The Central Bank of Nigeria (CBN) is doing a fierce, but one-handed battle to stabilize the naira. Since February, the CBN has pumped well over $2 billion into the market to halt the naira’s journey down the precipice. For obvious reasons, foreign investors are still watching from the sidelines. They have refused to invest.
The war has yielded a measure of positive results. The naira closed last week at N390 to the dollar in the parallel market. That was a remarkable gain after it depreciated to N410.
Within two months, CBN’s supply side intervention has taken the exchange rate of the naira from the calamitously low rate of N520 to N390.
For a currency with the pedigree of the naira, an appreciation of N130 within two months is remarkable.
For the first time in contemporary history of the apex bank’s fight against the tumbling value of the naira, the exchange rate war tacticians in the CBN have changed their strategy from that of mounting administrative obstacles on demand side to aggressive supply side intervention. That probably explains the positive results obtained in the last two months.
But from all indications, the apex bank is doing an up-hill battle in the forex market and there is reasonable doubt in international financial circles about the ability of the CBN to sustain the current war to strengthen the naira.
With oil price hovering above $50 and production heading for the OPEC-allocated quota of 2.2mbd, the CBN insists that it could sustain the fight for the soul of the naira.
However, the naira needs more than CBN’s new-found supply side intervention to regain its strength. The fluctuation in the exchange rate of the naira in the parallel market despite billions of dollars injected into the forex market to stabilize it is a clear indication that the apex bank may eventually lose the one-handed war except it embarks on radical reforms in the foreign exchange market that would encourage foreign direct and portfolio investment inflow.
Many had expected the CBN intervention to reverse the tumbling value of shares in the Nigerian Stock Exchange (NSE) by engendering the return of foreign portfolio investors. Unfortunately, the depreciation has continued. The market capitalization of the NSE was N12.1 trillion on April 2, 2015. Last week it only managed to crawl to N8.9 trillion, despite the setting up of a window in the forex market in April to facilitate the repatriation of dividend by foreign portfolio investors. Millions of dollars in dividend pay out could not be rapatriated due to the liquidity squeeze in the forex market.
Foreign transactions in the NSE dropped from N44 billion in January to N34.54 billion in February.
For three major reasons, foreign portfolio investors are still reluctant to return to the NSE. The first is inability to repatriate dividends. The second is that the federal government borrows money with risk-free, fixed interest instruments in the money market at 18.9 per cent. That is far above the yield in the NSE. Money market instruments are clearly more attractive.
The third is the yawning gap between official and parallel market rates of the naira. Last week, the naira traded at N306 to the dollar at the semi-official window, while the parallel market rate stood at N390.
That leaves a margin of N84 per dollar between the official and parallel market rates. Foreign portfolio investors believe that the parallel market rate presents a clearer picture of the market value of the naira.
They want a transparent foreign exchange regime and a liquid market that would enable them repatriate their dividends or capital gains at market-determined rate. That is lacking at the moment as the official rate of the naira is fixed by fiat. Those restrictions are responsible for the decline in foreign direct and portfolio investments.
In reality, the naira is not as weak as it is portrayed in the parallel market. However, it is also not as strong as the CBN portrays it in the official window. If interplay of the invisible hand of the market forces of demand and supply is allowed to determine the official exchange rate of the naira, the CBN would be surprised to see it fluctuating between N320 and N330 to the dollar.
The CBN believes that its supply side intervention would force a merger of the two rates. Ironically, last week’s depreciation to N410 suggests that the gap might even widen with time.
The CBN is scared about the inflationary trend that depreciation at the official window could trigger. However, the gains from improved inflow of foreign direct and portfolio investments would override the effect of inflation rising by a few notches.
Besides, most of the transactions and pricing in the economy are already based on the parallel market rates. The CBN might be surprised that the inflationary cost of allowing the naira to find its market-determined value might ultimately be negligible, given the pains already inflicted on the economy by the outrageous parallel market rate.
The truth however is that no matter how deep the exchange rate war chest of the CBN is, Nigeria cannot strengthen the naira by single-handedly funding the forex market. We need foreign direct and portfolio investments and that can only come with appropriate pricing of the naira at the official window.
