News Column

Chizea - Managing the Foreign Exchange Rate (I)

July 15, 2014

Boniface Chizea

DEVELOPMENTS at the foreign exchange market particularly the ability of the Central Bank to maintain stability of exchange rate in Nigeria are considered critical success factors by stakeholders and economic agents for the assessment of the performance of the Central Bank of Nigeria. And this preferred yardstick is not going to change in hurry even as we engage in this discussion. The reason for this state of affairs is not farfetched. The structure of the economy makes it overly exposed to shocks arising from changes in the external value of the country's legal tender currency - the Naira. There are hardly any sectors of the economy that are not to varying degree dependent on some form of foreign input necessitating the demand and consumption of foreign currency. The vulnerability of the economy is adumbrated from consideration of the fact that despite all efforts made in the country, particularly post the Structural Adjustment Programme (SAP) in the mid-1980s to enthrone market forces in resource allocation and to achieve rapid diversification of the economic base not much success had been recorded.

The monetary authorities hitherto have also allowed themselves to be influenced by this prevailing sentiment in the country regarding what makes for a successful management of the Central Bank. It is a matter for the records that the immediate past administration at the Central Bank in spite of the explicit articulation of the core mandate of the Central Bank to include the maintenance of price and exchange rate stability, issuance of and safeguard of the value of the legal tender in addition to contributing to the development of the economy simply narrowed this to the maintenance of stability of the exchange rate of Naira even at the cost of rapid depletion of the external reserves.

In fact someone who should know better in that administration when he was asked at a public forum why the Central Bank does not seem concerned with developments regarding the cost of capital did alarmingly observe that the management of interest rate is not within the direct purview of the Central Bank. But if the Central Bank accepts that it has a mandate to maintain price stability, it cannot in the same breadth claim that it is not concerned with the level of interest rates in the economy as interest rates are factor costs which directly impact price levels in the economy. This mindset probably explained why the Monetary Policy Rate (MPR) remained stagnant for a period of more than two years at an unsustainably high 12 per cent with some members of the Monetary Policy Committee venturing to suggest that the MPR should be increased to help in the fight against excess liquidity in the economy. One must not take the on-going discussion to mean that one is by any stretch of the imagination downplaying the importance of exchange rate in the economy; as the importance of exchange rate in the economy could be gleaned from the fact that it impacts other prices in the economy and therefore the general price level. It has far reaching implications for inflation, price incentives, fiscal viability, price competitiveness of exports, efficiency in resource allocation, international confidence and balance of payments equilibrium.

Godwin Emefiele the current Governor at the Central Bank has made his position quite clear regarding the management of exchange rate under his watch. He will aim for stability in the rates but ruled out Naira devaluation as an imminent option rationalizing correctly that devaluation is an ill wind which will not blow the country any good in its present situation of export dependence. It is apposite to recall here what The Guardian in its editorial of Tuesday, June 17, 2014 said regarding this stance of the Governor: 'Pandering to macroeconomic revisionism, the CBN considers inflation falling between six and nine per cent to be price stability as against the range of 0-3 per cent in focused economies that truly denote price stability. And that the Governor promised to gradually reduce interest rates which are generally above 15 per cent without setting any target rate and time limit.' Be that as it may it is known to all informed compatriots that most of these economic indices particularly interests rates and level of inflation are not amenable to sudden reversals no matter our best intentions. It would take determined and focused attention with the Fiscal authorities cooperating for any success to be recorded in this regard. But it is fair to observe that if there is one aspect in which the immediate past administration at the Central Bank achieved success, it is in the maintenance of stability of the exchange rate.

But if there are no accretions to reserves because of the challenges which the country currently encounters in the oil sector; direct theft, vandalism, illegal bunkering and the discovery of shale oil and gas in America and China leading to sudden and alarming drop in demand then some radical options must be considered if the Central Bank will continue to be alive to its responsibility of maintenance of the stability of the exchange rate. And one of the 'low hanging fruits' in this connection is to revisit the operations of the Bureaux de change in view of the hemorrhage which their operations is constituting on the reserves. There are currently 3,208 registered Bureaux De Change in the country with 1,417 applications for licence waiting approval. Funding of Bureaux De Change depleted the reserves at an average of $6 billion a year since inception. And in 2008 as much as $11 billion was used to fund BDCs. It should be obvious that Nigeria cannot continue to sustain this level of drainage on its reserves particularly in the context of the urgent need to maintain stability of the Foreign Exchange rate against the background of dwindling external reserves.

