FX Reforms: Achieving Transparency, Liquidity Cautiously-Analysts

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By NIYI JACOBS

Some financial experts in the country have agreed that the unification of the exchange rates would make for a more transparent forex market, engender healthy competition among FX dealers as merging the rates will reduce arbitraging, speculation, and curb multiple malpractices in the market.
However, they cautioned that the unification should be handled with utmost care so that it does not snowball into galloping inflation, rising poverty level and increasing hardship, against the backdrop of the recent oil subsidy removal, as the economic fundamentals required to support a naira float are still very weak, especially in relation to sources of forex.
Uchenna Uwaleke, Professor of Finance and Capital Market at the Nasarawa State University said: “Let me say upfront that I support the unification of exchange rates which makes for a more transparent forex market.
“But I think that the Central Bank of Nigeria (CBN) should implement that in a way that does not cause massive distortions in the general price level.
“In this regard, a sudden free float of the naira is not advised given that the economic fundamentals required to support a naira float are still very weak especially in relation to sources of forex.
“It’s rather early to bank on sustainable capital inflows from foreign direct investments due in part to insecurity and the overall unconducive environment of doing business in Nigeria.
“This sudden naira devaluation may draw foreign portfolio investments which is part of the reason the stock market is surging.
“But we also know that portfolio investments are hot money and do not represent a sustainable source of forex inflows.
“In consideration of this therefore, I would advise that the unification of exchange rates should not be a one step process but should be implemented over a period of time however short it may be.
“Empirical evidence suggests that reforms are more successful when they are sequenced and implemented in phases. This is against the backdrop of the oil subsidy removal which, taken together, can result in galloping inflation and rising poverty level.
“So, while fiscal and monetary policy reforms are welcome, absolute care should be taken to strike the right balance and minimize their unintended consequences”.
Dr. Chijioke Ekechukwu MD/CEO, Dignity Finance and Investment Ltd., in his reaction stated that: “The unification of the exchange rate and floating of the foreign currency market has come as a welcome development.
“With this, Deposit Money Banks (DMBs) can now go source their own funds and sell to users at their own rate and margin. This is going to bring a rate war amongst them, which will force the rates lower.
“Merging the rates will reduce arbitraging, speculation, and curb multiple malpractices in the market.
“In the short run, however, before the rates drop, and before a higher supply of foreign currencies, rates will still remain reasonably high, which may affect the cost and prices of imported products, including petroleum products. This may increase hardships and retain a high inflation rate”.
Dr. Muda Yusuf Director/CEO, Centre for the Promotion of Private Enterprise (CPPE) stated that the FX unification is not a devaluation policy, but a normalization of the foreign exchange policy regime and an adjustment of rate to reflect the fundamentals of demand and supply.

According to him, in the short term, a depreciation of the currency should be expected in the official window because of the huge demand backlog, but as the market conditions normalize and move towards equilibrium, the rate would moderate.
He also anticipates the new policy regime to boost inflows and strengthen the supply side amidst elevated investors’ confidence as the component of forex demand driven by arbitrage, rent seekers, speculators and other economic parasites would also fizzle out, thus restoring stability to the forex market.
Dr. Yusuf stated: “Meanwhile, it is important to reiterate that this is not a devaluation policy, it is a normalization of the foreign exchange policy regime and an adjustment of rate to reflect the fundamentals of demand and supply. It would be dynamic, and the naira will appreciate or depreciate depending on the fundamentals.
“In the short term, we expect a depreciation of the currency in the official window because of the huge demand backlog, but as the market conditions normalizes and moves towards equilibrium, the rate would moderate.
“We also expect the new policy regime to boost inflows and strengthen the supply side amidst elevated investors’ confidence. The component of forex demand driven by arbitrage, rent seekers, speculators and other economic parasites would also fizzle out, thus restoring stability to the forex market”.
Dr. Yusuf cautioned: “However, the CBN should position itself for periodic intervention in the forex market, as and when necessary, to stabilise the exchange rate and prevent volatility. This should happen not by fixing rate, but by boosting supply to the extent that the reserves can support”.
He commended the bold step taken by the government towards the unification of the naira exchange rate, and explained that the liberalization of the foreign exchange market would unlock the huge potentials for investment, jobs, capital flows and impact positively Investors’ confidence.
“Meanwhile, it should be clarified that this is not a devaluation policy, but a pricing mechanism that reflects the demand and supply fundamentals in the foreign exchange market.
It is a framework which allows for flexible rate adjustments as and when necessary. It is a model that is predictable, equitable, transparent and sustainable. It is a policy regime that would reduce uncertainty and inspire the confidence of investors. It would minimize discretion and arbitrage in the foreign exchange allocation mechanism”, Dr. Yusuf further explained.

He added that rate unification does not imply that rates will be exactly the same in all segments of the market, but noted that the objective is to ensure that the differentials are very minimal, possibly between 5-10 percent.
Expatiating on why the policy is laudable, Dr. Yusuf said: “A unified exchange rate regime offers the following benefits for the economy: It enhances liquidity in the foreign exchange market. It reduces uncertainty in the foreign exchange market and therefore enhances the confidence of investors. It is more transparent as mechanism for forex allocation.
“It minimises discretion in the allocation of forex and reduces corruption vulnerabilities.
It reduces opportunities for round tripping and other sharp practices. It would increase disclosures with respect to export proceeds and compliance with non-oil export declarations, especially the non-oil export documentation (NXP).
“It would boost government revenue by a minimum of N4 trillion through additional remittance of exchange rate surplus to the federation account by the CBN. The use of naira cards for limited international transactions would be restored in the short to medium term. It would facilitate the mopping up of naira liquidity in the economy in the short to medium term. This would impact positively on inflation outlook. It would deepen the autonomous foreign exchange market through the liberalisation of inflows from Export Proceeds, Diaspora Remittances, Multinational oil companies, diplomatic missions etc.”
Dr. Yusuf took the view that the erstwhile foreign exchange policy regime on the other hand was, for all practical purposes, a fixed exchange rate regime, which created many distortions and negative outcomes.
He enumerated distortions and adverse consequences of the fixed exchange rate regime to include: “Widening gap between the official, other multiple windows and parallel market exchange rates which created room forex roundtripping to flourish.
Collapse of liquidity in the foreign exchange market resulting in acute forex scarcity”.
Dr. Yusuf noted that “It fueled demand for forex because of the incredible rent opportunities created by the huge parallel market premium; created a major disincentive for forex inflows into the economy, thus suppressing forex supply”.