The Nigerian Foreign Exchange Market free essay sample

The Nigerian foreign exchange market; rate determination; control and prospects for Naira convertibility Good morning members of the high table, my colleagues in the industry and all other distinguished guests. It is my greatest pleasure to present this paper at the Foreign Exchange seminar organized by the Chartered Institute of Bankers of Nigeria. I hope I am able to shed light on this extremely challenging topic. Definition: The foreign exchange market can be defined as the collective activity of exchanging currencies i. e. here currencies are bought and sold. The price for the currency is known as the exchange rate. This is one unique market that is not located anywhere but exists on electronic platforms – telephones, telex, internet and other electronic gadgets. The reality of today is that most convertible currencies offer a 24-hour access for market participants. This unique feature has brought with it significant depth in the market. The Nigerian foreign exchange marke t: The Nigerian foreign currency market is to a large extent a part of the global Fx market. However, it is still in the infancy stage in terms of development and does not offer a 24-hour access to the trading of its local currency. To appreciate the Nigerian forex market it is pertinent to highlight its make up. In carrying out this analysis the market can be divided into two major categories; †¢ The official market †¢ The unofficial market These markets have unique features, which therefore dictate the profiles of its participants. The official market, as the name connotes, is the officially recognized market by the regulatory authorities. The market allows the sale of foreign currency for transactions that are eligible and allowed by the Central Bank of Nigeria (Federal Government of Nigeria). Such eligible transactions must be supported by all specified documents. This market is further broken down into two categories, the Central Bank of Nigeria (CBN) market the Autonomous market. The Central Bank of Nigeria (CBN) market: The market is peculiar in that it handles over 75% of the total volume of foreign currency sold in Nigeria (excluding inter-bank). The market is also used to manage the foreign exchange rate in the economy. The system currently adopted to sell foreign currency in the CBN market is the Dutch Auction System. I have used currently because the CBN has adopted a variety of distribution methods over the years. The CBN rate sets the direction for the market. Its rate is usually the lowest in all the foreign currency markets. The Autonomous market: This market comprises all other players in the official market other than the CBN. They are; ? The export proceeds market: This is the generic name for all foreign currency inflows outside of the CBN i. e. roceeds from exports, oil companies, government parastatals, individuals etc. The market supports the settlement required in the inter-bank market and settlements of capital accounts’ transactions that are not eligible for CBN funds though valid transactions. ? The inter-bank market: This market came into existence in September 1986 when the CBN allowed banks to trade foreign exchange amongst themselves (as is done internationally). The stan dard of trading in the market is â€Å"two-way quote† i. e. a quoting bank always gives its binding buying and selling rates to a calling bank. There is heavy documentation and reporting requirement on the buy and sell sides in the export proceeds and inter-bank markets. In some instances volume limits are imposed. ? The Bureau-de-change: These are small outfits licensed by the CBN to handle retail cash transactions. Recently some of their members were licensed to process funds required for travel purposes i. e. Business Travel Allowance (BTA)/Personal Travel Allowance (PTA). The unofficial market warehouses all FX utilisation that are not eligible, i. e. not allowed by the CBN, and all sales of foreign exchange that are not reportable to the CBN. This market can be divided into; the free-funds market and the street market. The Free-funds market is also known as the Transfer or Convertible market: This market has been promoted by the strict controls that exist in the official market and the transparency issue on duties. It has been said that this market provides support for the management of the duty applied on goods imported. The forex for all prohibited goods brought into the country may also have this market as its source. It is a widely held opinion that the substantial part of the supply to this market is â€Å"sterilized† official funds. Most foreign exchange earners (with low corporate/individual compliance commitments) supply funds to this market because of its higher rates i. e. premium over the official sources and confidentiality. The premium that obtains here is primarily due to the absence of documentation. The Cash/Travelers’ cheque (TC) market: This is the easiest of the markets to