The volatility in the foreign exchange market is naturally unsettling. But it is not unexpected given the long period of distortions in the foreign exchange market. Correcting the entrenched distortions would take some time.
But in the meantime, the monetary authorities should come up with a sustainable intervention framework to ensure the moderation of current volatility in the forex market. We recognize the forex supply limitations, but the system needs to be managed in way that would not undermine investors’ confidence. Erosion of confidence triggers speculation and influences expectations which in turn triggers diverse responses among economic players.
The foreign exchange market is evidently under pressure as a result of a number of factors:
There was a curious surge in monetary expansion in the last one month. Money supply grew by an unprecedented 15% in one month between May and June 2023. Broad money grew by over N9 trillion, from N55.7 trillion to N64.9 trillion. This surge in monetary growth is unprecedented. Obviously, this must have had an effect on the exchange rate. The monetary authorities should investigate this drastic growth in money supply and take steps to curb subsequent expansion. Such dramatic growth in money supply poses a significant risk to macroeconomic stability, especially price stability.
Over the last few years there had been a cumulative backlog of unmet foreign exchange demand, running into billions of dollars as a result of acute illiquidity in the foreign exchange market. With a more liberalized forex market , the pressure of the backlog of unmet demands and other maturing forex related obligations have been unleashed on the investors and exporters window.
Transiting from a repressive market environment to a more liberalized market could be a source of market instability. However, there is need for vigilance to prevent questionable capital outflows or speculative assault on the currency. A free market is not synonymous with complete absence of regulation. Free enterprise has to be complemented with an appropriate regulatory framework to curb illicit financial flows.
It is evident that the frequency and scope of CBN intervention in the forex market had decelerated compared to first five months of the year. Recent reports from the CBN indicate a total of $17 billion intervention by the CBN in the forex market in 2022. This an average of N1.4 billion per month. Since the inception of the present administration, it is doubtful whether we had seen an intervention of up to $1 billion in total. It expected that as the scale of intervention improves, the volatile will be subdued.
And only recently, the government paid $500m to settle matured debt service obligation on Eurobond. This could also be a constraining supply side factor.
The marginal decline in foreign reserves was also disproportionately amplified by the media . This also created some anxiety which could also have driven speculative activities in the forex market.
The CPPE believes that the Tinubu administration is on the right path and that the current volatility in the foreign exchange market are challenges typically inherent in a major policy transition. In a couple of months , we expect the instability to subside.
On the supply side, the trajectory is that there would be an improvement in oil output which would boost forex earnings.
The prospects of improved domestic refining of petroleum products in the coming months will reduce forex demand pressure from importation of petroleum products .
Improved investors confidence will boost Foreign Direct Investment [FDI] and foreign portfolio investments, and other remittances.
CBN should exercise better oversight on forex demands to ensure protection of the market from speculative assault and illicit capital outflows.
DR MUDA YUSUF
CENTRE FOR THE PROMOTION OF PRIVATE ENTERPRISE [CPPE]
23RD JULY 2023