Sunday, January 21, 2018 7:45:27 PM- Nigerian Stock Exchange.

  Flexible FX framework rolled out


June 16 (Lagos) - In response to the unanimous decision of the Monetary Policy Committee (MPC) to adopt a flexible exchange rate policy in a bid to enhance efficiency and facilitate a
liquid and transparent Foreign Exchange (FX) market, the Central Bank of Nigeria (CBN) released a revised guidelines on the operations of the Nigerian Inter-Bank FX market towards the liberalization of the market. 

Contrary to earlier guidance at the May MPC meeting that the CBN will maintain a window for “critical” transactions in raw material and machinery imports targeted at boosting local production, a single market structure will be operated through the autonomous/inter-bank market. The CBN may, at its discretion, participate in the FX market through interventions directly in the inter-bank market or through dynamic “Secondary Market Intervention
Mechanisms” – sale to wholesalers and end users. Furthermore, the CBN will introduce registered Authorized Dealers (FX Primary Dealers) designated to deal on large trade sizes (minimum $10 million) on a two-way quote basis. 

With no indicative rate specified, the interbank market is expected to trade largely based on the forces of demand and supply with intermittent interventions by the CBN.

Asymmetric Net Open Position to encourage Forward transactions

The CBN has consistently maintained its stance that the FX demand is artificial as market participants continue to front load future demands on the spot market due to uncertainty. In a bid to reduce the pressure on the spot market, the new FX framework will allow the CBN to offer long-tenored FX Forwards to Authorized dealers who may in turn sell trade-backed FX Forwards to end-users with full documentation.

However, the earlier 41-items excluded from the CBN window remain ineligible for FX spot and importers of these items are expected to continue to source FX from autonomous sources (to protect local investments in these items). Furthermore, in a bid to support the Authorized Dealers’ obligations as liquidity providers, the CBN has reviewed the daily foreign currency trading position (NOP) from the initial 0% to +0.5%/-10% of their Shareholders’ Funds unimpaired by losses. 

This implies that Authorized Dealers can be long the dollar up to a maximum 0.5% of their
Shareholders’ funds whilst they can be short the dollar up to a maximum of 10% of Shareholders’ funds. In our view, we believe the decision to introduce an asymmetric NOP is to encourage the Authorized dealers sell Forwards to end-users. Markets to rally as Naira gives way to price recovery

With the kickoff of the new framework slated for Monday, June 20, it remains unclear where the rate NGN/USD will open. Given significant pent-up demand amidst depleting foreign reserve ($26 billion), we foresee sizeable weakness from the current NGN199/USD rate. We recall that financial markets had rallied shortly after the decision of the MPC to introduce a flexible exchange rate. 

Now that the framework has been revealed, analysts at Vetiva Capital Management Limited in Victoria Island expect the markets to trade higher in the coming sessions (NSE ASI up 317bps yesterday supported by a late rally). Analyst believe the market will require other fiscal policies to complement the monetary decisions in a bid to sustain investor sentiment. 

Clarification needed in addressing pent-up demand

In his briefing, the CBN Governor said the bank has enough reserves (over 5 months import cover) to deal with the backlog of FX demand. We think it may be expedient for the CBN to address the backlog before the new structure can successfully take off. This should bring a much needed relief for foreign firms that had long sought to repatriate funds, particularly airline operators who are said to have up to $700 million of funds trapped in Nigeria. Clearing out the backlog of demand does raise some questions though. 

At what rate will the backlog be cleared? If it were to be accommodated in the new market structure, companies may have to take some sizeable haircuts when a new market-determined rate is applied. If the huge pentup demand is addressed in new market structure, the sheer size of it could weaken the currency significantly in the short term. Analysts at Vetiva Capital Management Limited in Victoria Island suppose these are questions that would be addressed as things unfold. However, we think the CBN may have to allow some significant depletion in reserves before this new market framework can successfully take off.

reporting for on Thursday, June 16 2016 from Lagos, Nigeria

Source - analysts at Vetiva Capital Management Ltd in Victoria Island

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