access. It commands the highest premium due to the speed and guarantee of delivery offered. The cash market is the street market mostly found around the international airports, hotels and major markets. (In Lagos – Tejuosho, Akerele, Ikeja) Rate determination in the Nigerian forex market As with other markets the interplay of demand and supply dictate the price. Demand supply: This simply says the higher the demand (over supply) the higher the price. If the demand for dollar increases significantly relative to its supply, more Naira will be required to purchase a single unit of dollars. However behind the demand and supply are a group of factors: Fundamental, Institutional and Technical. The fundamentals: By this I mean factors concerned with the economic financial condition of the country i. e. alance of payment (bop), interest rates and inflation rates, leading and lagging indicators, economic growth, fiscal deficits and the money supply, market expectation and economic ideology. Institutional factors constitute the policy framework surrounding a particular currency. Examples are exchange parities under Bretton Woods, European Exchange Rate Mechanism (ERM). Technical factors are the studies of the dynamics of market trends once they are under way, rather than with the supply and demand factors, which cause them. The study of how the market moves rather than why it moves. Search for psychological â€Å"resistance† and â€Å"support† levels in currency prices. The short-term scope of the foreign exchange market gives greater relevance to technical analysis over fundamental analysis. The Nigerian market is however rudimentary. Rate determination is not driven by institutional or technical factors. The fundamental factors have more relevance. The fragmentation of the market makes it difficult to have a unified rate for Naira against foreign currency (most importantly $/N). In the Nigeria therefore fx rates are determined in various ways depending on the market; The CBN market: As earlier mentioned the process adopted in this market is the Dutch Auction System (DAS). This is a system whereby a specific amount of foreign currency is offered for sale. The allotment of the currency begins with the highest bid rate received until the total amount offered is fully exhausted. The rate at which the last amount is taken up is the marginal rate or the CBN rate on the day in question. The customer determines the rate at which to bid for the funds required, however this is often informed by the volume on offer by the CBN, the demand at the previous bid and other fundamentals. This rate sets the pace for the market. And the actions of the CBN in its market affect the autonomous market, which is a very thin market – increase or decrease in supply will cause large movements in price. The export proceeds market: Most of the suppliers of funds within this market (especially the oil companies) also adopt the Dutch Auction System. They invite banks to bid for their funds. In this case, the bank is the one quoting and not the corporate customers/individuals. Prices quoted by banks are determined by the inter-bank market levels and the sentiments the inter-bank dealers hold. The inter-bank market: The money market standard for its members is the two-way quoting system. This is seen as the most professional market. Rates reflect the sentiments of the quoting banks and the market is akin to the standard of the international markets. It was introduced in Nigeria in 1997 and despite the numerous setbacks it has suffered it is still acknowledged as the best model of pricing. The position taking activities and predatory elements of the banks are basis of the flavour in this market. The market is ruled by fundamentals and the interpretation of news. The unofficial market: Rates are determined by forces of demand and supply with an underlay of fundamentals, government actions and regulatory policies. Control in the Nigerian forex market: I have taken the liberty to restrict the discussion on the controls in the market to sovereign and regulatory. This is informed by the next topic, which is convertibility. As a background therefore, we shall examine the exchange controls in the market. Sovereign control: The Federal Government of Nigeria has the final authority on foreign exchange management in the country. Until 1995, the country operated under the 1962 Exchange Control Act. In 1995, the market was partially deregulated with the Foreign Exchange and Miscellaneous decree. Some of us here will remember the statement of the then Finance Minister, Chief A. A. Ani when he presented the 1995 budget statement. Chief Ani is quoted inter alia â€Å"Bring N85 million and I will sell to you $1 million, (any amount of dollars as long as the exchange rate is at $/N85) even for BTA! †. BTA required only an airline ticket to travel abroad (Cotonou inclusive!! ) and a visa (in the case of Cotonou there was no need for a visa! ) Nigerians bought tickets and asked for dollars.