Forex: Interbank, parallel markets’ rates and BDC dilemma

Sources of supply and quantity supplied have remained at the centre of discourse since the beginning of the all-new flexible exchange rate policy. Both have also become strings pulling the rate determination at the interbank market, and by extension, parallel market wide margin and the return of confidence. Already, Bureau De Change operators have laid claim to the solution and are seeking return to the arena.

While the new exchange rate regime has been applauded severally, as having a measure of stability effect through the interplay of market forces – demand and supply, the twin issues of lone source of supply and channeling of some forex demand to the futures market are now emerging concerns among stakeholders.

Specifically, many forex demands still find their way to the parallel market segment, a development that has sustained high exchange rates at the segment. The situation for many is a continuous postponement of the expected convergence of both market rates, while others see it as a shadow over the ability of the new policy to effectively end the forex challenges or reduce its effect to minimum level.

For the Chief Executive Officer of Graeme Blaque Advisory, a financial advisory company with specialty in derivatives risks, Zeal Akaraiwe, the expectations of black market rate to converge with the official rate now is immature.

“What we should be talking about is the divergence that is acceptable. The combination of the lack of optimal dollar liquidity in the interbank market along with the pressure on the unofficial market by the 41 banned items will not allow for a rate convergence at all. We may need to reconsider the approach to the banning of the 41 items, amongst other things, in order see some of the desired positive in the unofficial market,” he said.

Already, two companies have renewed appeal to the Federal Government over their inability to import raw materials due to paucity and high cost of foreign exchange (forex), seeking the creation of alternative measures to enable genuine manufacturers access forex for enhanced production.

The Managing Director of Vitafoam Nigeria Plc, Taiwo Adeniyi, lamented that under the new regime, forex supply to manufacturers is now classified under futures placement requirement, which takes 90 days before forex could be accessed.

“The first half of the year was not too good for manufacturing sector. There were policy changes and it is too early to think that it has not added up issues on the business yet.

“On June 20th, we heard of the release of so much dollar into the system and everybody thought it was so and would continue so, but as I speak to you now, we are having to do with what is called Futures Placement for request of dollar. Its tenure is 30 and 90 days for us to have access to dollar. And I asked a simple question to the bank: if you are telling me that the next time I am going to get dollar to buy my material is in 90 days’ time, what happened before the 90 days? I should fold my hands and then wait? When would manufacturers get dollars to buy materials?” he queried.

The Managing Director of DN Meyer Plc., Kayode Okuwa, reiterated the need for government to assist manufacturers by establishing companies that would serve as intermediaries for manufacturers in accessing forex.

“85 per cent of ingredients we use in manufacturing are imported, while only 15 per cent is sourced locally. Government needed to assist us by having companies that would serve as intermediaries. This sector is supposed to drive the nation’s economy,” he said.

Inter-bank Forex Market

Since the beginning of the new forex operations, CBN’s intervention has contributed no less than 70 per cent of the forex traded at the interbank segment, in expectations of the return of foreign investors and auctions from multinational corporates.

The Central Bank of Nigeria (CBN), on the launch of the new policy, intervened with $4.02bn, made up of $3.5bn in forward sales and about $520m at the interbank market, targeted at clearing up the huge backlog of demands that have remained unmet.

It sold $697m in one-month futures, $1.22bn in two-month and $1.57bn due in three months, in order to clear a backlog of $4.02bn of demand, while recent demands are likewise settled at the market, which manufacturers are now becoming uncomfortable with.

Forwards market, as part of the new policy regime, is a trading window, where people can buy forex at present price for future use and most demands from manufacturers that are not considered as urgent, are channeled there.

The Acting Director of Corporate Communications Department, CBN, Isaac Okorafor, described the take off of the new forex market as a robust one, adding that the bank was happy that its objectives to clear the forex demand backlog, perform its role as strictly a market intervention participant and re-launch a functioning and efficient inter-bank market, were being met.

“The CBN, in line with its desire to promote a transparent, liquid and efficient market, and in order to engender market confidence and ensure credible price formation, intervened in the market through a special Secondary Market Intervention Sales (SMIS) addressing the issue of the forex demand backlog by clearing $4.02bn through spot and forward sales. This served in no small way to stimulate price discovery, with the determination of a marginal rate of $/₦280 through the Special SMIS process.

“So, we can state, that the FX demand backlog has now been cleared and behind us for good,” he said.As a follow up, he announced the planned launch of Naira-settled OTC FX Futures due seven days later.

Naira-settled OTC FX Futures

CBN Governor, Godwin Emefiele, at the launch of the Naira-settled Over-The-Counter (OTC) Foreign Exchange (FX) Futures, expressed delight that the foreign exchange market in Nigeria has attained the position where participants can settle foreign exchange futures transactions in Naira.

