“People are afraid to buy because they don’t know what might happen next. The gain is too fast in just three days,” said a Bureau de Change (BDC) operator who prefers to remain anonymous.
The last three days have been remarkable for the exchange rate between the naira and the dollar, which, as of Friday, December 6, 2024, had gained 8.9% in one week.
Starting the week at N1,672, the exchange rate closed at N1,535 on Friday, December 6, 2024.
While the official market experienced rapid gains in the exchange rate, the parallel market, where forex is sold unofficially, presented an even more unsettling scenario for speculators. The naira was gaining faster than they could sell.
By the end of the week, operators informed Nairametrics that the exchange rate was trading at N1,570/$1, a sharp decline from N1,700/$1 earlier in the week, as the naira continued its strong recovery against the dollar.
Why is the naira gaining
Unbeknownst to many Nigerians, the Central Bank of Nigeria recently launched a new trading system called the Enhanced Foreign Exchange Market System (EFEMS).
EFEMS essentially consolidates all previous official foreign exchange windows into one unified system.
This consolidation replaces the fragmented structure of multiple windows, such as the Investors & Exporters (I&E) FX Window, the SME Window, and the Invisible Window. But how does this explain why the naira is gaining against the dollar?
EFEMS Introduces transparency: According to the CBN, EFEMS is expected to simplify operations and improve price discovery, thereby ensuring that trades are more transparent and easier to monitor.
- This has largely contributed to the positive outcomes currently being recorded in the official exchange rate.
- For example, one person familiar with the operation of the market suggests that the market is experiencing more supply than demand.
- With supply outstripping demand, the naira has gained against the dollar.
- However, it is unclear where the supply in the market is coming from, as there is no official data to explain this.
- For instance, the dynamics of pricing might change if the supply is primarily driven by the central bank.
The new system also mandates a minimum trade value of $100,000 for all interbank FX transactions, which seems to have curtailed speculative activities in the market.
Quoting System: Another plausible reason is the format for placing orders and pricing the exchange rate.
- Unlike the previous opaque system, forex dealers informed Nairametrics that the current system is order-based, similar to the way stocks are traded on the NGX.
- For example, bids (buying requests) are displayed on the system along with their bid prices, while offers (selling requests) are also shown with their corresponding prices.
- This makes it easier to determine how much forex is available in the market and the prevailing prices.
- Another stakeholder suggests that EFEMS also implements a two-way quote system, meaning dealers are expected to display both bid and offer prices. T
his ensures that when trading forex, participants must indicate how much they are willing to buy and sell, regardless of their position in the trade.
EFEMS/Guidelines Still New: Analysts also opine that the nascent nature of EFEMS creates some uncertainty among traders.
- According to one trader, “As a new system, people are obviously wary and do not want to be on the receiving end,” suggesting that the need to comply with market rules is ensuring transparency for now.
- The CBN’s new guidelines for forex trading also introduce rigorous reporting requirements. For example, Authorized Dealers must report FX transactions to the CBN within 10 minutes via an API-based system.
- BDCs are required to submit daily activity reports through automated portals, while Commercial and Merchant Banks must adopt real-time reporting to enhance monitoring and oversight.
BDC role – The role of Bureau De Change (BDC) operators is critical under the new regulations, fostering further transparency in the functioning of the market.
- For instance, under the new guidelines, licensed BDC operators are allowed to buy foreign exchange (FX) from Authorized Dealers to meet customer needs.
- This measure aims to balance market accessibility with effective monitoring and control.
- The BDC segment, which had previously been excluded from certain FX market activities, is now positioned to play a more active role in meeting retail FX demand.
- This inclusion is expected to provide a buffer against the FX pressures faced by individuals and small businesses reliant on BDC services.
If BDCs are sourcing FX from the same market, their pricing is unlikely to diverge significantly from official rates, reducing the wide disparities previously observed.
- This marks a significant departure from earlier years when the black market often influenced official rates.
- However, this expanded operational scope comes with a caveat: the total monthly transactions for BDCs are subject to an aggregate cap as determined by the CBN.
It is also worth noting that the Association of Bureau De Change Operators of Nigeria (ABCON) informed Nairametrics that the permission for BDCs to purchase foreign exchange directly from Authorized Dealers is not automatic.
Only BDC operators that meet the current capital requirements are permitted to participate in this market.
- “We received the news with mixed reactions,” said Gwadabe, a representative of ABCON. “While it is intended to increase liquidity at the retail end of the forex market, it is contingent on meeting the new recapitalization requirements of either ₦500 million or ₦2 billion as stated in the May guidelines.
However, it does not specifically permit all currently licensed BDCs to purchase foreign exchange from the interbank market.”
- He added, “It is tied and subject to meeting the new capitalization guidelines introduced by the CBN in May 2024. This also addresses questions about the sources of funds under the new BDC guidelines raised by many applicants. It is not automatic but conditional on meeting these new requirements.”
Panic Selling– Panic selling is widely regarded as a significant factor behind the sharp appreciation in the exchange rate between the naira and the dollar.
- Traders who spoke to Nairametrics anonymously suggested that many of their suppliers were in a hurry to sell, as no one wanted to hold on to a currency rapidly losing value against the naira.
- One trader disclosed that they even sold at rates as low as N1,500/$1 on the parallel market, despite it being much lower than the rates obtainable on the official market.
- These actions have been attributed to panic selling, particularly by speculators who had hoarded dollars for months in anticipation of the naira’s continuous depreciation.
Several economic reports have suggested that the exchange rate of N1,600/$1 is not reflective of the naira’s true value, a sentiment echoed by CBN Governor Yemi Cardoso at the Bankers’ Committee annual dinner.
Speculators worry
If this is indeed what is happening, more losses could await speculators who are uncertain about when the market will bottom out.
- Some speculators also point to the December period, which, according to historical data, is often associated with the naira strengthening against the dollar.
- This trend is partly attributed to increased dollar inflows from diaspora Nigerians returning for the Christmas holidays.
Finally, it is worth noting that similar boosts in Nigeria’s forex market have been observed before, where the naira suddenly gains strength before depreciating again.
For example, in April this year, the naira appreciated to as high as N1,072/$1 before it started to weaken again. At the time, the central bank had just lifted the suspension of forex sales to BDC operators, injecting liquidity into the system.
