The global economy in H1'2012

A recession in Southern Europe, sluggish growth in the U.K. and much of Northern Europe, near-trend growth in the U.S. and sustained but slower growth in China and other emerging market countries characterized the global economy in H1’2012. During the period, the lagged impact of last year’s monetary tightening in the E.U. -- and in many emerging countries -- and the direct (and indirect) effects of the continuing financial crisis in Southern Europe remained the key constraints to economic growth. In spite of these constraints, economic activity in 2012 started off stronger than I expected with global GDP expanding 2.9% Y-o-Y in Q1’2012[1] -- 10bps higher than Q4’2011 -- as economic data in the U.S. and Asia remained above trend in early Q1’2012, and the European debt crisis appeared reasonably well contained.

With the strength in global economic data, particularly in the U.S. labor market in Q1’2012, global equity markets enjoyed their best rally in several years. In Q1’2012 the Dow Jones Industrial Average gained 8.8%, the S&P 500 Index rose 12.6% and the Nasdaq Composite jumped an impressive 19.0%. The results outside of the U.S. told a similar story, although the magnitude of gains trailed slightly. The MSCI World ex-US Index rose 10.4%, with the DAX up 17.8%, the FTSE up 4.8%, the Nikkei 225 Index up 20.3% and Shanghai Composite advancing 4.7%. Emerging markets as a whole were a bright spot, with the MSCI Emerging Markets Index up 14.1%.

Despite a strong start to 2012, U.S. economic activity took a turn for the worse; with inventories -- which had contributed an outsized 1.8% to Q4’2011 GDP – dropping to a far more sustainable pace of 0.6% compared to 2.2% of GDP growth in the same period in Q1’2012. Also, the strength in consumer spending, which increased by 2.9% in Q1’2012, was offset by tepid core business expenditures which advanced 1.7% and government spending which contracted by 3% -- led by a drop in defense spending. The U.S. manufacturing sector remained a bright spot for economic activity in H1’2012 as the Institute of Supply Management (ISM) Manufacturing Index remained stable and firmly above the expansion/contraction demarcation level of 50%. Additionally, consumption – which represents ~70% of U.S. GDP -- continued to rebound during the period, led by improving automotive sales. Interestingly, U.S. personal consumption expenditures exceeded the growth in personal income during H1’2012, resulting in a drop in the savings rate by 50 bps Y-o-Y to 3.7%. On the other hand, U.S unemployment remained stubbornly high, with the decline to the current level of 8.2%, resulting from a drop in labor participation rate -- as discouraged workers exited the work force.

In Europe, the sovereign debt crisis remained at the forefront of the economic deceleration. In H1’2012, E.U. policymakers came under significant pressure to allay global doubts about the solvency of several Southern European states and their banking systems. This pressure was couponed by the incessant sovereign ratings downgrades across the E.U. which limited member state’s ability to put in place sufficient financial firewalls to moderate the impact of a possible crisis – given the E.U.’s weakening fundamental outlook and a possible Greek exit from the E.U.  In the midst of the deteriorating economic spiral, the European Central Bank (ECB) intervened with a EUR1.01 trillion lending program to European banks in late Q1’2012. The primary goal of this program was to spur on-lending to increasingly constrained Southern European governments. While the ECB’s quantitative easing bode well for financial markets, it did little to stem the fiscal avalanche and even less to promote economic growth in the region. In H1’2012, most European countries remained mired in recession and yet still faced significant fiscal austerity programs.

In Asia, Chinese and Japanese growth held up; with fiscal stimulus and reconstruction efforts combining to support growth in China and Japan respectively, while export demand from Europe waned.  In China, policy makers crafted definitive policy measures to ensure a soft landing – and they succeeded. In H1’2012, the Chinese GDP growth remained at a brisk pace, in spite of a pull back in the manufacturing and exports, and the continued correction in its domestic residential property sector. Overall, China’s real GDP surged 8.1% Y-o-Y in Q1’2012 while inflation remained persistently high around 6.31% in H1’2012 -- compared to 5.6% in the same period last year. In spite of the inflationary pressures, the People’s Bank of China (PBoC) cut its minimum reserve ratio for the first time since 2010.

