The Central Bank this week announced the termination of its weekly retail Dutch auction window in an unanticipated move which left me all the more frustrated at our green tie loving Governor. Why? Only last week when quizzed about the likelihood of such a move, he defended the status quo stating that as an import reliant country we needed to still try to keep the naira stable. A bit of history here, the CBN last attempted to float the naira in 1986 as part of conditions for the IMF SAP bailout. However, it was swiftly abandoned following the high volatility and sharp depreciation – an undesirable quality. To forestall that occurrence under the new interbank, the CBN via FMDQ introduced a sort of crude free float – one which is order driven vs. a conventional 2-way quote as characteristic of most pure floats. The order driven is sort of like buying/selling stocks which together with the removal of the over-valued N168/$ peg greatly removes the incentive to speculate on the naira. To ensure things don’t break down, the CBN underwrites the process by agreeing to clear all unmet FX demand before the close of trading each day.
Which is the weak link in the whole set-up as daily FX interventions since the start of the experiment last week Friday hovered between $200-300m daily? Put simply, they are running down our FX reserves quite quickly as with each passing week they blow out $1-1.5billion. With oil prices remaining low, the reserves depletion pace could be much faster which will end in only one way the CBN is forced to abandon its guarantee scheme sometime later this year. But this is where the governor gets some credit, he’s trying to ensure the path of least pain in the transition to naira convertibility. Key takeaway: The era of cheap dollars is over.
Guess who gains the most from the devaluation? The Nigerian Federal Government! This is as with dollar based oil revenues; the FG gets to convert its cash at a higher rate providing much needed respite. Not that it will help soften the havoc caused by the plunge in oil prices since June 2014, it only ameliorates the pain. Worse the decision to reduce fuel prices now looks increasingly unsmart as the subsidy bill is now much bigger thanks to the devaluation.
But if the outlook for the naira is bad, it means two things for the economic structure: we will have to wean ourselves off imports, get used to local rice, food, clothes, shoes as domestic prices will have to upwards. Flour millers have adjusted prices and so yes you’ll start paying more for bread. On the flipside, a weaker dollar benefits the you if you’re an exporter.
You can send me questions if you’re having difficulty explaining the change. FMDQ has a document explaining how the new interbank works here.