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Nigeria floats the naira: Winners and Losers
In the wake of the oil crash, the Central Bank of Nigeria (the “CBN”) in Q2 2015 took the decision to peg the Nigerian currency to around N197 to the US dollar. This move, whilst implemented with the good intention of stabilising the economy, had the opposite effect, and served to plunge the economy into further chaos. Since the pegging of the currency, investor confidence has plummeted, capital has been driven out of the country and the lack of independence between the government and central banking system has been woefully exposed. The words of the opposition politician and former presidential candidate, Olapade Agoro, almost seem apt to summarise the situation: "Nigeria has never been this bad."
Recently, the CBN signalled the abolishment of these capital controls with the announcement of a new, flexible foreign exchange regime. In this blog, we speak to Desmond Ogba of Templars law firm in Nigeria, who helps us pick out some of the winners and losers of this long-awaited change in FX policy.
1. Authorised dealers
We know from Templars’ recent client alert, "An Era of Change in the Nigerian Foreign Exchange Market," that under the new guidelines, there are a number of financial institutions that will have the requisite qualification to be appointed to trade on a wholesale basis with the CBN as FX primary dealers in the FX market. Amongst these preferred institutions are the international and national banks operating within the country referred to as "primary authorised dealers." In our conversation, Desmond points out that these "primary authorised dealers" were initially chosen by the CBN on the basis of their “level of shareholders’ fund unimpaired by losses; value of their total foreign currency assets; high liquidity ratio; strong FX trading capacity; and improved IT system”. Our view is that as in any industry, limiting the number of traders can lead to the threat of establishing a cartel along with prohibited practices such as price-fixing and collusion. Desmond informs us that in order to diminish such a threat, the CBN reserved for itself the right to review the qualifying criteria for the appointment of primary authorised dealers and has since after its initial announcement, changed the rules in order to qualify more banks as primary authorised dealers. Thus, currently, the stringent rules requiring high level of shareholders’ funds unimpaired by losses and such other requirements have been deferred and the licensed international and national banks in the country are now eligible to operate as primary authorised dealers. But the smaller banks such as the regional banks and merchant banks, although eligible to participate in the FX market, are still not qualified to trade or operate on a wholesale basis with the CBN as primary authorised dealers under the revised rules.
2. Foreign Investors
In theory, those holding dollars look set to gain from the present situation due to the strength of the US currency against the naira. With traders speculating that the naira could depreciate by more than 10% in the next 3 months, those with a keen eye on the markets could see big returns. The key, however, is timing. Desmond informs us that there was a low volume of trade on the first day of opening of the new market. . This, combined with speculation of how long CBN will continue to prop-up its own currency indicates that many are concerned about selling at the wrong rate. Although the self-professed long term goal is for the rate to be "market-driven," CBN governor, Godwin Emefiele, stated that the CBN would periodically intervene where necessary. Desmond highlights that this policy was adhered to in the first week of trading, as the CBN intervened by injecting over $4billion into the market.
1. Bureau de changes ("BDCs")
BDCs are still barred from purchasing FX in the new FX market due to, among other reasons, the inability of the CBN to monitor or confirm that the FX purchased by the BDCs from that market will be sold for only "eligible transactions" as required by the CBN. Desmond states that this is in part down to the fact that BDCs are not subject to the same level of strict monitoring and regulation as the banks but also due to the fact that in the past there has been clear evidence of fraudulent activities such as round tripping and false declarations and returns to the CBN on the part of the BDCs. He provides the following example: "Under the old regime, the CBN provided roughly $10,000 per BDC on a weekly basis for the purposes of FX trade in eligible transactions to retail end users at a regulated price, yet in some cases BDCs were selling such funds to end users for all manner of transactions with very high margins thus widening the gap between the CBN rates and the rates offered by BDCs”. When questioned as to their future prospects in the market, Desmond's view was that given their only remaining function at the moment was the conversion of small amounts of foreign exchange to naira (e.g. Nigerian nationals returning from holiday and other foreign exchange earners who are not obligated to sell their foreign exchange in the new FX market) there is a risk that the majority of BDCs will go out of business.
2. The Notorious 41
There is also bad news for purchasers of goods and services on the "Notorious 41" list as these continue to remain ineligible for purchase of FX from the new FX market. The underlying rationale behind the prohibition against the "Notorious 41" is that some of these items do not add any value to the economy while some of them can be sourced locally in order to encourage local industries. Desmond made a useful distinction, placing the goods in two broad categories: (i) luxury items; and (ii) items which should be domestically produced. In other words, he explained that if an individual has enough money to buy a private jet which is on the prohibited list, they should not be taking advantage of the cheaper dollar rate offered by the CBN or the banks under the old FX regime to purchase such luxury items. On the other end of the scale, items such as rice and tomatoes are banned due to a belief that they should be produced domestically rather than imported.
There has been a mixed reaction to this decision by the CBN. Firstly, the new FX regime evidently renders point (i) above invalid, as there may no longer be "cheap dollars" available since the exchange rate is now market-driven although there is the possibility that continuing to allow such items access to the new FX market could suck up FX which would otherwise have been available for other participants in the market looking to purchase FX to import raw materials for local production and for other economy stimulating transactions. Secondly, there is an argument that the government could benefit economically by imposing a levy on the purchase of these items within Nigeria but it remains to be seen whether this shift in fiscal policy will take place. Thirdly, in relation to those items that are banned due to the fact that they should be domestically produced, many commentators have pointed out that in the wake of an event such as a natural disaster, it would be impossible to meet demand for staple items and so importing will always be required. Moreover, some industrialists have argued that most of the items on the list are not and cannot be produced locally in sufficient quantity to serve Nigeria’s ever growing population and as such a phased (rather than outright ban) would have been more welcome.
3. Local market
The biggest loser in this situation is set to be the average Nigerian. The naira in their pockets will not stretch as far as it previously did and, if rates continue to increase further, there is a threat of inflation and a subsequent increase in interest rates by the CBN. Desmond predicts that those that are exposed to foreign currency loans may find it difficult to service repayments since their naira revenues may not purchase sufficient foreign currency to repay their loans as they fall due and consequently banks are likely to see an influx of requests for loan restructuring and tenor extensions. It is clear from our conversation that there will need to be further reforms in domestic policy to stabilise the economy, as currency correction itself will not do the trick. It is a long and arduous road to economic stability and, unfortunately, it is the Nigerian people who will bear the brunt of this journey.
[Hogan Lovells would like to thank Desmond Ogba, Managing Counsel in the Finance & Projects team at Templars for speaking to us for the purposes of this blog post. Desmond has been named as a "rising star" by IFLR 1000. Templars law firm is one of the relationship firms we work with in Nigeria.]
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