In Japan, the economy rebounded strongly in Q1’2012, growing 2.7% Y-o-Y, albeit from a low base of -0.2% in Q1’2011 -- when the March 2011 earthquake and tsunami occurred. In H1’2012, private consumption -- which makes up about 60% of economic activity -- rose 1.1%, helped by government subsidies on sales of fuel-efficient cars, even as public investment to cover the post-tsunami rebuilding effort added 0.3% to the expansion. A fall in the yen in H1’2012 compared with Q4’2011 and a mild pick-up in overseas demand late in the period saw exports rise 0.1% to end the period.

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[1] IMF

Outlook for H2’2012 (Developed Markets)

U.S.: Remains likely to outperform

The U.S. economic recovery lost momentum in H1’2012, however with moderate employment gains in recent months and a pick-up in the pace of consumer spending; I expect real GDP growth to increase to trend thorough H2’2012, in spite of the events in the E.U. -- I remain of the view that the transmission mechanism of the European crisis to the U.S. economy are relatively limited. My view on the U.S. economy is further anchored on improving confidence in both businesses and households across the U.S., as well as slower deleveraging, which should allow the saving rates to ease. Housing demand has increased noticeably in 2012, but the overhang of unsold homes and the tide of foreclosures have scuttled a speedy revival in residential investment.

I expect the medley of the aforementioned factors to spur growth in H2’2012, driven by private-sector demand rather than by policy. In fact, I see fiscal consolidation in the U.S. as a possible drag on growth with the risk of excessive fiscal tightening in 2013 still to be addressed. Moreover, long-term fiscal sustainability in the U.S. remains to be achieved, and a credible fiscal plan is needed to ensure it.  Given the still fragile recovery, monetary policy should remain accommodative, but conditional upon other developments. Given the foregoing, I do not expect a moderation in fiscal policy to significantly offset the gains in private sector activity in H2’2012. Furthermore, I have adopted a cautiously optimistic, view of the U.S. equity markets in H2’2012, while being mindful of the risks.

Europe: Outlook remains negative

Activity in the E.U. stagnated in Q2’2012 after contracting at the end of 2011 and Q1’2012. Unemployment has risen consistently through H1’2012 and is set to rise further in H2’2012, owing to weak confidence and difficult financial conditions related to the sovereign debt crisis. Provided that policy actions are sufficient to improve confidence, activity should begin to recover gradually in the H2’2012, notwithstanding fiscal consolidation and private sector deleveraging across the region. However, I am not optimistic that this view will materialize. Rather, I anticipate that E.U. policymakers will muddle through H2’2012 with a series of half measures (the result of a sustained failure to reach consensus) that will prove inadequate to thoroughly resolve the region’s problem. Accordingly, I expect a divergence between moderate growth in creditor countries (particularly Germany and France) and, weaker/delayed recovery in countries with large debt overhang, even as the large margins of spare capacity across the region moderate inflationary pressures. The main risks to this outlook for the region in H2’2012 centre’s on a possible intensification of the debt crisis and the economic effects of high public and private indebtedness. Though recent decisions have significantly increased the capacity of Europe’s firewall to address government funding problems, I remain of the view that it remains insufficient and fraught with regulatory handicaps. With these constraint in view, I expect monetary conditions to ease further in H2’2012 – possibly in the form of a 25 bps cut to the ECB’s prime rate. With the scope for monetary and fiscal stimulus limited, reforms to labor market institutions, product market regulations and the tax system needed to sustain growth and boost jobs, I retain the view that European financial markets are likely to underperform their developed market pairs. 

