It would seem that a crisis afflicts the Central Bank of Nigeria’s (CBN) recently re-introduced interbank market for foreign exchange. Given the paucity of funds available to the central bank on its introduction, there were always going to be “teething” problems with the new architecture. Thus, the market’s consensus was that low levels of liquidity would drive the naira’s exchange rate up, initially. Average daily turnover in the new market, for example, has been around US$40m as against US$1bn a couple of weeks before. At the same time, expectations were that the subsequent higher naira exchange rate would then lure autonomous suppliers of foreign exchange back to the market.
That is how unfettered markets work. A shock (whatever its provenance) that attenuates supply to a market, while demand for the product in question remains the same, inevitably drives prices up. Higher prices in any market, on the other hand, either incentivise existing producers of the scarce goods to increase capacity, and/or invite new suppliers. Both of these responses to the price stimulus force price down to a new equilibrium — now this is often different from the old price at which the market cleared the good/service in question. Irrespective of where the new equilibrium lies, the challenge of regulators of a free market is to remove barriers to price discovery, and to the exit and entrance of new actors to the market.
How is the CBN’s new market failing? The ructions in the global economy, in the aftermath of Britons voting to exit the European Union is one reason. This has meant that one supply source, foreign funds managers, may now demand higher returns from holding naira-denominated assets in the increasingly uncertain post-Brexit global environment. But a far bigger cause of concern about our new “flexible exchange rate” architecture is the apex bank’s apparent resolve to keep the naira exchanging for the dollar around a pre-determined band. Anecdotal reports out of the interbank market indicate that bids are not being matched. And, indeed, that much of the reported trade may be make believe.
The markets believe that the apex bank is somehow managing demand at the market. Evidence? Simple. Despite low levels of supply, and the market’s huge, and largely unsatisfied appetite for foreign exchange, the naira has barely moved from the levels it reached after the first day of trading. Black market rates, on the other hand, have also held at where they moved to after the initial shock of a new market mechanism being introduced. So the arbitrage window between the “official” and “parallel” market remains.
Of course, the arbitrage window has always indicated levels of market inefficiency. Still, the persistence of the window could be argued in terms of the initial difficulties with setting up a new market mechanism. In addition, all of the “evidence” in favour of the apex bank’s micro-management of the market is conjectural.
The big pachyderm in the room, though, is the acknowledgment that investors believe the market manipulation story. And in these matters, “perception” is no less tactile than “facts”. Indeed, in recent reports on the economy, Bloomberg News quotes investors as saying that the “naira’s 29% depreciation isn’t enough”. Tellingly, Bloomberg quotes Rick Harrell, an analyst with Loomis Sayles & Co as arguing “That the currency’s been so stable since the devaluation tells me that the central bank is still heavily managing it. If we saw gradual depreciation to 300 or above, investors might feel more comfortable coming back.”
At the heart of the crisis in the new interbank market, then, is a disagreement about what is fair value for the naira. An out-of-pocket CBN that is reported to have assured the fiscal authorities that this value stands around US$1/N250, is hoping to attract interest from an investor community that puts the naira value a lot closer to the parallel market rates. In between this rock and a very hard place is a fiscal authority that is minded to abrogate the “laws” of economics, and a significant portion of the populace that would not mind cocking a snook at the entire foreign investor community.
All fair at this point. But interrogate the dynamics of this economy a little, and it is obvious that the failure of the CBN’s “market-based” foreign exchange pricing mechanism would have us on the road to Pyongyang, with a brief stopover in Caracas. It would then not matter that the apex bank’s commitment to “free markets” was superficial. It would be enough that this failure would have helped reinforce in minds that were never of a strong persuasion the narrative around markets’ supposed boons being illusory, ensuring that future reforms of an increasingly unproductive economy, would be that much harder to implement.