The Central Bank of Nigeria’s (CBN) recent move to reintroduce the Retail Dutch Auction System (rDAS) has garnered significant attention and mixed reactions from analysts, economists, and stakeholders across various sectors. The reintroduction of rDAS, which was previously suspended in 2015, is part of the CBN’s broader strategy to stabilize the foreign exchange (FX) market amidst mounting pressures on the Nigerian economy.

A Temporary Reprieve in a Stormy Market

The auction, which saw bids totaling $1.2 billion from 32 Authorized Dealer Banks, represents a substantial effort by the CBN to inject liquidity into the FX market. Of the total bids, $876.3 million from 26 banks qualified at an approved cut-off rate of ₦1,495.0/$, while bids valued at $313.7 million from six banks were disqualified. This intervention led to a 1.7% appreciation of the Naira at the NAFEM window, with the currency closing the week at ₦1,574.2/$.

However, while this immediate impact appears positive, the broader implications of the CBN’s strategy raise questions about its long-term sustainability. Analysts at Afrinvest (West) Africa Limited have expressed concerns that the CBN may not possess the necessary financial resources to meet the average FX demand over an extended period. This concern is echoed by various stakeholders who have called on the CBN to ensure that its interventions are sustainable and do not lead to further economic instability.

Historical Context: The rDAS and Nigeria’s FX Challenges

The rDAS system, a mechanism for direct FX sales by the CBN through banks to end-users, was initially suspended in 2015 due to challenges in maintaining a stable exchange rate. The decision to suspend rDAS was influenced by a combination of factors, including declining oil revenues, reduced FX reserves, and a growing gap between the official and parallel market exchange rates. The reintroduction of rDAS in 2024 reflects the CBN’s recognition of the need to actively manage FX liquidity and address the widening gap between supply and demand in the market.

Nigeria’s FX market has long been a source of economic volatility. The country’s reliance on oil exports, which account for more than 90% of FX earnings, has made the economy vulnerable to fluctuations in global oil prices. This dependency has been further exacerbated by challenges in domestic oil production, pipeline vandalism, and underinvestment in the oil sector. As a result, the CBN has often resorted to various measures, including FX restrictions and multiple exchange rate windows, to manage the supply of foreign currency and stabilize the Naira.

The Sustainability of CBN’s FX Strategy

The sustainability of the CBN’s current strategy is a topic of intense debate among economists and market participants. The CBN’s foreign reserves, which stood at $37.1 billion as of the last Monetary Policy Committee (MPC) meeting, are a critical factor in determining the central bank’s ability to continue its interventions in the FX market. According to Dr. Yemi Cardoso, the CBN’s reserves are sufficient to cover 11 months of imports, based on a monthly average import bill of $3.3 billion.

However, the International Monetary Fund (IMF) estimates Nigeria’s monthly import bill at $6.0 billion, suggesting that the reserves could cover only six months of imports. This discrepancy underscores the fragility of Nigeria’s external position and raises concerns about the CBN’s capacity to sustain its interventions, especially if FX demand continues to outpace supply.

In a report dated August 9, 2024, Afrinvest analysts highlighted the potential risks associated with the CBN’s strategy. They warned that if the magnitude of bids at the rDAS auction ($1.2 billion) were to be met weekly, and if the rate of reserve accretion does not offset outflows, Nigeria’s FX reserves could run dry in six to nine months. This scenario would leave the economy vulnerable to a severe FX crisis, with potentially devastating consequences for businesses, consumers, and the broader economy.

The Manufacturing Sector’s Plea for Stability

One of the most vocal critics of the current FX regime is the Manufacturers Association of Nigeria (MAN). The association has expressed deep concern over the CBN’s ability to fulfill its obligations under foreign exchange forward contracts, which were issued to manufacturers with the promise of delivering foreign currency at a specified future date in exchange for an upfront Naira payment.

The Director-General of MAN, Segun Ajayi-Kadir, warned that the CBN’s failure to honor these contracts could plunge the manufacturing sector into a crisis. The sector, which is heavily reliant on imported raw materials and machinery, has already been grappling with the effects of FX shortages, which have led to higher production costs, reduced output, and job losses. The ongoing investigation by the Economic and Financial Crimes Commission (EFCC) into certain FX transactions has further complicated the situation, raising concerns about the CBN’s credibility and the potential for further disruptions in the FX market.

Broader Economic Implications

The challenges facing the CBN’s FX strategy are not limited to the manufacturing sector. The broader economy is also at risk, particularly in light of Nigeria’s weak economic fundamentals. The country’s GDP growth has remained sluggish, averaging just 2.1% between 2015 and 2023, well below the rate needed to keep up with population growth. Unemployment remains high, and inflation, driven by rising food and energy prices, has eroded the purchasing power of consumers.

Moreover, the persistent gap between the official and parallel market exchange rates has created opportunities for arbitrage, further distorting the FX market and undermining the effectiveness of the CBN’s interventions. The introduction of the rDAS system, while intended to enhance FX liquidity and support price discovery, may not be sufficient to address these underlying structural issues.

The Need for Comprehensive Economic Reforms

To achieve lasting stability in the FX market and the broader economy, analysts and stakeholders have called for comprehensive economic reforms that go beyond short-term measures like the reintroduction of rDAS. These reforms should focus on boosting economic productivity, diversifying the economy away from oil, and improving the business environment to attract long-term investment.

One of the key areas of focus should be the oil sector, which remains the backbone of Nigeria’s economy. Increasing oil production to at least 1.8 million barrels per day (mbpd), as suggested by Afrinvest analysts, would help to boost FX earnings and support the Naira. However, this will require significant investment in oil infrastructure, as well as efforts to address security challenges in the Niger Delta region, where pipeline vandalism and oil theft have been major obstacles to increasing production.

Another critical area is the inflow of remittances, which have become an increasingly important source of FX for Nigeria. Encouraging more remittances through official channels, with a target of at least $20.0 billion per annum, could help to support the FX market and reduce the pressure on the CBN’s reserves. This would require policies that make it easier and more cost-effective for Nigerians in the diaspora to send money home, as well as efforts to reduce the influence of informal remittance channels.

Finally, attracting foreign direct investment (FDI) is essential for long-term economic growth and stability. Nigeria has struggled to attract FDI in recent years, due in part to concerns about policy uncertainty, corruption, and the ease of doing business. Implementing reforms to improve the business environment, protect property rights, and enhance transparency would help to attract more patient, long-term capital, with a target of at least $10.0 billion per annum.

Conclusion: A Delicate Balancing Act

The CBN’s reintroduction of rDAS and its broader FX strategy represent a delicate balancing act between managing short-term market pressures and ensuring long-term economic stability. While the immediate impact of these measures has been positive, the underlying challenges facing the Nigerian economy suggest that more comprehensive and sustainable solutions are needed.

As stakeholders continue to call for the CBN to maintain its interventions, it is crucial that these efforts are supported by broader economic reforms that address the root causes of Nigeria’s FX challenges. Only through a combination of sound monetary policy, strategic fiscal measures, and structural reforms can Nigeria achieve lasting stability in the FX market and lay the foundation for sustained economic growth.

In the meantime, businesses and investors must remain vigilant, as the risks associated with the current FX regime are likely to persist. The potential for further volatility in the Naira and the broader economy underscores the importance of prudent risk management and a cautious approach to investment in Nigeria.

As the CBN navigates these complex challenges, the eyes of the world will be on Nigeria, watching closely to see whether the country can successfully chart a course towards economic stability and prosperity.

photo source: Google

By: Montel Kamau

Serrari Financial Analyst

13th August, 2024