Global Outlook and Investment Strategy

Global Markets - 2011 Review

Mixed economic data and policy induced uncertainty were major themes in the global economy in 2011. However, the aftermath of the global financial crisis remained the overall determinant of sentiment, as European policy makers struggled to allay doubts about the solvency of several EU states. Of note, the weaker fundamental outlook for the economic zone prompted a loss of investor confidence in Italy and Spain, turning the spotlight on vulnerability in the region’s banking sector.

Across the Atlantic, an unprecedented U.S. sovereign credit rating downgrade following an extended congressional debate on lifting the country’s debt ceiling further magnified uncertainties. Nevertheless, bearish signals from stagnating economies of other developed countries caused investors to seek safety in US treasuries and led to a broad sell-off in risk assets, particularly in Q3’2011. The MSCI All Country World Index fell 16.8% in Q3’2011 alone (its worst quarterly performance since Q4’2009). Also, in 2011, capital flight from emerging and frontier market assets was particularly severe, prompting some governments to intervene in their respective currency markets.

Outlook and Strategy

As I head into 2012, the global caution that prevailed at the end of 2011 is likely to continue -- and for good reasons. In 2012, as Greece continues to totter on the brink of default and the fate of the Eurozone -- and the Euro -- remain unclear, Europe is likely to drift back into recession. Also, as elections loom in the U.S, and China engineers a soft landing, I see 2012 unfolding with a myriad of adjustment risks which need to be surmounted. Accordingly, I also expect 2012 to be another eventful and challenging year for many financial markets, as the political and economic problems of 2011 persist.

In my view, the best opportunities globally are in high quality dividend-paying equities that have global exposure. There is also a stronger case for increased U.S. exposure based on growing signs of an incipient recovery. I also continue to favor strong business franchises in classically defensive sectors such as healthcare, telecoms and non-cyclical consumer areas such as food producers. With commodities and energy, there are strong supply-driven reasons to have exposure to these areas. I expect that, as long as central banks’ accommodative postures persist, gold will continue to provide a hedge against monetary debasement. Finally, in the fixed income space, based on the potential for monetary easing , following a tighter 2011, I continue to favor emerging and frontier market sovereign debt.

A bet on the Naira!

Naira’s strong start to 2012

A turbulent H2’2011 saw the Central Bank of Nigeria (CBN) falter in this efforts to maintain the Naira/US dollar (NGN/USD) exchange rate band (-/+3% of N150/USD) at its Wholesale Dutch Auction System (WDAS), and the adoption of a revised target exchange rate band of -/+3% of N155/USD. However, as I expected, the Naira has begun 2012 on a strong note. At yesterday’s WDAS auction, the Naira appreciated 0.10% to N156.85/USD, as the CBN once again sold US$250 million. While total demand at yesterday’s WDAS was not disclosed, the exchange rate move left the Naira within the N156/USD – N158/USD trading band which the CBN appears to have adopted, after its November, 21st 2011 decision to devalue the Naira.

On the interbank market the Naira closed at N160.05/USD yesterday (a 3-week high against the US dollar), after touching a 2012 high of N159.80/USD during intraday trading. On the parallel market, the Naira also strengthened to N164/USD as traders appeared to benefit from the increased US dollar liquidity from interbank sales of US$100 million, US$66 million and US$10 million, by Royal Dutch Shell, Total and Addax respectively.

Whats up?

