The Price Club: The New Nigerian Naira (best Layman's Explanation) - Business
The Price Club: The New Nigerian Naira
By Feyi Fawehinmi
15 June 2016
I feel like the last year has been one maddeningly long and unending conversation about the exchange rate of the Nigerian Naira. In all that time, I always found it difficult to argue for a full float of the naira. That’s what I wanted but it felt like asking for too much. So devaluation seemed like a halfway house that would ease things a bit. The main thing being that the fixed rate of N199 to $1 was completely ridiculous and untenable.
“I don float am. Una dey craze. Make una free me”
Today, the CBN went all the way to a float. To be clear, nobody ever floats their currency willingly — you are always forced into it. An example was ‘Black Wednesday’ which forced the UK to float the Pound in 1992. It was painful and embarrassing but you won't find anyone who wants to go back to pre-1992 here anymore.
So what did CBN just do? Let’s get into the meat of the matter based on what was in their circular.
Inter-Bank Foreign Exchange Club
Let’s be honest here — this is nothing new in particular. We’ve had Inter-Bank markets before but the CBN shut it down last year when it didn't like the rates the market was giving it. But given that the last year has been so abnormal, the mere presence of something so normal…my goodness. It feels like clean fresh air after being locked inside a damp house for years.
The gist of the ‘new’ market is pretty straightforward — it’s a market where people can buy and sell dollars. Think of it as a pool. All the forex coming into the country will be dumped into that pool. From there, those who want to buy will buy at whatever the price is. Before you put your forex in the pool, you will get a price from people who are waiting to buy it.
Previously the CBN only allowed banks to buy and sell forex at N197.50 and N199 respectively. Nobody was allowed to trade outside of these prices (at least not legally). This meant that a lot of the people who would normally have poured their money into the pool decided not to do so. As such, CBN was the only one filling the pool from time to time.
That’s gone now. First of all, the spread between buying and selling will be determined by the market (Point 2.1.4). Feel free to charge a N4 spread to win market share if others are charging a N5 spread. What will be the new spread? We shall see when the market kicks off next week.
Last time I was in Nigeria, I wrote about how I made a card payment and the money got converted at N288 to £1 when I had gotten N450 to £1 the same day at the airport. This was because the banks were only allowed to buy £s at the official rate (although they found ways to sell it at the unofficial rate). That too is gone now. If you visit Nigeria from abroad and you use your card, you will get a market rate i.e. the rate at the interbank determined by the market. Same goes for Western Union. I doubt anyone has been sending money to Nigeria using Western Union and MoneyGram lately. Now you can — your money will be converted to naira at the interbank rate.
This is all good stuff.
The VIP Section
The CBN has introduced something ‘new’ to the market, however. A new creature to be known as Foreign Exchange Primary Dealer (FXPD) has been created. CBN released a separate set of guidelines for these creatures.
In the club, these FXPDs are the guys who will sit in the VIP section with CBN. If forex is champagne, these creatures will be served first before anybody else. But don’t panic, this is a good thing.
These guys are not going to be dealing in small small stuff. Minimum is $10m to sit in this club. That is, to buy dollars from the CBN, they will have to quote in batches of $10m. But remember CBN is no longer going to be the sole source of dollars — so these creatures will also get to buy from oil companies and exporters.
What will they do with all that money? From the FXPDs, the money will flow downwards till it gets to you or anyone else who needs it. Not every bank will qualify for this FXPD creature status — the VIP section can only take so many people. So banks who are not FXPDs will get to buy from FXPDs.
What of Bureau De Change? They are not even allowed in the club talk less of sitting in the VIP section. Having said that, I’m told that people sometimes jump the fence to enter clubs in Lagos. Or stand outside the gate hoping to be let inside at some point. Ultimately, they will get money but only after it has flowed down from CBN to FXPDs to Non-FXPDs. Don’t cry for them — they will be ok.
These FXPD creatures can be kicked out of the VIP section by the CBN if they misbehave. I imagine no one wants to leave the VIP section to mingle with the sweaty masses on the crowded floor so hopefully, they behave. But there will always be that one fly who is not satisfied just watching the dead body being lowered into the grave…
Hedging As A Product
How do people in countries with a floating currency cope with wild swings? I mean, if you leave the currency to market forces, in theory, you can just wake up one morning and the currency has dropped by 50% ke? In theory, yes, in practice, no.
