After a year of rancour, the Central Bank of Nigeria (CBN) finally gave in and abandoned the unrealistic peg at N197 to $1 that it had maintained was suitable and necessary. The whole of social media was ablaze with commentary. When I read through the (pretty robust) memo detailing the changes, I was impressed. No halfway house here. A full float of the currency and the introduction of naira settled non-deliverable futures (NSNDF) to curb speculation**. It was a little too good to be true. They seem to have covered everything. For a good coverage, check out Feyi Fawehinmi’s post – The Price Club: The New Nigerian Naira.
I probably should point out I’m absolutely convinced they didn’t cook that stuff up overnight. I’m sure they’d been working on this for a bit and didn’t have the liver to put it out there probably because… Yes men are afraid of their oga. The only weird bits were the insistence on maintaining the ban on the 41 items from the interbank market as well as blocking the banks from selling to the BDCs. The combination of these meant that part of the demand was shifted to the parallel market and we could continue to expect a significant spread between that and the interbank as the BDC operators would probably have to get their dollars from more expensive sources.
So all well and good. A floating currency with the price determined by market forces and a futures market to hedge risk. Big big transformation. On the day it launched we were all checking out Bloomberg, Google, FMDQ, Yahoo Finance and the myriad of sources to see what gives. Palpable excitement in the air. But nothing much happened, the CBN had to extend the trading day and step in to sell dollars and futures – a whopping $532m in the spot market and another $3.5bn in futures. The next day some more trading – mostly driven by the CBN. And so it has been everyday since then. Nothing much happens – and then the CBN steps in and there’s some trade between the banks and the CBN. So much for an interbank market.
The way the market should work on a normal day is this. Caveat: this is very simplified.
- Buyers and sellers show up – this is not a given. If both parties are not present there is no market.
- The buyers bid a price and quantity (known as bid)
- The sellers ask for a particular price for an available quantity (known as ask)
- The trade happens when the bid matches the ask and that price is the market clearing price at that point. The sellers want to sell at the highest price possible and the buyers want to buy at the lowest price they can. In that tug of war the “best” price is arrived at based on the availability (supply) and want (demand).
Armed with these basics it’s easy to get some understanding of what is going on in the market. I made some observations:
- Liquidity requires sellers and buyers, but it doesn’t seem that there are any sellers apart from the CBN. All the banks seem interested in doing is buy.
- There are two possible explanations for that. One is that nobody else has dollars to sell apart from the CBN (ehrm…), the other is that nobody else has dollars to sell at the current bid prices.
- I believe the second explanation is the correct one, after all our dear BDC operators always seem to be getting dollars to sell. I tested the market with $1k on day two of the floating regime. Disappered immediately for about N335 : $1.
- If the bid prices are too low to attract sellers the normal thing that should happen is that the bids go up until they are fulfilled – unless there is a maga somewhere (read CBN) ready to supply at a price below everyone else in the market.
Cue the conversation below on Twitter yesterday:
Bro! Are we on a managed floating system or a free floating system? @DoubleEph
— Otsu Aloaye Collins (@ALOAYE_JAVI) June 29, 2016
Atink we are on a kite system. It can go up but the rope is still in someone’s hand on the ground https://t.co/nRnIGjT9B4
— F (@DoubleEph) June 29, 2016
The naira is supposed to be floating, with market forces determining the price. But that is a story. In reality it is allowed to float, but only to an extent. Once the rope plays out to the end of the predetermined height, the CBN steps in and tugs. This is not much different from what we had before where the CBN fixed a midpoint and allowed trades within a band. Sure, the CBN reserved the right to step in as deemed necessary. But it looks like they’re still the only game in town at this point. The only way to fix that is to stop intervening everyday and providing these cheap dollars that the system has been hooked on for so long. In that scenario it’s conceivable that bid prices will go up until a market clearing rate is reached.
There seems to be a major reluctance to do that. I’m not surprised. The President is still not convinced that the floating/devaluation thing is the right thing to do, he said as much just two days ago. The CBN governor had barely announced the float before he was writing letters to the president to assure him of what the rate would be in the future (oh crystal bollocks) and also important to note is the restructuring of the petrol pricing that happened some months back. In that move, it was assumed that dollars would be sourced at about N285. If the USD were to freely trade at say N320, it may be reasonably assumed that petrol prices will have to go up. We all know the President wouldn’t like that as well.
We expect that foreign exchange will be sourced at an average of about N285 to the dollar, (current interbank rate).
— Prof Yemi Osinbajo (@ProfOsinbajo) May 13, 2016
We’ve been on this price fixing thing for too long. Even before there was an interbank market, the VP knew what it’s current rate was. I’m not surprised that that’s the precise rate that we don’t seem to be able to go past with this our floating kite market. You can’t fool people by telling stories. If you didn’t want to float, devlaue and leave it at that. These games destroy our credibility and undermine every good thing that we attempt to do. And investors don’t like to deal with people with a bad cred.
Foreign investors are still skeptical
& will take some time to convince them
So for now, only CBN & IOCs are selling
Market needs more
— Tunji Andrews (@TunjiAndrews) June 29, 2016
The Nigerian government needs to get everyone into a room and decide what they really want to do. Once they decide, they need to go out and then do it. This idea of saying one thing and then doing another and hoping no one notices stinks. Enough of the stories.
** The NSNDF stuff mentioned earlier is particularly important. I did some googling on that to understand what it meant and the implications. The point of a futures contract is to hedge some of the risk involved with prices that flap about a lot (e.g. floating currencies) and is essentially an agreement to supply a good (in this case dollars) at some future date at a pre-agreed price. With that contract in place you can stop worrying about the future price that you can’t control/predict and focus on your business. The non-deliverable part is interesting. In this contract you don’t actually supply the dollars – you simply look at the difference between the price you agreed on (futures price) and the price on that day (spot price) and you pay the difference to the whoever deserves it – in naira (hence the naira settled part).