In previous a commentary, I highlighted the growing importance of imports and direct remittances (a proxy for non-trade related demand composed largely of financial instrument transfers by non-Nigerian individuals and corporations to their home countries) in shaping the level of “fundamental” demand at the WDAS -- and by extension of the direction of the Naira. To this end, while the CBN has remained tight lipped about the levels of demand at the WDAS thus far in 2012, data from the National Bureau of Statistics (NBS) indicates that imports declined 13.3% YoY by October 2011 (in what appears to be a continuing trend from the previous two quarters). Furthermore, data from the CBN shows that direct remittances as a percentage of WDAS sales declined 50.34% in Q4’2011. With regard to this point,   I do not rule out the role of monetary policy initiatives taken in October and November 2011 to support the Naira/US dollar exchange rate in shifting the direction of currency flows. However, given the tighter regulatory environment, anecdotal evidence in the form of average WDAS/interbank exchange rate differentials, suggests that a positive shift in market dynamics and expectations may have occurred. In all, market participants have remained largely in tune with the CBN’s “apparent” policy trading band of N156/USD – N158/USD thus far in 2012 as is evident from the fact that the average WDAS/interbank exchange rate differential has declined 31 kobo from N4.33 to N4.03 thus far in 2012.

Optimism!!!

On balance, I remain cautious in forming an outlook for the Naira/US dollar exchange rate in 2012, given the multitude of factors and evolving uncertainties that are shaping its direction. While my prognosis for the Naira in 2012 is largely positive, I expect the Naira’s direction to ultimately be determined by the level of external reserves and market expectation.  On the latter point, market data suggests that expectations for sharp Naira declines in 2012 have become more subdued, although I suspect that the recent reversal of the government’s decision to completely eliminate subsidies on petroleum product – as well as moves being considered by the Senate to revise the benchmark price for Bonny Light crude in the 2012 budget could weigh negatively on those expectations.  On the former point, data from the CBN shows that Nigeria’s external reserves are currently at US$33.96 billion (the highest level since October 19th 2011), as the combination of moderating demand and improving accruals have combined to strengthen reserves. On this point also the aforementioned risks are relevant.

Given my expectations that fuel subsidies are likely to require ~N790 billion in additional spending in 2012 (44.4% of the N1.78 trillion used in 2011), I have tempered the impact of these risk on my expectations for the Naira –- assuming that crude oil prices remain stable and no major disruptions to supply occur in H1’2011. Furthermore, I have incorporate the possibility of a positive surprise like proceeds from the disposal of PHCN assets, which was not included in the 2012 revenue forecast in the 2012-2015 Medium Term Fiscal Framework in coming to a largely more positive view of the naira in 2012.  

Tepid times for NSEASI

Troubling Times

Last week, global equity markets dipped sharply as the European debt crisis worsened and the US congress’ super-committee failed to reach an agreement on budget deficit cuts. In a week that capped of what is on course to be the worst November for global equities since the financial crisis in 2008; the Dow Jones Industrial Average fell 4.8%, the S&P 500 Index dropped 4.7%, the Nasdaq Composite sank 5.1%, the DAX index dipped 2.2% and the CAC 40 index declined 1.9%. In my view, global equity market performance thus far in November has been a response to the high degree of uncertainty surrounding the nearly endless array of negative outcomes that the political deadlock in western nations could impose on the global economy and markets. For the Nigerian equity market, my research shows that global uncertainty is a key drag on performance, due to increased integration with global fund flows and the continued dominance by foreign investors who appear unmoved by attractive valuations.

European Debt Crisis – a global problem

While much of the focus on the Euro debt crisis has been on Greece and its risk of defaulting, in recent weeks, that focus has shifted to a shortage of liquidity in the European debt markets. Global banks, in their struggle to maintain credit ratings, have aggressively reduced exposure to troubled European sovereign debt. This selling pressure has further compounded the problem by triggering a renewed surge in government bond yields and forcing more countries into higher debt burdens and bigger deficits. As things stand, it is clear that the measures taken thus far to stem the crisis have been insufficient and that the risk financial of contagion of global credit markets from a severe European bank deleveraging is more likely.

