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DUTCH AUCTION SYSTEM SHUTDOWN: IMPLICATIONS FOR THE NAIRA

The Central Bank of Nigeria midweek announced the shut-down of the official foreign exchange market, an action that is aimed at shoring up the value of the naira. Tunde Abodunde in this piece examines the implications of this development on the national currency. We do hope you find it educative and informative.

Global oil price has begun its ascent, but the pressure on the naira and its toll on Nigeria’s external reserves has yet to subside, a situation that has led to a de-facto devaluation of the naira by the Central Bank of Nigeria (CBN).

As part of on-going measures to shore up the value of the naira, the CBN on Wednesday 18th February closed the official foreign exchange market, the twice weekly retail Dutch Auction System (RDAS) where it sells forex to banks, thereby transferring all demands to the interbank market where the dollar sells for an average N198.

Under new trading rules, banks will only be able to purchase foreign exchange if they have a prior order from a corporate customer, such as a fuel importer or foreign mobile phone company looking to repatriate profits or dividends.

Devaluation of the currency had become imminent, as the demand for forex continued to rise despite the repeated intervention of the Central Bank, forcing the CBN Governor, Mr Godwin Emefiele to state at a stakeholders meeting in Lagos that it would stop its support for the importation of some products.

Emefiele stressed the need to produce locally most of the commodities that are presently being imported into the country, so as to develop the country and strengthen the currency.

“In the course of time we are not going to ban the importation of rice but we are not going to provide foreign exchange if you are going to import rice into the country. So if you are interested in rice, I will advise that you go into the production of rice.

“If you want to use your dollar that you have kept somewhere, there is no problem but at some point we will not allocate foreign exchange for you to import rice. The same way we will graduate it to other products,” he had emphasised.

Following the closure of the rDAS, the CBN will now only meet forex demands which it deems genuine; as it had assured that it will continue to provide foreign exchange for legitimate investors and businesses.

In a statement issued and signed by the director of Corporate Communications, Ibrahim Mu’azu, the apex bank said it had taken the decision to close the official window to end the multiple exchange rates and also preserve the country’s dwindling external reserves.

The apex bank noted that the wide gap between the official and interbank value of the naira had engendered “undesirable practices including round tripping, speculative demand, rent seeking, spurious demand and inefficient use of scarce foreign exchange resources by economic agents.”

In view of this, Mu’azu in the statement said, “it has become imperative that appropriate actions be taken to avert the emergence of multiple exchange rates regime and pressure the country’s foreign exchange reserves.

“Consequently, we wish to inform all authorised dealers and the general public that with effect from the date of this press release, the RDAS/WDAS foreign exchange window with the CBN is hereby closed. Henceforth all demand for foreign exchange should be channelled to the interbank forex market.”

In view of this development, some of the likely effects of the shutdown are discussed below:

  1. Real Valuation of Naira: Under the former regime, Naira losses were often frequently large enough to trigger a daily shutdown of Nigeria’s foreign exchange market. In response to this pressure, the CBN intervened directly through special auctions, filling demand for forex directly, but at a much higher dollar-naira exchange rate than that prevailing at the bi-weekly official retail Dutch auctions. The nullification of the exchange rate band will once and for all end speculations on the Naira.
  2. Restoration of Fiscal Discipline: Prior to the Wednesday’s announcement, importers of fuel products and certain categories of manufacturers were allowed to buy their foreign exchange through the CBN window. But as the margin between the official and interbank rates widened in recent months, it became more lucrative for eligible buyers to engage in arbitrage instead of importing the goods for which they had supposedly bought their foreign exchange from the official window of the CBN. The shutdown of RDAS would disabuse banks from the sharp practices of speculation and round-tripping.
  3. Diversification of Economy: Diversifying the economy has been an issue that has continually been hammered on by government, economists as well as operators in the real sector. In the era of a low currency value the former Deputy Governor of the Central Bank of Nigeria (CBN) Tunde Lemo, noted that Nigerians will have to depend on import substitution and increase export drive to be able to scale through 2015. “We need to buckle up. Nigerians should be patriotic, let us depend less on importation, let us be self-sufficient. Let us embrace import substitution, if we do that, it will not matter what the exchange rate of the naira is. The disengagement of banks from forex activities may shift their focus to developing the real sector in order to diversify the nation’s economy.
  4. Convertibility and Acceptability of Naira across the Borders of Nigeria
  5. Creation of more transparency in the forex market
  6. Re-pricing of goods which were previously imported at the RDAS rate, etc.