When the country established Bureau De Change in 2006 to grant access to small users of foreign exchange and to facilitate the elimination of the informal market in foreign exchange, only two countries in the world funded their BDCs - Nigeria and Kenya and it is a matter for the records that Kenya has since discontinued the practice of direct official funding of BDCs. In effect what this means is that it is only Nigeria that currently officially funds the operations of BDCs. When the Central Bank licensed the BDCs, the initial intention was that the BDCs would operate as Stand Alone operators. They were meant to source their funding from the private sector. They were disallowed from; the maintenance of any foreign relationships in this regard, engage in import related business, or directly or indirectly in any form of outward and inward foreign currency transfer activities, credit card services, round tripping of foreign exchange acquired from official sources and not to engage in street trading in foreign currency.

And what is of paramount consideration now is that the need for the operations of the BDCs has waned considerably considering the numerous on line payment options now available to users of foreign exchange. If one is going overseas now you do not carry more than the foreign currency that would enable you to pay for incidental expenses on the journey. Using credit cards the banks now offer seamless transfer services as their customers are able to withdraw foreign currency on arrival for as long as prior arrangements have been made. There are also many credit or debit cards available such as Master Card, Visa Card, etc that one could take advantage of to meet the need for foreign currency. And quite recently the CBN issued guidelines for the regulation of International Money Transfer Services aimed to provide minimum standards and requirements; specify delivery channels for inbound/outbound flows in a cost effective manner. And in view of the fact that the activities of BDCs resulted into multiple exchange rates thereby putting a lot of pressure on interbank rates leaving the CBN no option but to intervene in the market further leading to a depletion of the reserves; the fact that their activities lead to the dollarization of the economy contributing to the negative image which compatriots have abroad as compatriots move about with large amounts of dollars in cash, it is time for the monetary authorities to take measures to reduce the impact of the operations of BDCs in the management of the foreign reserves consistent with their extant relevance in this connection.

It is germane to take a historical excursion into the country's experience in the various attempts it has made so far to confront the challenge of finding a realistic rate of exchange for the naira as effort was made to regulate the parallel market premium to checkmate the temptation to round trip and to highlight what objective lessons are there to be taken on board as we continue to grapple with the management of the exchange rate in the country. Nigeria over the period had practised the fixed rate regime, floating and hybrid which are predominantly found in developing countries of the world. The fixed exchange regime was adopted in the country prior to 1986 and had many variants; single currency peg, crawling peg system, peg to a basket of currencies and adjustable peg system or otherwise referred to as, "fixed with bands".

Under the floating rate regime, the managed or dirty float exchange rate instrument was the major tool used in the determination of the ruling rate at the market. The choice of market determined rate since 1986 was made as part of the complement policies and programmes that heralded the commencement of the Structural Adjustment Programme. The fixed exchange rate regime failed to correct the imbalances in both internal and external positions. The fixed exchange rate regime was discarded in September, 1986 to be replaced with a flexible exchange mechanism. During this period the exchange rate was driven by market forces with the monetary authorities intervening as the need arose to maintain some level of stability and achieve policy objectives.

Under the floating market determined exchange regime there were a number of experimentations. On September 26, 1986 the Naira was first floated at the second Tier Foreign Exchange Market (SFEM) thus there was in existence two markets for the same commodity in one market; a perfect recipe for the exploitation of arbitrage opportunities. While at the First Tier market the exchange rate was administratively determined and dedicated to be used for official transactions including debt service payments, expenditure on Nigerian missions abroad and public sector transactions, the floating exchange rate was used for other transactions using pricing methods such as the average of the successful bids, marginal rate and the Dutch Auction System (DAS).

-To be continued tomorrow.

- Dr. Boniface Chizea wrote from Lagos.

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Source: AllAfrica

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