No silver a bullet

In my view, resolving the Euro crisis will require a variety of adjustments to the European Union treaty to give greater autonomy to the European Central Bank (ECB), as well as a write-down of significant amounts of peripheral European sovereign debt. Furthermore, I suspect that it will also require the creation of a commonly issued Euro-bond to contain the debt crisis. Thus far Germany has resisted this proposal; however there are growing indications that its tone is changing (after an unsuccessful bond auction last week and a significant spike in its borrowing cost) and that this solution may well be in the offing. Regardless of what happens with the debt crisis itself, a recession in Europe now seems to be a foregone conclusion. However, if policymakers are able to come to an effective resolution soon, the recession is likely to be moderated. I am not optimistic about this outcome and have begun to project the extent to which a European recession would impact the global markets.

Outlook: Tepid growth & increased volatility

Lost in all of the Euro debt brouhaha and US political headlines, is the fact the US economic data has shown a gradual improvement (with the notable exception of last week’s downward revision of third-quarter GDP growth) and while growth in China, India and Brazil have slowed, the fundamentals of emerging market growth remains strong. As such, I expect Q4’11 global GDP to come in at better than Q3’11’s as yearend consumer spending boosts economic growth. This should create firmer footing for stocks, however for the time being I believe global markets will remain focused on the short-term headlines, as they have all year.

What does it mean for NSEASI?

My research shows that the performance on the Nigerian Stock Exchange has increasingly mirrored trends in other major frontier markets and, to a lesser extent, patterns in developed markets. In particular, a correlation analysis shows that daily performance of the NSEASI has a 90.63% correlation with the MSCI Frontier Markets Index in 2011. Further analysis reveals that the daily performance of the NSEASI has a -0.847 correlation with the one day lag of the changes in the VIX (Chicago Board Options Exchange Market Volatility Index[1]). These statistics suggest that the Nigerian market are increasingly linked to global capital flows and is unlikely to avoid the significant headwinds likely to affect global markets in 2012.

My outlook suggests continued volatility across global markets. In fact, I have seen the VIX reach 50 during the height of the sell-off in 2010 and 2011. Compared to 2010, the VIX has traded higher in 2011 and with a longer period of heightened volatility. On balance I expect this trend to continue into 2012 and to spike as global headings emerge. In particular, a key risk to the VIX is the European Financial Stability Facility (EFSF) package which “kicked the can down the road” effectively reducing the risk of a small loss at the expense of potentially increasing the chance of a larger one later. All in all my outlook suggest the trading patterns on the Nigerian market in 2012 could resemble 2011’s as it moves in line with increasingly volatile global markets − with even greater volatility.

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[1] The VIX is a popular measure of the implied volatility of S&P 500 index options. Often referred to as the fear index or the fear gauge, it represents one measure of the market's expectation of stock market volatility over the next 30 day period.

Inflation, again?

October inflation trends higher

Last week, the National Bureau of Statistics reported a rise in Year on Year (YoY) inflation to 10.5% for October 2011 (September: 10.3%). This marks the second month in double-digit territory, following two consecutive months of single-digit inflation. On a Month on Month (MoM) basis, inflation rose 0.5% in October, as the Rural All Items Monthly Index rose 0.90% MoM and the Urban All Items Monthly Index declined 0.10% MoM. The largest contributor to inflation was higher fuel prices - kerosene (DPK) and diesel (AGO) accounted for the bulk of the price increase.

Food inflation unexpectedly higher

I expected downward pressure on food prices in October in the aftermath of the year’s major harvest. However, Food CPI rose 9.7% YoY in October, as compared to 9.5% YoY in September. On a MoM basis, food inflation rose 0.2%, compared to 0.9% MoM in September and my forecast of a 1.6% decline MoM. I suspect that the rise in the Food CPI, contrary to my expectation, was the result of higher transportation costs, which resulted from an increase in diesel prices. Farm produce prices have historically trended lower MoM in October, on account of increased supply following the harvest which usually commences in the middle of September[1]. Available data suggested that while prolonged dry spells across the North-East Zone, in September, and excessive rains in the South-West, North-Central and South-South Zones, destroyed farmlands, fishponds and crops[2], these events did not significantly affect farm produce prices. As a result, the Farm Produce index declined 0.2% MoM.

