CEM REPORT, FINANCE | In a dramatic move to halt the Nigerian naira’s precipitous decline, the Central Bank of Nigeria (CBN) on Wednesday imposed stringent limits on how much foreign currency banks can hold, raising concerns about a potential squeeze on dollar access for businesses and individuals.
The naira’s freefall reached a record low on Tuesday, plunging below the unofficial black market rate for the first time ever. This followed a controversial decision by the market regulator, FMDQ Exchange, to tweak its naira closing rate calculation methodology, effectively amplifying the currency’s woes.
With dollar-denominated sovereign bonds also taking a beating, the CBN felt compelled to act decisively. The new policy places a cap of 20% of shareholders’ funds on banks’ net open foreign currency positions for short positions and imposes a complete ban on long positions. Additionally, banks are mandated to harmonize their foreign exchange reporting procedures, bringing greater transparency to the sector, a Reuters report details.
The new limits effectively force banks to liquidate their excess dollar holdings, potentially making it tougher for businesses and individuals to access hard currency through official channels. This could dampen economic activity and fuel inflation, raising concerns about the potential downsides of the CBN’s intervention.
“While the CBN’s intentions are noble, the immediate impact of these restrictions could be a tightening of dollar liquidity in the market,” notes Wale Adesina, CEO of Pan-African investment firm Vetiva Capital. “The key now is for the CBN to implement these measures carefully and ensure that businesses have alternative channels to access forex to avoid economic disruptions.”
CBN New Forex Policy
The new measures, outlined by the CBN, are nothing short of a seismic shift in Nigeria’s forex policy. Here’s a breakdown of the key changes:
Limits on Open Net Positions: Banks are now restricted from holding net open positions exceeding 20% of their shareholders’ funds for short positions and zero for long positions. This effectively clamps down on speculation and forces banks to balance their foreign currency holdings.
Harmonized Reporting: Banks are mandated to adopt a standardized reporting format for their forex transactions, allowing the CBN to better monitor and regulate the market.
Liquid Asset Cover: Banks must maintain liquid foreign assets to cover maturing foreign currency obligations, ensuring they have enough reserves to meet their commitments.
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Forex Contingency Plans: Banks are required to establish foreign exchange contingency funding arrangements with other institutions, enhancing their resilience to unforeseen shocks.
Eurobond Repatriation Controls: Early repayments of Eurobonds will require CBN approval, preventing sudden capital flight and protecting the naira’s stability.
These measures represent a significant departure from the CBN’s previous hands-on approach to managing the exchange rate. In the past, Nigerian banks enjoyed relative freedom to hold open net positions on the dollar, allowing them to act as market makers and facilitate two-way forex trading. However, the CBN argues that this system incentivized banks to hoard foreign currency, further exacerbating the dollar shortage and fueling exchange rate volatility.
The new regulations, while aimed at stabilizing the naira, are likely to have significant implications for Nigerian businesses and individuals. Access to foreign currency could become more limited, potentially impacting import-dependent industries and raising the cost of imported goods. Additionally, the uncertainty surrounding the new policy may dampen investor confidence and hinder economic growth.
“These are drastic measures, but they are necessary to address a crisis of confidence in the naira,” commented economist Ayo Okunola. “The long-term goal is to create a more transparent and efficient forex market, but in the short term, Nigerians will need to brace themselves for some turbulence.”
Beyond immediate challenges, the CBN’s move highlights the underlying vulnerabilities of the Nigerian economy, heavily reliant on imported goods and exposed to fluctuations in global oil prices. Diversifying the economy, bolstering export earnings, and addressing structural issues remain crucial for long-term currency stability and sustainable economic growth.
Only time will tell if the CBN’s gamble pays off. But one thing is clear: the days of unfettered forex speculation in Nigeria are over. The question now is whether these new measures will be enough to stabilize the naira and navigate the country through its current economic storm.
