Rumors of rate fixing. Scarcity of foreign exchange. A widening gap between the official rate and the runaway blackmarket. Nearly four months after Nigeria adopted a flexible exchange rate policy to avoid these very problems, the problems are all still here and in many ways, worse than they were before the policy change.

So, how has Nigeria managed to sharply devalue its currency while worsening the very problem the devaluation was meant to solve? The answer is a combustible mix of bad sequencing and the primacy of petrol prices.

Today, the official interbank market closed at 306 naira to $1. But over at Abokifx, the same US dollar sells for 473 naira on the black market—a spread of 55%, enough to tempt even the purest of souls into a game of ’round-tripping’. This is when insiders buy foreign exchange at low official rates usually under the guise of importing raw materials or machinery for manufacturing and then simply selling the forex at a higher rate on the black market for a tidy profit.

The Price of Petrol

In May, the Nigerian government, after months of crippling petrol scarcity, finally succumbed and raised the price of petrol to 145 naira a liter, up from 86.50 naira. At the time, the exchange rate was still fixed at 199 naira to $1, where it had been for more than a year. Stories at the time suggested policy makers had arrived at the new petrol price by using an exchange rate of 280 naira/$1—an acknowledgement of the fact that no one could get the dollars they needed at the fixed official rate. The exchange rate is of course inextricably linked to the price of petrol given that Nigeria imports nearly all the refined petrol it needs using a network of traders and ‘marketers’.

The Central Bank and petroleum ministry have decided that petrol imports are the most important use of scare foreign exchange at the moment.

Setting the price of petrol using an arbitrary rate was always going to be a problem if and when the hard peg of the naira to the dollar eventually came to an end. If there is one thing we can be certain any Nigerian government doesn’t enjoy doing, for reasons of political expediency, it is raising petrol prices. The moment the naira was ‘floated’ on June 20 this year, the authorities then found themselves in a position of not wanting the exchange rate to depreciate past a certain point to avoid the knock-on effect of higher petrol prices.

Nigeria does not have the foreign reserves to mount a defense of the naira when it comes under pressure. It is also not earning enough dollars due to the combination of low oil prices and the activities of militants in the Niger Delta who are hell-bent on crippling Nigeria’s oil output. This meant that the only way to stop the naira floating away beyond reach was to employ the old tricks of hobbling the markets, fixing rates with a mixture of persuasion and mostly threats and generally wrapping the whole thing in a thicket of rules.

On the day the naira was floated in June, the Central Bank of Nigeria (CBN) intervened in the markets to clear the huge backlog of unmet demand with a mixture of spot rates and forward contracts to be filled up to one year later. Since then, the CBN has abandoned the interbank market and no longer participates in the market to inject some dollars into the system.

Once the CBN had left the market, the next best source of supply of dollars are the major oil companies who sell crude oil for dollars in the international markets. Typically, these guys would hold auctions for their dollars and Nigerian banks will bid to exchange the dollars to naira for them. The CBN and the petroleum ministry stopped these auctions and directed the oil majors to sell their dollars to the marketers who import petrol. All of a sudden this major source of supply to the interbank market was cut off. Now the oil majors go to NNPC who tell them which marketers have been given allocation to bring in petrol and they sell to them. In other words, the CBN and petroleum ministry have decided that petrol imports are the most important use of forex at the moment and must be prioritized over every other type of demand.

The biggest source of supply has been taken out of the market leaving it to get by on infrequent foreign portfolio investors and random people.

In the absence of the CBN from the interbank market, the money from the oil majors probably made up between 50%-60% of the supply of forex to the market. All of that has now been commandeered for petrol imports. But even at that, the oil majors typically have more dollars than is required for petrol imports. That is, even after satisfying the demand of petrol marketers, there is still a decent amount of dollars left that could be sold on the interbank market. Not so fast said the CBN—the oil majors were also instructed that after selling their dollars to petrol marketers, any leftover had to be sold to the CBN. The reason for this directive remains unclear especially as the CBN is no longer intervening in the forex markets. There is some speculation that the CBN is using the excess dollars to patch the hole it blew in the nation’s reserves when it cleared the backlog of demand in June.

IMTOs and BDCs

After the oil majors, the next best thing in terms of supply of dollars to the market are remittances from Nigerians in the diaspora via the international money transfer operators (IMTOs). Here too, the CBN has wielded its big stick to force through its opinion on where that particular supply of forex should go. Banks have been directed to sell their foreign exchange to the Bureau de Change operators (BDCs).

The Central Bank of Nigeria has once again gone down the rabbit-hole of price fixing and hobbling the markets.

In Nigeria’s foreign exchange tapestry, it is hard to describe where exactly BDCs reside. They are not quite an official market but you need a license from the CBN to operate one. They are not the black market either as they can get their dollars legally from official sources. Depending on the mood of their regulator CBN, they are either demonized or tolerated as part of the foreign exchange architecture of the country. Persistent whispers for years have also said that most of the active BDCs licenses out there are held by CBN staff inside the bank.

Reuters/Afolabi Sotunde People stand at a complex with bureau de change operators in Abuja.

The CBN also recently announced it will start selling dollars directly to the BDCs again.

The 60-40 rule

In August, the CBN sent out a circular to all banks asking them to allocate 60% of their forex sales to imports of ‘raw materials and machineries’ and the remaining 40% to anything else that is not banned.

Things like school fees and payment for services will now be made out of that 40% that is left.

Taken together, it’s not hard to see what all these things have done to the forex market in Nigeria. The biggest source of supply has been taken out of the market leaving the market to get by on spotty and infrequent foreign portfolio investors and random people who bring much needed forex into the country now and again. Whatever is left is subject to strict rules about how it can be used.

Having severely constrained the space for the market to operate, it is thus no surprise that even people with legal and valid demands cannot get forex to buy. A huge chunk of the market is now restricted to fighting for forex scraps within the boundaries of the 40% leftover. Naturally, this legitimate but unmet demand then finds its way to the black market which inevitably causes rates there to spike.

Starting with the belief that one type of forex demand is far more important than others, the CBN has once again gone down the rabbit-hole of price fixing and hobbling the markets. This is how a country can abandon a hard exchange rate policy in favor of a flexible one and end up worse than where it started from with fewer suppliers and an even more acute shortage of forex than before.

If ever there was a perfect example of how not to float your currency, this is it.