As markets and investors await Central Bank of Nigeria’s (CBN) new window for determining the flexible exchange rate regime announced at the last Monetary Policy Committee (MPC) meeting, analysts from FBN’s market and liquidity risk management department and Rencap have said that the apex bank is likely to float the national currency around N298/$ and N315/$.
While FBN, in its Foreign Exchange Risk Outlook, puts the likely exchange rate about which the naira would hover at N298, Recap believes the rate would oscillate within a band of N255 and N315 to the dollar.
While both analysts are not precise on the likely rate of exchange under the new CBN proposed flexible exchange regime, they are in agreement that it could lead to higher inflation when not properly managed.
Attributing the prognosis of the range around which the floating rate might hover to the markets, FBN in its latest Weekly Risk Digest said, “The CBN will float the flexible rate around the autonomous rate of N298/$ granted for oil importers by the Petroleum Products Pricing Regulatory Agency (PPPRA)”.
But Rencap in its Economic Research of May 25 said it resorted to mathematical models to arrive at its expectations. “We think this is somewhere between the fair values suggested by our two real effective exchange rate models – N255/$1 and the longer dated one, at N315/$1.”
Are there upsides to the proposed exchange rate regime? Both analysts think so. According to Rencap, “We believe decent growth would return, particularly given the low base effect”.
To FBN, “Naturally, this should influence increased foreign portfolio inflow and improved Foreign Direct Investments in the medium term”. This also includes potentials for arresting exchange rate volatility and temper exchange rate risk in the short term.
But there are downsides to the proposed flexible exchange regime in the near term as proposed by the monetary authorities including inflation and short term market instability, according to the two analysts’ opinion.
“A market determined rate is likely to worsen inflationary impacts and instability in the short term”, FBN says.
Rencap agrees, “This would imply short-term pain, not least because of the inflationary effect”.
Inflation rate for the month of April was put at 13.72 percent, according to figures by the National Bureau of Statistics (FBN), but FSDH Inflation Watch “expects the May 2016 inflation rate (year-on-year) to increase to 15.58%”.
The FSDH inflation figures do not take into consideration exchange rate induced hikes but are attributed to the usual basket including transportation costs triggered by increase in the pump price of premium motor spirit (PMS).
“Meanwhile”, the FBN report cautions that “there are anxieties that the CBN’s new liberalised FX regime could easily veer off the intended course, (like the alternate parallel market festered) leading to market confusion and in fact forcing the central bank, to rescind its position on the flexible structure, except it is handled cautiously and prudently”.
Citing research by the International Monetary Fund (IMF) of 116 separate cases, where an exchange rate fell at least 25 percent within a year (between 1975 and 1996), the report notes that “about half were under flexible regimes”.
“Some countries have in fact reverted from flexible to fixed rate regimes including Argentina and Hong Kong. Others that suffered very high rates of inflation shifted back to a pegged exchange rate in a crucial attempt at attaining price stability.
“Frankly, the most efficient regime is the one that stabilises macroeconomic performance, that is, minimises unpredictability in output, consumption, price level, among other variables and its long-term success depends on a nation’s commitment to achieving sound economic fundamentals.
Meanwhile, with yet dampening growth forecasts for the Nigerian economy, it is tempting to criticise the CBN for not loosening the monetary policies further to allow for an easier glide-through in the economy. However, there are concerns that the ‘policy rate had become negative in real terms’. More so, there are high prospects that the accommodating N6.06 trillion budget matched with efficient diversification modalities and a transparent FX market, might suffice to set the nation on a prospective path for improved growth, in the long run.
According to the FBN in its last weekly risk digest, the MPC decision to create a two-tiered exchange rate system was just what the market needed to move from a twenty-day stagnation.
The interbank FX rate, which is widely discussed these days, following the decision of the MPC to adopt a flexible exchange rate, had remained unmoved for 20 days at N197.43/$. The highly regulated rate was, however, jolted from its slumber, to close the week at N198.94/$ (losing N1.51/$ w-o-w according to FMDQ), after the CBN revealed its plans for the implementation of a two-tiered exchange rate system, the report noted.
The weekly report also posits that the flexible rate proposed by government has potential to attract foreign capital because it would help investors better value their investments.
“It is expected that the shift from the somewhat doctored fixed exchange rate will enable a truer posture for the Nigerian local currency. As the naira exchanges with the dollar at a non-superficial rate, foreign investors are more convinced about the values of their investments, as opposed to the ambiguities witnessed when the rates were controlled by the CBN.”
Meanwhile, reports suggest that the CBN may reverse itself on the policy following delay in announcing the new window following Tuesday’s meeting with Financial Market Dealers Association (FMDA), an association made up of currency dealers, a Reuters report notes.
“We are unlikely to get anything in the next two to three weeks. I don’t think the guidelines are ready. The reality is that he (the governor) does not understand the meaning of signals,” said one senior banker, speaking on condition of anonymity.
“By not coming out (with details) the governor has shown he doesn’t believe the policy. There is the risk the policy could be reversed,” the senior banker added.
Analysts at DaMina Advisors say the delay could cause the central bank to backtrack as it tries to reconcile the new policy with the president’s vow not to devalue the naira, the report noted.
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