Energy inflation – ahead of our expectations

Energy CPI showed a slight moderation in October. The index declined to 14.8% YoY from 18.7% YoY in September (I had forecast Energy inflation of 17.5% YoY). This moderation was primarily due to the impact of a negative base effect—resulting from the electricity tariff hike earlier in the year— which continued to impact Energy CPI for a full annual cycle following implementation. My model suggested that the marked differential between our forecasts and actual YoY energy inflation was the result of an overestimation of the impact of higher electricity tariffs from a hike that occurred earlier in 2011. However, Energy CPI rose 1.03% MoM, largely driven by higher diesel and kerosene prices in rural areas.

My outlook for inflation

Core inflation: Likely to stay in check

My analysis indicates that demand deposits and currency in circulation are important drivers of core inflation – the measure of price increases in components other than food and energy. Currently these monetary aggregates are above the Central Bank of Nigeria’s (CBN) annual target levels and I expect them those aggregates to remain elevated. However, the lagged effect of MPC’s October decisions —particularly raising the benchmark rate by 275 bps and the CRR by 400 bps to 8% —  and expected tightening should moderate the upward pressure on core inflation. Overall, I expect core inflation to remain moderate through the rest of the year. However, I note that higher energy prices could potentially filter through to some core components, exerting upward pressure on core inflation.

Headline risks persist

In spite of the scale of damage in flood ‐ and drought‐affected areas across the country, these areas of below‐average production account for less than 20% of the total annual food production[3]. I note that in 2011, croplands have experienced above average rainfall and increased cultivation.  As such, I expect higher crop yields YoY and a normal to above average harvest.  Accordingly, farm produce prices should moderate in the months ahead -- with the Food CPI following closely in line. However, I note that higher transportation costs and fuel prices portend potential risks to my expectations for food inflation -- as was the case in October. Furthermore, I expect YoY Energy CPI to remain elevated, even as further hikes in electricity tariff and deregulation in the downstream petroleum sector are expected early next year.

Ammunition for the MPC

The initial market reaction to these inflation figures was an almost unanimous 45bp upward adjustment in the yields on OMO bills. This is perhaps understandable in the light of recent comments made by the Governor of the CBN in an interview granted to Reuters on 31st October, 2011, indicating that monetary policy was likely to remain tight for the foreseeable future in order to “ward off inflationary pressures”. With these comments as context, ahead of this week’s Monetary Policy Committee (MPC) meeting, it would appear that the reinforced upward trend in inflation may provide justification for further tightening. Furthermore, the increased frequency and value of Open Market Operations (OMO) following the MPC’s emergency meeting in October (where it increased MPR by 275 bps and raised CRR by 400bps) suggests that the outcome of its policy measures might have been less than satisfactory. At current levels, further OMOs are likely to come at considerable cost to the CBN. Consequently, the MPC is likely to be motivation to explore other monetary options in an attempt to manage inflation, as Naira devaluation and deregulation of the downstream sector take effect.

Stay short, buy the tightening

In view of my outlook for inflation in the near term and the potential upside risks, I would expect the CBN’s hawkish posture to persist as policy makers and market participants come to better grips with unfolding developments in the currency and debt markets. Clearly, this consideration may lead investors to demand higher compensation for risk and supports the view that current yields may trend higher in anticipation of further monetary tightening – or following actual policy action. Accordingly, I believe short dated debt instruments provide the optimal vehicle to exploit such conditions.  Indeed, I note the upward trend in short dated yields pre-MPC decision and highlight the opportunity to selectively increase exposure to this asset class, as it is likely to experience a modest rebound post-MPC decision – partly due to significant liquidity inflows, particularly in the form of higher year end FAAC allocations.

