Learnings from Nigeria's new *managed float FX window
Still early days, but it will take more than a float to spur FDI et FPI inflow in Nigeria
Milton Friedman once said that we should judge public policies by their results, not their intentions. I share this exact train of thought, especially as it concerns Nigeria.
On June 14, 2023, Nigeria’s Central Bank of Nigeria (CBN) announced a float of the Naira on the official Investors and Exporters’ foreign exchange window (I&E FX window).
I immediately commenced tracking the daily opening and closing prices in the I&E window to observe a probable convergence (with the parallel market) and a surge of FX inflow.
It has been exactly seven days since and the naira has lost about 14% of its value against the U.S. dollar in that time-frame at the I&E Window.
While this is an early price discovery period, here is what I have learned so far….
The Float That Didn't Float
Nigeria's recent decision to float its currency, the naira, was supposed to be a major step towards attracting foreign investment and stimulating economic growth.
However, while we're still in the early days, so far, the float hasn't had the desired effect.
Before the float, the black market was the main source of FX liquidity in Nigeria. This meant that businesses and individuals who needed foreign currency had to go to the black market to get it, often at a much higher price than the official rate.
The float was supposed to increase FX liquidity in the official market, but this hasn't happened yet. The reason for this is that there is still a lot of uncertainty about the future of the naira, which is making investors and businesses reluctant to bring their foreign currency into Nigeria.
As a result, Nigeria still has a long way to go before it can attract the needed FX liquidity to spur growth. The government needs to take steps to improve the business environment and make Nigeria a more attractive destination for foreign investment.
But the CBN has a more pivotal role to play.
Here are some specific things the CBN must do to attract FX supply inflow:
The Central Bank of Nigeria (CBN) has been under pressure to attract foreign portfolio investment (FPI) in order to boost the country's foreign exchange (FX) reserves. However, the CBN has so far been unsuccessful in attracting significant FPI inflows.
There are a number of reasons for this, including the high cost of doing business in Nigeria, the lack of transparency in the FX market, and the now-defunct restrictive capital controls. However, the CBN can take a number of steps to make Nigeria more attractive to FPIs.
Here are some of the steps that the CBN can take so that the float yields expected outcomes:
Provide a hedge mechanism that is priced in line with the market. This will give FPIs more confidence in the FX market and make them more likely to invest in Nigeria.
Ensure that market yields are attractive to FPIs. This can be done by increasing interest rates (I was not a fan of this until last week) and making it easier for FPIs to invest in Nigerian assets.
Ensure transparency in the FX market. This will make it easier for FPIs to understand the risks involved in investing in Nigeria.
Remove all controls around domiciliary accounts. This will make it easier for FPIs to move their money in and out of Nigeria.
Clear the dollar backlog in the market. This will make it easier for FPIs to find the dollars they need to invest in Nigeria. For example, the total amount of international airlines’ funds trapped in Nigeria has now reached $812.2 million, the highest in the world.
Lift capital restrictions for investors waiting on the sidelines to repatriate their funds. This will allow these investors to bring their money back into Nigeria, which will boost the FX reserves.
By taking these steps, the CBN can make Nigeria more attractive to FPIs, attract the FX supply that the country needs to grow its economy, thus ensuring that this ‘float’ is a worthy float.
In essence, the CBN's core focus should be on 'attracting FX supply'. This means creating an environment that is conducive to FPI inflows, such as by providing a hedge mechanism, ensuring market yields are attractive, and removing all controls around domiciliary accounts.
By taking these steps, the government and the CBN can help attract the needed FX liquidity to spur growth in Nigeria.
But will they? Or will Nigeria continue to be stuck in a rut, unable to attract the foreign investment it needs to grow? Only time will tell.
In the meantime, businesses and individuals who need foreign currency will continue to have to go to the black market, where they will be forced to pay a premium. This is a lose-lose situation for everyone involved.
The clock is ticking.