March 12, 2021/Cordros Report

Over the last year, the Central Bank of Nigeria (CBN) has found it challenging to maintain the rate within a tight band of the official rate within its managed-float system. In recent months, the apex bank has issued a substantial array of policy pronouncements to improve liquidity. These pronouncements have included requiring (1) exporters to repatriate FX earnings within a specified timeline and (2) international money transfer operators (IMTO) to pay out diaspora remittances in US dollars. The CBN’s most recent pronouncement, the “Naira for Dollar Scheme”, is closely related to the latter as it seems the bank has beamed its spotlight firmly on diaspora remittances as a means of improving FX supply. As part of the scheme, all recipients of diaspora remittances, through licensed IMTOs, are to be paid NGN5.00 for every USD1.00 received as remittance inflow. The scheme took effect from 8th March 2021 and ends on 8th May 2021. In this report, we discuss the importance of remittances to Nigeria’s FX market, the significance of the CBN’s actions, and the potential impact of the new policy on the FX market.

Why all the Fuss about Diaspora Remittances?

Nigeria’s US dollar sources have changed over the past decade. Oil earnings have stagnated over time and have become a less significant pie piece. In contrast, foreign investments have almost tripled since 2009. They now account for a much greater share of FX inflows than at the start of the last decade (Fig 1). The trend in diaspora/workers’ remittances is quite different. In 2019, these remittances were only about 1.3x higher than in 2009 (Fig 2). However, the remittances accounted for an average of 20.8% of foreign inflows over the last decade (second-highest source of dollar inflows after oil exports), and this stability seems to make it highly regarded by the apex bank.

Liquidity, Convergence or Both?

We think the CBN sees the bypassing of official channels partly responsible for the significant disparity between the parallel and interbank/I&E rates. “Partly” being a keyword. We are still of the view that the CBN’s refusal to drastically overhaul its FX policy and allow for proper price determination in the exchange rate is the primary reason for the divergence.

Also, in our view, the raft of CBN policy pronouncements on diaspora remittances signal that the bank is unwilling to make further adjustments to the naira band at the I&E window. Hence, it has become imperative to fashion out innovative ways of reducing the premium between the parallel market interbank/I&E rates.

Naira 4 Dollar Scheme

Next up in a long line of CBN policies is the recently introduced Naira 4 Dollar Scheme. Duly named, the scheme provides NGN5.00 for every USD1.00 collected by a recipient either in USD cash or paid into their domiciliary accounts. According to the apex bank, the policy is meant to boost its chances of increasing diaspora remittances via banking channels. We see this as purely another attempted incentive for senders and recipients of diaspora remittances. Given that the incentive is meant to increase remittances’ inflow, the ultimate goal is to improve the US dollar supply to the parallel market. The recipients can now receive the remittance in foreign currency and convert it to the local currency at the optimum price.

We highlight the significant reasons why remittances mostly bypass official channels – (1) high transaction costs, (2) the wide gap between the official and parallel market rates, and (3) extended delays associated with receiving funds through IMTOs and direct local banks. These contributed immensely to the proliferation of other mediums such as Bitcoin and other cryptocurrencies. These channels are faster, have cheaper transaction costs, and have a relatively higher value in naira terms. We think this was why the apex bank promptly cracked down on cryptocurrency exchanges.

The fundamental question then is: “by how much will the policies on diaspora remittances drive down rates in the parallel market?”

How Effective can this be in Nigeria?

In estimating how effective the “Naira 4 Dollar Scheme” could be in achieving rate convergence, we wanted to find out how much demand moved to the parallel market in 2020 and how much remittance dollars would be enough to plug the gap.

We examined the CBN’s pre-pandemic interventions across the different FX windows and compared this to its 2020 interventions. We used the difference between the two periods as a proxy for the parallel market demand.

Covering all Bases

On a balance of factors, we think the new policy will have a limited impact in the short-to-medium term. Hence, we do not believe it would lead to any significant rate convergence. Our baseline expectation is for the currency to trade between NGN450.00/USD and NGN455.00/USD at the parallel market by the end of the year.

Overall, we reiterate that the effective policy measure to encourage remittances through official channels is to unify the exchange rates at the different windows by devaluing the currency towards its fair value (Cordros’ REER: NGN453.67/USD vs CBN’s RPPP: NGN431.71/USD). The unification is needed to eliminating the parallel market exchange rate premium. Over the long run, the need to diversify the economy’s export base is paramount to solving the exchange rate issues.

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