He said the product is also expected to provide relief to Nigerians seeking Dollars to import critical machinery and raw materials from abroad as they can now lock-in their foreign exchange deals in earnest against their future demands.

Since the new policy started, dollar supply from multinationals and foreign currency earning corporates to the interbank market is estimated at $37.2m, by Nigerian units of ExxonMobil, Chevron, Eni and Addax making the combined sale.

About two days after the launch of Naira-settled OTC, the CBN and Citibank executed the country’s first Naira-settled Futures trade against the dollar, estimated at $20m. However, the parallel market rates have hovered around N333-N351 from the onset of the new policy to date.

The Managing Director/Chief Executive Officer of FMDQ, Bola Onadele, has described the Naira-settled OTC FX Futures product as a major milestone in the evolution of Nigerian financial markets.

“The futures market is an opportunity to transform risk into certainty – a major paradigm shift in the financial markets landscape. This innovation provides opportunities for government, businesses, pension fund administrators, investors, individuals to hedge (not speculate) and cope with exchange rate risks.

“It also affords the CBN a greater opportunity to manage exchange rate volatility, thus achieving greater market confidence, liquidity, improvement in business planning, job security, employment, better allocation of resources, global competitiveness of the Nigerian financial markets, and all in all, a thriving economy,” he said.

Hope Rising for BDCs

THERE was hope rising for BDCs under the new currency exchange regime as the Deputy Director, Financial Policy and Regulation Department, CBN, Anthony Ikem, affirmed that their proposal to participate at the interbank market was under consideration, at an interactive session in Lagos, with the Association of Bureau De Change Operators of Nigeria.

According to him, the apex bank recognises the BDC sub-sector as a critical segment of the market and is working on how to accommodate them in the new forex regime.

“The CBN is asking the BDCS to exercise patience. The New policy is still being tested to see how it would be better. Even as the policy is being tested, the CBN still understands the role of the BDCs in the country. They are still relevant in the scheme of the affairs of the country,” he said.

Few days before the interactive session, ABCON President, Aminu Gwadabe, had told journalists that CBN would in a matter of days, admit BDCs into the interbank forex market, adding that it was the outcome of its peace talks with the regulator in Abuja.

“The BDCs agreed to support the CBN, and deepen their rendition of returns as well as following the guidelines on Know Your Customer requirement.
“Following the outcome of a just concluded peace talks with the CBN, ABCON leadership wishes to assure you that sales of dollar to BDCs will resume very soon. Once again, you are urged to avoid hoarding and currency speculation and all other unethical practices,” he said.

Even on the sidelines of the interactive session, where the CBN representative’s statements were far from definite, Gwadabe maintained that a deal has already been brokered and that CBN would soon re-integrate them in the forex market.

Gwadabe claimed the operating modalities for the policy is already being worked-out and should be ready in the next one week, although it is about two weeks now going by his calculations.

The development has been greeted with mixed feelings from stakeholders, who wonder if the said deal was a mere promise or political intrigues in the pipeline, while on the other hand, the opportunity for negotiations and any possible realization represent lack of policy assurance and somersault.

ACCORDING to Akaraiwe:“BDCs believe they play an important role, but personally, I don’t see what they do to create value that the banks with their extensive branch network can’t. We have more BDCs than we should and it is clearly a sector where regulatory oversight isn’t efficient.

“I expect that for progress to be made regarding forex policy direction and true price discovery, we need to have well thought – through policy changes regarding BDC operations, their regulatory oversight and some cohesion on fiscal policy between Ministry of Finance, Customs and the CBN,” he said.

Similarly, he said the decision to float the naira and the introduction of the Futures market, made it very attractive for foreign investors to reconsider Nigeria as a destination market.

He noted that the Futures market assures of an exit price that adequately compensates for the investor as a result of the inherent liquidity and country risks.

“The settlement dates for $3.5bn are still some weeks away and I’d expect major investors to wait and gauge performance on them before taking any major investment decision in Nigeria.

“The Futures market also allows importers to push out their demand at a guaranteed price and therefore, we expect a reduction in immediate demand for foreign exchange to give the CBN time to conclude various negotiations and to shore up cash-flow from exports.

As with introducing a new product and restarting any process that has been shut down for a long time, we don’t expect optimal performance immediately, especially where external parties are expected and needed to come to the table for us to achieve the desired goals.

“I don’t think any professional player expected the market reopening to coincide with an influx of dollar liquidity, which the market still expects. This first two weeks have had the typical teething issues we would expect, but we are still heading in the right direction as long as we are effectively monitoring the market and being dynamic to the challenges,” he added

The Chief Executive Officer of Cowry Asset Limited, Johnson Chukwu, said the decision to implement a flexible foreign exchange policy would certainly have positive effect on the Naira in particular and the Nigerian economy in general.