When a currency moves about wildly, that is a risk. This risk brings up different opportunities for risk management products. Imagine you’re a guy who needs to order a container from America in November this year. You know the exchange rate today but you don't know what it will be in November. You can leave it in God’s hands and take whatever the rate is in November when you need to pay.
But maybe the rate is N350 to $1 today and you think it will rise to N400 to $1 by November when you need it. To avoid that, you buy a hedge for N350 to $1 to pay out on the day you need it in November. This service will not be free —you will have to pay a fee for it. But it guarantees that on the day you need the dollars in November, you will get it at N350 to $1. Remember that you can’t see the future (well, maybe you have ‘washed’ your eyes sha) so on the appointed day in November, it might be that the dollar is actually N320. Sorry. You still have to pay the N350 you agreed to and you have lost money. But it might also be N400 on the day as you guessed. More power to you — you have saved money.
The risk in you people’s country is too much. Your container can be on the high sea on the way to Nigeria minding its business when some attention seeking militant decides to blow a pipeline just for fun. You have not finished paying for the goods when this happens. The market hears it and decides that this means that oil income will drop in the next few months, as such the price of the dollar goes up by 10%. Now, something that does not concern you at all will cost you 10% more.
All the grammar in the screenshot above is describing products that will protect against such unforeseen risks. For foreign investors, this will be a good thing. They know you can’t really trust Nigerian policymakers not to misbehave from time to time so products can be designed to reduce the kind of wild swings that cause painful losses.
I only ever check the £ to $ rate when I am about to make a trip to America. Beyond that, I don’t really care even though I have some $ exposure in some of my investments. I trust that the people who manage my small investments have protected it against wild swings. This is why countries with floating rates have the most stable exchange rates over the long term. It sounds counterintuitive but when you know the rate is determined by the market, it forces you to innovate in ways that reduces risks to manageable levels.
Friends, this is another very good thing that the CBN has done.
https://aguntasolo.co/the-price-club-the-new-nigerian-naira-6e9613715acb#.fm5meaqgo
By Feyi Fawehinmi
15 June 2016
I feel like the last year has been one maddeningly long and unending conversation about the exchange rate of the Nigerian Naira. In all that time, I always found it difficult to argue for a full float of the naira. That’s what I wanted but it felt like asking for too much. So devaluation seemed like a halfway house that would ease things a bit. The main thing being that the fixed rate of N199 to $1 was completely ridiculous and untenable.
“I don float am. Una dey craze. Make una free me”
Today, the CBN went all the way to a float. To be clear, nobody ever floats their currency willingly — you are always forced into it. An example was ‘Black Wednesday’ which forced the UK to float the Pound in 1992. It was painful and embarrassing but you won't find anyone who wants to go back to pre-1992 here anymore.
So what did CBN just do? Let’s get into the meat of the matter based on what was in their circular.
Inter-Bank Foreign Exchange Club
Let’s be honest here — this is nothing new in particular. We’ve had Inter-Bank markets before but the CBN shut it down last year when it didn't like the rates the market was giving it. But given that the last year has been so abnormal, the mere presence of something so normal…my goodness. It feels like clean fresh air after being locked inside a damp house for years.
The gist of the ‘new’ market is pretty straightforward — it’s a market where people can buy and sell dollars. Think of it as a pool. All the forex coming into the country will be dumped into that pool. From there, those who want to buy will buy at whatever the price is. Before you put your forex in the pool, you will get a price from people who are waiting to buy it.
Previously the CBN only allowed banks to buy and sell forex at N197.50 and N199 respectively. Nobody was allowed to trade outside of these prices (at least not legally). This meant that a lot of the people who would normally have poured their money into the pool decided not to do so. As such, CBN was the only one filling the pool from time to time.
That’s gone now. First of all, the spread between buying and selling will be determined by the market (Point 2.1.4). Feel free to charge a N4 spread to win market share if others are charging a N5 spread. What will be the new spread? We shall see when the market kicks off next week.
