By Babajide Komolafe

It was a very familiar road with a familiar destination which the Lamido Sanusi led Central Bank of Nigeria chose to embark on.

Sanusi

At the end of January 2013, the official exchange rate stood at N155.74 while the parallel market rate was N159 per dollar. The difference between the two rates, referred to as the parallel market premium was N3.26 or 2 per cent, well below the five per cent global benchmark.

But by the end of the year, the premium had widened to 11 per cent or N17.3. Though the official exchange rate remained stable at N155.7 per dollar, the parallel exchange rate had risen by 8.8 per cent to N173 per dollar.

“The Committee also expressed concern about the widening gap between the official and the BDC exchange rates, noting that this could precipitate speculation and round-tripping.

Though, the BDCs represent a small component of the foreign exchange market, the widening spread appeared to have fed into creeping increases in core inflation”, lamented the

CBN Governor, Lamido Sanusi   at the Monetary Policy Committee (MPC) meeting held on January 21st.

But this should not have happened in the first instance but for the fact that the apex bank surprisingly  forgot what happened in 2011.  That year, specifically in June, the CBN, restricted to $250,000 the amount of autonomous foreign exchange each bank could sell to BDCs.

The apex bank observed that much of the foreign exchange demand in the interbank market and causing the interbank rate to rise persistently is not consistent with economic realities. It was informed that most of this demand was coming from BDCs.

Of course the demand was actually been fuelled by politicians who have suddenly adopted the dollar as their currency of trade because of its portability. Thus the apex bank decided to restrict dollars that banks can sell to BDCs.

The restriction though caused the interbank exchange rate to fall and converged with that of the official rate and hence close the gap between the two rates, it however caused the parallel market exchange rate to rise from N158 per dollar to N167 per dollar, with the gap between the official exchange rate and the parallel market rate widening from N3.19 to N16.54.

Thus, it was surprising, when the CBN in September last year introduced a set of restrictions on the foreign exchange market. It banned foreign currency collection of proceeds of international money transfer, banned importation of foreign currency by banks, and pegged dollar sale of banks to BDCs to $250,000 per BDC per week.

According to former President, Chartered Institute of Bankers of Nigeria (CIBN) and Managing Director, Maxifund Securities Limited, “It was a bad policy.”  In simple economics, the restrictions were reductions in foreign exchange supply and in response to the law of demand and supply, the parallel market exchange rate begin to rise.

Furthermore, the restrictions empowered the banks as the major source of foreign exchange supply of autonomous foreign exchange in the open market. Consequently they became price givers and dictated the foreign exchange rate at which they sell to BDCs.

When the CBN introduced a circular that pegged their margin to one per cent above interbank rate, the banks resorted to hoarding and round tripping.  “Some of the banks would even post the rates but when you want to buy they will say that they don’t have”, noted Alhaji, Aminu Gwadabe, President, Association of Bureaux De Change Operators of Nigeria (ABCON), which is the umbrella body of BDCs.

It was this scenario that caused the parallel market exchange rate to rise from N163 per dollar at the end of September to N173 per dollar at the end of December. It was a problem caused by forgetfulness of history.

Though very harmful to the economy, the parallel market premium is however caused by the government or its monetary agency. This lesson which is also the conclusion of many academic works on parallel market and parallel market premium is summed up by Babajide Komolafe (2009) as follows.

“The parallel market derives its importance and power from the premium. Also the size of the premium reflects the amount of official restriction of external transactions in the official foreign exchange market and it is the motivating factor for diversion of foreign exchange from the official market to the parallel market”.

It is for this reason that the Professor Soludo led CBN in 2006, introduced the policy titled, “Further Measures To Liberalise the Foreign Exchange Market. The aim of the policy was to address the widening gap between the official exchange rate and the parallel market rate.

Earlier that year the apex bank following introduction of Wholesale Dutch Auction (WDAS) had achieved convergence of the official exchange rate and the interbank exchange rate. But while the interbank rate declined and converged with the official exchange rate at N130 per dollar, the parallel market exchange rate rose from N142 per dollar on February 20th when WDAS was introduced to N152 per dollar on March 26th.

Thus the gap or premium between the official/interbank exchange rate and the parallel market rate widened to N20 from N10.  The strategy   adopted to arrest the situation was to increase supply of foreign exchange in the parallel market and at the same time reduce demand in the market.

To achieve the former, the CBN admitted BDCs into the official market through direct dollar sale, and also allowed them to act as brokers in the interbank market. To achieve the later, the CBN removed restrictions on foreign exchange purchases by widening the scope of transactions that can be funded by official foreign exchange.

The effect was phenomenal. In the first month of implementation, the parallel market exchange rate dropped to N142 per dollar and by July 13th, it converged with the official and interbank rates at N130 per dollar. Thus for the first time in the history of the nation’s foreign exchange market the elusive parallel market was arrested and the influence of the parallel market especially the black market was whittled down.

That is the lesson of history which the present administration of CBN learnt bitterly in 2011, and had to learn last year. In realisation of this blunder, the apex bank on Friday 24th January removed the limit of $250,000 imposed on foreign exchange sales to BDCs by banks.

That is the first step. The parallel market exchange rate has dropped to N168 per dollar and the premium reduced to N12.25 or 7.8 per cent but this is still huge and quite above the 5.0 per cent global benchmark. The solution is to remove other restrictions to foreign exchange supply, and thus weaken the monopoly of the banks in the market.