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[1] Fewsnet, NIGERIA Food Security Outlook

[2] Fewsnet, NIGERIA Food Security Outlook

[3] NIGERIA Food Security Outlook

A view from the Top : CBN jumps into inter-bank market

CBN experimenting with new models in currency markets

While the response to the recent tightening measures by the CBN has been a moderation US$ demand at recent WDAS auctions and an appreciation in the official USD/NGN exchange rate to N149.94/US, the Naira has continued to show signs of weakness in the interbank and parallel markets.  On the interbank market in particular, the Naira has declined 4.40% to N158.98/US since the end of Q2’11, as compared to the 2.50% appreciation recorded on the WDAS over the same period. As at yesterday, the divergence between the WDAS and interbank market rates stood at N10.98 (close to the 2011 high of N12.11).  In response to this situation the Central Bank of Nigeria (CBN), yesterday released guidelines on its planned intervention in the interbank market. In a statement explaining the decision, the apex bank noted that it plans to intervene in the interbank market in two ways:

Method A: Intervention through the purchase and sale of US Dollar directly from/to Authorized Dealers.

In this method of intervention the CBN will buy or sell US dollars to Authorized Dealers in the interbank market through the submission of bids and offer rates for specified amounts of USD. This process, while similar to the WDAS, will not replace the bi-weekly auction but instead will enhance the CBN’s capacity to maintain liquidity through increased frequency of sales to Authorized Dealers. Furthermore, the guidelines for Method A noted that the spread between the bid and offer rates presented to the CBN in such bids may not exceed 20pips (20 kobo) and will be settled into the Authorized Dealers’ Trading Nostro Settlement Accounts  as opposed to their FEM Nostro Settlement Accounts, which are used to settle WDAS transitions.

Method B: Intervention through direct market participation

This method entails the CBN, active participation in the interbank market like any other registered bank.  The guidelines stipulated that with effect from Monday October 24^th 2011, the CBN will begin contacting Authorized Dealers and providing bid/offer quotes for the standard trade amount of US$250,000 with the standard spread of 5pips (5 kobo). However, the guidelines further state that Authorized Dealers will be allow the increase their required bid/offer spreads to 20pips (20 kobo) in cases where the CBN opts to demand amount greater than US$250,000.

A departure

In what appears to be a an attempt to enhancement market liquidity, the intervention guidelines allow the resale of US dollars purchased from the CBN on the interbank market to other Authorized Dealers on the interbank market, even as a separate circular (also released on October, 20^th 2011) revised the Foreign Exchange Net Open Position for Authorized Dealers to 3% from 1%, which was pronounce at the emergency MPC meeting last week.  However the guidelines, stipulates that Authorized Dealers would not be allowed to move funds from their FEM Nostro Settlement Accounts to Trading Nostro Settlement Accounts to settle interbank transactions. Furthermore, while Non-settlement of transactions with the CBN would not necessarily result in cancellation of the intervention to Authorized Dealers; defaults on either US Dollar or Naira settlements, within T+2 of the transaction with the CBN would attract suspension from WDAS spot and forward markets.

What is the CBN trying to achieve?

My guess is that this move may be designed to help the CBN gain better visibility into trends in the interbank markets and allow it take greater control of events in that market. However, the CBN is probably also trying to alter the economics behind demand and supply of foreign exchange. By participating in the inter-bank, it is able to adjust its interventions in a more timely fashion, a facility that may, help it fight adverse trends. In a sense, the new system moves us closer to a market structure I have long advocated, where CBN participates, like other dealers, in a common market,  responding to market vagaries as best suits its policy goals.

The impact of the new system could be far reaching and, while it does not entirely remove the ills of the old system, I am sure that it is a step in the right direction. I expect to see a little more volatility in exchange rates and assume that with the adoption of the new regime the CBN could become somewhat more flexible in the WDAS as well. In fact, I suspect that if it is able to achieve its aims of better managing the market the CBN may use this as a stepping stone towards a more “liberalized” regime.