Forex Crisis : Monetary Authorities Should Narrow the Spread

Boniface Chizea

Foreign exchange brouhaha still on my mind today. As a result of my post yesterday on the worrisome development with regard to the falling foreign exchange rate, as should be expected I received a deluge of feedback and we have shared knowledge which is the one item that grows when you share. I am able to attest that we have been able to gain from the various perspectives as should be expected.

What came out strongly is the recommendation that the monetary authorities must find a way to narrow the spread between the official window rates and those of the parallel market. The spread today is in excess of 25% while the received wisdom in this respect is that the spread should be kept below 5% otherwise the temptation to round trip and capitalize on the arbitrage opportunity becomes irresistible.

 I also encountered disagreements with my observation that the Central Bank is the dominant and for that matter only sole supplier of foreign exchange in the economy. The argument is that there are considerable private holdings of foreign exchange in the country but most stakeholders take flight to dollars as a hedge against ravaging inflation. And as a result of the apparent misalignment in rates humongous inflows particularly from Nigerians in Diaspora have found their way into the economy outside the official Channels. My off hand take on that development is that eventually such goods and services contribute to the nation’s Gross Domestic Product regardless of the preferred channel.

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The argument is that if we devalue the Naira exchange rate to narrow the spread; such a move would catalyse response which will make stakeholders end their current unhelpful stance of sitting on large amounts of dollars. Such a development it has been argued in response to the search of supply/demand equilibrium price would result to an appreciation in the rate of exchange of the Naira. But the question on my mind is that even if that was possible whether it will be long lasting? What will kill the propensity to speculate is to bring to an end the fact that you could safely take a bet on the exchange rates by sometimes finding a way to have the rates appreciate in a fairly sustainable manner.

We must remind ourselves that one fact about the exchange rate of the Naira is that it is one item which ones the rates go up they do not come down. The rates never respond to the law of gravity as they are sluggish, if at all coming down!

Witness the fact that in 2005/2006 when this administration came on board that the rate of the exchange was around 160 Naira to the dollar. Today eight years later we are battling at the official window with rates hovering around 420; a depreciation of almost 200%! Unbelievable! So, this scenario does not give any confidence to the argument  that the rates will firm up in any significant manner and remain so for a while if we devalue.

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There is also an obstacle in this respect as the authorities have made it quite clear that devaluation as a strategy is off the table. The reasoning is that devaluation is an export led strategy which is meant to grow market share overseas as exports become price competitive. But Nigeria has no export base for that strategy to become viable. Our major export revenue earner; oil has its price denominated in dollars and therefore such a strategy will only spike the inflationary spiral exacerbating the misery in the Land.

For some of us who have been around for a while there is no experiment that has not been tried to no avail in an attempt to come to grips with finding a stable rate of exchange. The Dutch Auction system both wholesale and retail were mentioned. Let’s explain what the Dutch Auction system entails to ensure we are all on the same page as we continue with this dialogue. It is system whereby the monetary authorities announce the quantum of dollars on offer and banks bid with what they are prepared to purchase the dollar with an indication of the amount demanded.

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The bids are ranked and allocations are made until the amount on offer is exhausted. The cut off rate becomes the ruling rate until the next auction. The auctions at that time were held twice a week. And if allocations are made to all using the cut off rate it is regarded as wholesale but when made to each according to their respective bids; that is referred to as Retail. But the records indicate that by February 19, 2015, the Central Bank announced the immediate closure of this market. The pertinent question to ask is why the closure if it was the panacea that it was purported to be!

Yes there is the urgent need to bridge the spread currently seen in the foreign exchange market. Otherwise, the temptation to round trip will remain irresistible to most stakeholders. But I am at a loss to proffer any strategies as a way out. And after some reflection I am still of the view that the search for effective strategies remains work in progress if not elusive in the present circumstances. We must always remember that the problem confronting us today is lack of a diversified productive base despite all the efforts made in this respect commencing with the Structural Adjustment Programme (SAP) which was introduced in 1986. We should therefore resist the temptation to find a scapegoat!

Dr  Boniface Chizea is an economist and former banker

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