Last time I was in Nigeria, I wrote about how I made a card payment and the money got converted at N288 to £1 when I had gotten N450 to £1 the same day at the airport. This was because the banks were only allowed to buy £s at the official rate (although they found ways to sell it at the unofficial rate). That too is gone now. If you visit Nigeria from abroad and you use your card, you will get a market rate i.e. the rate at the interbank determined by the market. Same goes for Western Union. I doubt anyone has been sending money to Nigeria using Western Union and MoneyGram lately. Now you can — your money will be converted to naira at the interbank rate.
This is all good stuff.
The VIP Section
The CBN has introduced something ‘new’ to the market, however. A new creature to be known as Foreign Exchange Primary Dealer (FXPD) has been created. CBN released a separate set of guidelines for these creatures.
In the club, these FXPDs are the guys who will sit in the VIP section with CBN. If forex is champagne, these creatures will be served first before anybody else. But don’t panic, this is a good thing.
These guys are not going to be dealing in small small stuff. Minimum is $10m to sit in this club. That is, to buy dollars from the CBN, they will have to quote in batches of $10m. But remember CBN is no longer going to be the sole source of dollars — so these creatures will also get to buy from oil companies and exporters.
What will they do with all that money? From the FXPDs, the money will flow downwards till it gets to you or anyone else who needs it. Not every bank will qualify for this FXPD creature status — the VIP section can only take so many people. So banks who are not FXPDs will get to buy from FXPDs.
What of Bureau De Change? They are not even allowed in the club talk less of sitting in the VIP section. Having said that, I’m told that people sometimes jump the fence to enter clubs in Lagos. Or stand outside the gate hoping to be let inside at some point. Ultimately, they will get money but only after it has flowed down from CBN to FXPDs to Non-FXPDs. Don’t cry for them — they will be ok.
These FXPD creatures can be kicked out of the VIP section by the CBN if they misbehave. I imagine no one wants to leave the VIP section to mingle with the sweaty masses on the crowded floor so hopefully, they behave. But there will always be that one fly who is not satisfied just watching the dead body being lowered into the grave…
Hedging As A Product
How do people in countries with a floating currency cope with wild swings? I mean, if you leave the currency to market forces, in theory, you can just wake up one morning and the currency has dropped by 50% ke? In theory, yes, in practice, no.
When a currency moves about wildly, that is a risk. This risk brings up different opportunities for risk management products. Imagine you’re a guy who needs to order a container from America in November this year. You know the exchange rate today but you don't know what it will be in November. You can leave it in God’s hands and take whatever the rate is in November when you need to pay.
But maybe the rate is N350 to $1 today and you think it will rise to N400 to $1 by November when you need it. To avoid that, you buy a hedge for N350 to $1 to pay out on the day you need it in November. This service will not be free —you will have to pay a fee for it. But it guarantees that on the day you need the dollars in November, you will get it at N350 to $1. Remember that you can’t see the future (well, maybe you have ‘washed’ your eyes sha) so on the appointed day in November, it might be that the dollar is actually N320. Sorry. You still have to pay the N350 you agreed to and you have lost money. But it might also be N400 on the day as you guessed. More power to you — you have saved money.
The risk in you people’s country is too much. Your container can be on the high sea on the way to Nigeria minding its business when some attention seeking militant decides to blow a pipeline just for fun. You have not finished paying for the goods when this happens. The market hears it and decides that this means that oil income will drop in the next few months, as such the price of the dollar goes up by 10%. Now, something that does not concern you at all will cost you 10% more.
All the grammar in the screenshot above is describing products that will protect against such unforeseen risks. For foreign investors, this will be a good thing. They know you can’t really trust Nigerian policymakers not to misbehave from time to time so products can be designed to reduce the kind of wild swings that cause painful losses.
I only ever check the £ to $ rate when I am about to make a trip to America. Beyond that, I don’t really care even though I have some $ exposure in some of my investments. I trust that the people who manage my small investments have protected it against wild swings. This is why countries with floating rates have the most stable exchange rates over the long term. It sounds counterintuitive but when you know the rate is determined by the market, it forces you to innovate in ways that reduces risks to manageable levels.
Friends, this is another very good thing that the CBN has done.
https://aguntasolo.co/the-price-club-the-new-nigerian-naira-6e9613715acb#.fm5meaqgo
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