carried out and forex needs met. But that changed after the Central Bank of Nigeria (CBN) collapsed all the multiple exchange rates into the I&E window, which allows forex buyers and sellers to mutually agree on rate of transaction.

That move ensured that the International Air Transport Association (IATA) rate, Interbank Exchange Rate, Bureaux De Change (BDC) rate, among others, were unified into the I&E window in line with CBN’s rate harmonisation policy. The impact of the policy shift is already reverberating across markets with domestic and international stakeholders giving their assessment. Already, three incidents happened at the forex market last week. The I&E window, which saw the naira depreciate for two straight days – Wednesday and Thursday – achieved its maiden closing gain of N39/$1 on Friday. The naira appreciated from N702/$1 to N663/$1, according to rate movement chart monitored from the FMDQ Exchange.

The window also saw an uptick in transaction volume from $70.74 million on Thursday to $311.83 million on Friday. The 340.81 per cent surge in forex transaction volume was a huge liquidity boost for the market. Finally, the International Monetary Fund (IMF) gave its backing to the government’s decision to abolish multiple exchange rate regime and the collapse of all rates into the I&E window. The Fund said it stands by and supports the implementation of the new operational changes to the forex market.

How it started

 President Bola Ahmed Tinubu had, during his inauguration, said the monetary policy needs thorough housecleaning and directed the CBN to work towards a unified exchange rate. Acting CBN Governor Folashodun Shonubi introduced some operational changes to the foreign exchange market in line with the exchange rate unification plan. These moves excited the IMF, which gave its support to the government. IMF Resident Representative Nigeria, Ari Aisen, said: “The Fund greatly welcomes the authorities’ decision to introduce a unified market-reflective exchange rate regime in line with our long-standing recommendations. We stand ready to support the new administration in its implementation of FX reforms.”

Understanding I&E window operations

According to the CBN Operational Changes to the Foreign Exchange Market report, all eligible forex transactions in the market will, henceforth, be done only through the I&E window as all other windows ceased to exist. “The  I&E market functions by a willing buyer, willing seller system, where an entity with demand for forex seeks out another entity with forex to sell at an agreed price through an authorised dealer. In this model, rates are mutually agreed by both parties,” the apex bank said.

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 Under the new rule, Personal Travel Allowance (PTA), Business Travel Allowance (BTA), and other invisible transactions will continue to be accessed through the banks at the prevailing market rate. The CBN added that there are no changes in the application process.  “All applications shall be through the banks and all documentation requirements remain the same. The weighted average rate is a summation of the volume of forex traded multiplied by the various rates at which the deals are consummated, divided by the total volume of trade,” it said.

 According to the CBN, government-related transactions are transactions with Ministries, Departments and Agencies (MDAs). Order-based two-way quotes are a two-way quote trading in which all transactions are trade backed. “The order book is an electronic trading system where demand can be matched to supply on any given trading day and is visible to the entire market. The status quo remains on the 43 non- eligible items. The items are not permitted to be funded from the I & E window,” the bank said. 

Views from stakeholders

  Analysts said the surge in transaction volume, rebound of the naira at the I&E Window and IMF’s backing were positive feedback that indicate what lies ahead of the market. In emailed report to investors, an economist and Managing Director, Financial Derivatives Company Limited, Bismarck Rewane, said the adoption of a single exchange rate and the “willing buyer-willing seller model” by the CBN is, no doubt, cheery news for the market. He said the new exchange rate framework is expected to increase transparency in the forex market, reduce exchange rate misalignment and transaction costs, and buoy investor confidence.

“However, exchange rate management goes beyond exchange rate unification. It must address issues surrounding market structure, easy access and adequate supply. This means effectively dismantling forex rationing, administrative controls, and reviewing import restrictions. As Barack Obama declared, ‘Africa doesn’t need strongmen, it needs strong institutions’,” Rewane said.

Speaking on the performance of the market, former Executive Director, Keystone Bank, Richard Obire, said Friday’s appreciation of the naira at the I&E window, the first since the discontinuation of the multiple exchange forex rates framework was announced, was a good sign. He said: “On Friday, forex trading volume at the I&E window grew by 340.81 per cent to $311.83 million from $70.74 million on Thursday, June 15, 2023. The significantly increased forex liquidity may have played a role in the 5.58 per cent appreciation of the naira against the dollar seen at the market on Friday.   

