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«THE BACKGROUND On August 14, 2007 Professor Chukwuma C. Soludo CFR, the Governor of the Central Bank of Nigeria (CBN), announced to the world the ...»

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On August 14, 2007 Professor Chukwuma C. Soludo

CFR, the Governor of the Central Bank of Nigeria (CBN),

announced to the world the intention of the CBN to

move the Naira into a realm of full convertibility by

January 2009. This momentous announcement was

accompanied by the announcement that by August

2008 the “old” Naira (NGN) would be replaced by a

“new” Naira (NGF) as the official currency for Nigeria.

Much has been made of these announcements and much speculation as to their intent. One must understand that the CBN has acted neither rashly nor on the spur of the moment in making their intentions clear, indeed the path to liberalization of the NGN started no less than 4 years ago when Governor Soludo was appointed to his post.

The CBN has consistently stated that its ambition is to move the Nigerian financial markets to the forefront of the African continent and indeed for the “new” Naira to act as the reserve currency for all African nations.

This dream is laid out clearly in the manifesto of FSS2020, in which the Nigerian economy is moved into the top 20 globally and Lagos becomes the financial hub of

-1- August 17, 2007 By: Malcolm Gilroy and Idowu Ogedengbe Africa. To get there full convertibility of the currency is an essential ingredient.

The road to Naira convertibility requires enormous changes in the structure of the Nigerian financial markets and indeed the economy as a whole. Let’s go back to the beginning of the dream, the year 2004 and the period of Professor Soludo’s appointment as the CBN Governor. The official Naira rate was N132.75 but the black market rate was closer to 140. The country had almost $40 billion in foreign debt and another N900 billion ($7 billion) in outstanding Treasury Bills and FGN bonds, N430 billion legacy bonds an illiquid stock market that traded N225.82 billion ($1.75 billion) per annum and no secondary fixed income market. The year before the country had audaciously tried to float a 4 tranche issue of Federal Government bonds in 3; 5;

7 and 10 year tenors. This was done in the old fashioned manner of a stock market flotation. Bear in mind that in the eighties Nigeria had had a successful bond market and some of these bonds were still in circulation, although not trading, having been issued with original tenors of up to 20 years. With the exception of the 3 year issue the others were all undersubscribed, in fact the 7 and 10 year issues were all but ignored. There was no pension fund industry and there was a very fragile banking sector with 89 small and rather inefficient banks. The insurance industry, if anything, was much weaker than the banking industry.

A study of the proposed N150 billion 1st. FGN Bond has brought out some interesting observations. The 3 year tranche was oversubscribed by almost 80%, the 5 year at

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By: Malcolm Gilroy and Idowu Ogedengbe badly. Comfort could be taken from the success of the 3 year issue but when quizzed about the lack of success in the longer tenors, investors replied that the bonds expired after the term of the current government, and one could not trust a new untested government; the lack of liquidity for the bonds as there was no secondary market and the fact that the CBN did not regard the bonds as liquid assets. The general apathy toward the longer dated bonds was also predicated on the fact that there were few investors in the country with a need for bonds. The pension funds used money market instruments and commercial real estate to function as the cash flow portion of their portfolios as did insurance companies. This lack of a bond market also led to the phenomenon of Nigerian equity investors being overly concerned with the level of dividend yield in all their investments. The past had been bleak and the future didn’t look much rosier.

However The Federal Government had a different view and a dream of bringing the Nigerian economy into relevance on a regional and international level. It had appointed a strong economic team and Professor Soludo was the final piece to be added to the puzzle.

During that year the Pension Reform Act was passed.

Adherence to this act would provide the country with real long term funding which would be instrumental to the building of the capital markets needed to power the economy into the 21st Century. The first major announcement of the new Governor on July 16, 2004 was that banks would be given eighteen months to bring their capital base from N2 billion ($15 million) to a minimum of N25 billion ($190 million). This announcement was met with dismay and anger mixed with disbelief. It was however only the first step in an

-3- August 17, 2007 By: Malcolm Gilroy and Idowu Ogedengbe audacious plan to build Nigeria into a modern day financial powerhouse. It was the first step towards the full liberalization of the Naira.

Economic Benefits of Liberalizing the Currency

• Increased flow of direct foreign investment

–  –  –

o Better business practices

• