Recent media reports indicate that rates on the official and parallel markets have converged. This was achieved through a deliberate CBN policy of selling forex directly to the bureau de changes, flooding the market with dollars strengthening the value of the naira.
The objectives of this exercise are to reduce the incidence of round tripping (forex from the official market being recycled in the parallel market to take advantage of the discount) and to reduce the influence of the parallel market, ensuring that all forex moves through official channels.
Targeting these two issues may have been successful; however there are other aspects of the forex market that may have been affected. First the closing of the gap between the official and parallel markets took a space of about a month, indicating that these markets are not that significant. When the South Africans narrowed the gap between the financial and commercial rand shortly after apartheid, it took two years which allowed various stakeholders ample time to adapt their balance sheets to what was a well known government objective.
Who gains? Importers, as naira is cheaper meaning their goods are more price competitive; however government policy is designed to discourage imports so their ability to leverage this opportunity is minimal. Who loses? Individuals with dollar assets (including FG and States). FG and State budgets are priced in naira but converted from dollar earnings; an appreciating naira means more dollar assets to fund the budget or the alternative, increased deficit financing.
Remittances; with the large number of Nigerians resident abroad, their relatives at home have come to depend on the remittances they get to cushion the high cost of living. Estimates of the size of this market are not available but indications are they could be as much as USD4billion per annum. Much of it coming in through unofficial channels. An appreciating naira means a reduction in their buying power. With the pension fund mess, these remittances have become the cushion of the affected.
Forex Market Prior to 2003
Between 1999 and 2003 the naira experienced a gradual depreciation from some N100 to the dollar to some N150. This gradual depreciation had impact on inflation keeping it at double digit levels. This is difficult to avoid since the country is heavily dependent on imports.
The parallel market maintained a slight discount on the official market of some 10-15%, which is where the round tripping market draws its life. FGs reserves at that time were a little over USD1billion although increasing gradual with the financial prudence of the new administration. However, debt obligations and a high import bill did not allow enough room in those reserves to tackle the exchange rate problem.
Developments since 2003
The country’s financial picture has improved. A cap on budget pricing at $30 and later $33 per barrel of oil has expanded foreign reserves with oil prices well above the cap. Reserves currently at $36 billion put FG in a strong position to fund budget, imports and tackle the exchange rate issue.
Also debt relief has reduced obligations to donors limiting pressure to draw down reserves to service debt. The exchange rate in this regime has stabilized maintaining a narrow range of 130 – 150 not the depreciating trend of the prior years. This has helped to contain inflation somewhat, though still high. However, the parallel market continued to maintain the discount to the official market.
Going Forward
It appears CBN is in a strong position to reverse the trend in the value of the Naira. They have achieved partial success by converging official and parallel markets. It appears the next goal is to take the naira higher. An appreciating naira has long term damage to the economy, same as a depreciating naira. The naira rising some 20% in just a month will cause some serious rethink in the financial decisions of those who depend on that market.
It may cause them to reduce activity until there is sign of stability in the market. The time frame for achieving either is also a factor in the equation. Very short term rises or drops in a currency can send shocks through the economy if stakeholders do not have ample time to adapt. Exchange rates tend to fluctuate over time; however being able to keep rates within a narrow band over the long term is preferable for business.
Converging the official and parallel markets is a good thing, however further appreciation of the naira is not. A naira moving within a narrow band provides a more predictable planning environment for government and businesses that depend on foreign exchange.
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