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“If as we expect, going forward, forex liquidity or supply continues to increase with the discontinuation of the multiple exchange rates regime, then we should see a stable equilibrium exchange rate emerging in the near future. It is important that the monetary authorities stay the course and do not send any mixed messages to the market,” Obire stated while calling for continuous observation of the market trends going forward to determine the real impact of the policy on market developments.

 Nigeria Country Representative, European Organisation for Sustainable Development, Jide Akintunde, said observers would like to see how transparent the new foreign exchange market is and whether rates offered by the banks converge with parallel market rates. He said liquidity in the market and whether investor confidence is restored in the country – through significant improvement in foreign investment flows are also to be considered by investors. “In the short-to medium-term, the equilibrium price of the naira would be between the last I&E window rate and that of the parallel market before the policy was introduced. There is no exact science to determine that equilibrium. So, the rates we are seeing now fall within the bracket. But they are closer to the erstwhile parallel market rate than the I&E Window rate — indicating dollar supply shortfall exists in the market,” he stated.

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 Chief Executive Officer of Economic Associates, Dr. Ayo Teriba, said that with the new forex policy, dealers do not need  CBN’s approval to buy forex because the market has been liberalised in terms of who can buy and sell. The unified exchange rate would also boost government revenue from the sale of forex at an attractive rate. He said aside saving money that the government is losing by giving access to forex to some people below market rate, it will also end forex subsidy regime that has created frivolous demand in the market. He added that with a single rate market, government will get more revenue, since all the forex at its disposal will be sold at the market rate.

 Teriba said: “The ‘privileged persons’ who access the cheap dollar and sell to the Bureau de Change operators will no longer see it attractive. The presence of the special rate for special people means that some of the special people who don’t need the forex will demand it just because of the profit they make from it.”

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 Explaining further, he said: “People round trip because they are in the corridors of power and they can’t be denied access to forex. Now, if you eliminate that profit, it will lead to reduced demand for forex because they don’t need it. The reduced demand will strengthen the exchange rate. So, you are likely to get an exchange rate that is far from the Bureaux De Change rate and closer to what we are trying to fix.”

 Teriba explained that unifying the exchange rate will drag the parallel market rate down which would lead to a decline in inflationary pressure. He further said the policy would encourage people to channel their forex to the official market and open up Nigeria’s investment climate. He maintained that the policy is in the right direction because multiple exchange rates distort prices and becloud the investment climate. “You having a single exchange rate will send a clear signal because demand will fall, supply will increase and the naira will be strengthened,” he stated.

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 Fiscal Policy Partner and Africa Tax Leader at PwC, Taiwo Oyedele, said that with the I&E window policy, government’s revenue would rise in naira terms resulting in a higher tax, revenue to Gross Domestic Product (GDP) ratio. It will also lead to possible reduction in budget deficit and some cost savings for government.

 “With the Nigerian naira now exchanging in the official forex market at market determined rates, a significant market distortion has been removed. Expectedly, impact on diaspora remittances would be marginal, the capital market will benefit as it is likely to appreciate further as foreign investors take position, there should be negligible impact on the general prices of goods and services as products already factored in parallel market rates to a large extent. Overall, this is a positive move,” he said.   

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Continuing, he said  the government needs to manage the dynamics to restore confidence, adding that the backlog of forex demands needs to be addressed and government should be ready to supply forex to stabilise the exchange rate in the short term. Oyedele added: “Government also needs to relax capital control and administrative bottlenecks including unbanning the list of items prohibited for forex (and complement with higher import duties), remove the need for certificate of capital importation among others to prevent the parallel market rate from simply moving further away from the official market rate. Stop the demand for certain taxes and levies in foreign currency, it creates unnecessary forex demand without adding to supply.

