Fixed-Float: A Battle for Convergence
In August last year, the Central Bank of Nigeria (CBN) clamped down on dozens of Money Transfer Operators (MTOs) by restricting inbound money transfer operations to companies that satisfy certain minimum requirements. Following this, only three MTOs – Western Union, MoneyGram and Ria, will be able to continue operations in Nigeria.
The CBN took this decision in a bid to achieve convergence of the interbank (official) and parallel market exchange rates. This move is significant as a bulk of the $20 billion remittances to Nigeria in 2015 was sent via mobile-based MTOs.
It is easy to understand why the Central Bank took this decision. In other countries, MTOs receive foreign currencies from their clients and exchange them for local currencies through the respective country's central bank. In Nigeria, most MTOs deal in offshore swaps (these companies accept foreign currency as payment from senders, then swap the cash with foreign counterparties at more attractive offshore rates). Some MTOs also sell forex to the local parallel market and credit beneficiaries via a deposit. These forex transactions are subsequently sold by the BDCs to bidders.
In both cases, the foreign currency remains unaccounted for in CBN external reserves. This is partly responsible for the significant disparity between the parallel and interbank rates. The CBN hopes that the clampdown will hasten the convergence of the interbank and parallel market exchange rates.
While an argument could be made that the move is necessary because of backhand operations of these MTOs, the policy could eventually dent the volume of remittances to the country. Given the scarcity of foreign exchange and the precarious state of the Nigerian economy, it is a strikingly risky move.
The aim of market rate convergence cannot be achieved by fiat or by force. Instead, the CBN may need to accept that the first step out of this unpalatable situation is a float of the naira to allow proper price determination in the exchange rate.
It should be noted that the CBN had vehemently resisted calls for a float of the currency in order to ease pressure on the external reserves and attract foreign portfolio investor for over a year before it relented in June. Furthermore, hindsight has revealed that the June announcement was actually a devaluation or extreme dirty float, thus reducing investor confidence in the bank.
A float of the Naira is not a silver bullet which will cure the current economic malaise; it will simply provide a foundation for the introduction of policies which will encourage investments and support economic growth.
It is pertinent that the CBN allows the Naira find its fair value via a float. Only when this occurs will investment flow back into the economy. Investment in the country dwindled and capital flight has become the norm since the introduction of capital controls. However, a free float of the naira will restore investor confidence as investors will no longer fear an erosion of the value of their investment. This will help improve liquidity in the market and subsequently, reduce the demand being rolled over to the black market. With time, market rates will tend towards convergence.
A float also means that the CBN would not need to spend the nation’s thin reserves on defending the Naira. So far, external reserves have dropped from about $54 billion in 2008 to just over $25 billion at the end of 2016.
Most importantly, it should be noted that the black market is a consequence, not the cause of shortages. Eliminating the black market by fiat or decree is impossible. It can only happen when market forces are allowed to determine the fair price of a product. And this becomes likely when there are fewer market restrictions. For example, the list of 41 items barred from the official market creates a wedge between the official and black market rates.
In light of this, it may be prudent for the CBN to review its policy and allow mobile MTOs back into the market. Right now, the apex bank is merely treating a symptom while allowing the disease to fester. It needs to ensure that the market determines the fair price of the currency. A free float will boost investor confidence, improve liquidity and lower the spread between the official and parallel rates. If the CBN remains focused on dictating market prices while restricting forex inflow, it would surprise no one if economic conditions deteriorated further.
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