He noted that the Naira has enjoyed some stability in all the market segments since the introduction of the new forex policy unlike when we had wide fluctuations in the parallel market.

“It should be emphasised that what business managers seek for is not necessarily a revaluation of the Naira, but exchange rate stability to enable them plan.

“For those expecting Naira to appreciate, this may be feasible in the medium to long-term when the country’s foreign exchange earnings improve and previously active but now dormant sources of foreign exchange inflows get reactivated, particularly Diaspora remittances, foreign portfolio investments and foreign direct investments and non-oil exports.

“The introduction of the flexible foreign exchange policy, which removed the peg of the Naira from an artificially overvalued rate of about N197/$ to a more market reflective spot rate of N280 – N282/$ has restored some stability, including the parallel segment where Naira is still trading at about N350 – N352/$, against fluctuations between N320/$ -N400/$.

“Also the new forex policy has eliminated some distortions in the economy by creating a fair playing field as against the previous arrangement where some people accessed forex at N197/$ while others sourced theirs from the parallel market at N380/$,” he said.

But he said that readmitting BDCs is hinged on the desire to create multiple sales outlets and reduce the spread between the interbank rate and the parallel market rate.

Citing the CBN-led Prof. Chukwuma Soludo era, he said increased dollar sales to BDCs led to drastic reduction in the spread between the official and parallel market rates to about N2/$.

“Given that there is no longer an official exchange rate, what the CBN is considering may be to allow the BDCs buy from the banks and resell to their customers who need minimal dollar cash for personal and business travel allowances. It will certainly improve supply in that market and reduce the current premium of about N70/$ between the interbank rate and the parallel market rate,” he added.

For a currency expert and Research Analyst at FXTM, Lukman Otunuga,
a there was a strong feeling of positivity dispersed across the economy in June following the unexpected decision to de-peg the Naira against the dollar in an effort to ease the severe pressures on external reserves and foreign exchange supply shortages.

For an extended period, depressed oil prices have weathered the nation’s government revenues, while supply disruptions heightened concerns over a potential slowdown in domestic economic momentum.

“With fears elevated that Nigeria could enter a potential technical recession in second quarter, the swift decision taken by CBN consequently boosted investor sentiment.

“Unfortunately, the policy faces noticeable pressure now, following the fading optimism over the effectiveness of the Naira de-peg and such has created unease throughout the Nigerian economy.

“However, while it was expected that the Naira should depreciate heavily post de-peg as the natural forces of supply and demand create an equilibrium price, it really does not reflect on the official exchange that showed N281 against the dollar.

“Although there are fears that a weakening Naira could drive inflation higher in the short term, this same weak Naira could attract foreign investments while boosting demand for domestically created products.

“The decision taken by the central bank to float the Nigeria may have been a painful move in the short term, but this could be the first critical steps needed to steer away from oil reliance, while also promoting economic stability in the long term.

“Naira weakening on the parallel markets cannot all be put on CBN alone. Global instabilities have exposed the Nigerian economy to downside risks while the awful mixture of depressed oil prices and a firming dollar will translate back to a vulnerable Naira.

“With liquidity still lacking, coupled with the 41 banned items, which cannot be purchased on the official exchange, market participants will be naturally attracted to the black markets,” he said.

Also, the Executive Director, Investment Finance, BGL Capital Limited, Olufemi Ademola, assessed the new policy as going in the right direction as expected.

The implementation of the flexible exchange rate policy is going on very well. As expected the level of the demand in the market is driving the exchange rate rather than the CBN fixing the prices.

However, it appears that the CBN is the only supplier of foreign currency to the market for now and the market is pricing the high demand into the rates.
“If you check the bids submitted to the CBN by banks on the first day of trading, some were as high as N382/US$. This is based on the request of the customers (since they are requested by banks to state the price in their bid instruction) who just want the foreign currency to complete their transactions.

“With the clearing of the backlog of forex demand and the introduction of forward contracts and futures market, it is expected that going forward, future demand would be lower and even over the period as artificial demands and speculative activities moderate significantly.

“Therefore, as more forex supplies enter the market from International Oil Companies, other exporting companies and foreign investors, the rate is expected to moderate in the very near future.

“The continued ban of some 41 products from accessing the interbank forex market will continue to create opportunities for black market and account for a large amount of forex transactions.

“Additionally, the difficulty in accessing the interbank market by end users, especially retail and individuals due to the stringent requirements for accessing the market otherwise, is leading to the continued patronage of the black market by the end users. These are making the efforts of the CBN to appear futile,” he said.

Still, he said BDCs need to be accommodated and given a role to play, otherwise they will continue to trade outside of the official market and keep the parallel market significantly active.

“The consideration to engage the BDCs for forex trading was a good one, which need not be politically motivated by big economic players or any other persons for that matter. It should be a rational economic decision with a view to make the foreign exchange policy successful,” he added.