 “The aggregate demand for forex across markets should reduce as round-tripping incentive is removed, for instance people who fake foreign travels just to get forex at discounted rates. Also, Nigeria’s sovereign credit rating should improve if this is complemented with the right fiscal and monetary policies thereby attracting more forex inflows and lowering the cost of borrowing,” he stated.

 CEO of Moniepoint, Tosin Eniolorunda, said the CBN’s decision to float the naira is a clear step in the right direction for our economy, ensuring investor confidence continues to grow. “The decision is good for business, jobs and growth. It will help Nigeria’s brilliant entrepreneurs to do business globally and attract foreign investment. It will also help reduce inflation, leaving more money in people’s pockets,” he said.

Policy implications for forex users

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In announcing the policy shift, CBN Director, Financial Markets, Angela Sere-Ejembi,  said the operational changes to the foreign exchange market also include the re-introduction of the “Willing Buyer, Willing Seller” model at the I&E window. “Operations in this window shall be guided by the extant circular on the establishment of the window, dated 21 April 2017, and referenced FMD/DIR/CIR/GEN/08/007. All eligible transactions are permitted to access foreign exchange at this window,” she said.

According to the circular, all operational rate for all government-related transactions shall be the weighted average rate of the preceding day’s executed transactions at the I&E window, calculated to two decimal places. “Proscription of trading limits on oversold FX positions with permission to hedge short positions with OTC futures Limits on overbought positions shall be zero. Re-introduction of order-based two-way quotes, with bid-ask spread of N1. All transactions shall be cleared by a Central Counter Party (CCP). Reintroduction of Order Book to ensure transparency of orders and seamless execution of trades. The operational hours of trades shall be from 9am to 4pm, Nigeria time,” the circular said.

 In a report titled: The Parallel Exchange Rate Problem: The World Bank’s Approach to Helping People in Developing Countries, former World Bank President, David Malpass, said around 24 emerging and developing economies (EMDEs) have active parallel currency markets. “In at least 14 of them, the exchange rate premium – the difference between the official and the parallel rate – is a material problem, exceeding 10 per cent,” he said.

 He described parallel market exchange rates as expensive, highly distortionary for all market participants, are associated with higher inflation, impede private sector development and foreign investment, and lead to lower growth.  “They benefit the group that has access to foreign exchange at the subsidized rate, paid for by everyone else (which may include the World Bank Group and its stakeholders).  Hence, there is also a strong correlation, if not causation, between the existence of parallel rates and corruption,” Malpass said.

 “Parallel exchange rate markets can also significantly diminish the impact of World Bank projects. A primary problem is the lack of value-for-money when financing projects that have local currency expenses. When World Bank dollar-denominated loans are converted into local currency at the overvalued official rate, fewer local-currency resources are available than if the exchange had happened at the parallel market rate. This reduces the development impact of World Bank operations. For example, if the World Bank operation is financing cash transfers for the poor paid in local currency, this means fewer people will enjoy the benefit.,” he added.

 Continuing, Malpass said a second problem is that some of the proceeds from the World Bank loan (which are in dollars) can be diverted by governments to finance expenditures not related to the project and could lend themselves to corrupt practices. He said a related problem is that the government incurs higher foreign-currency debt to achieve a given level of local-currency spending on the project, making future debt service payments more burdensome and increasing the risk of debt distress.

 “On a larger scale, there is a risk that sizable World Bank financing that provides funding through the parallel market regime perpetuates it. We have taken a set of measures at the World Bank to discourage the subsidized rate, or at a minimum mitigate the impact of parallel exchange rates on our operations,” he said.

“This is to ensure that our financing benefits rather than harms people in developing countries. First, we do not provide budget support assistance to countries with sizeable and persistent foreign exchange rate premiums, unless the distortion is addressed through a program of exchange rate reforms in collaboration with the IMF.

 “Second, we try to ring-fence available resources and protect the value-for-money for our investment loans. This can be done by requiring that loan resources be used only to finance ‘foreign expenditures and the government should finance any “cost of local expenditures” from its own resources. Another way is to ask the government to provide counterpart financing to partly compensate for the exchange premium between the official and the parallel foreign exchange rate in countries where the cost of the policy is most apparent and distortive,” he stated.

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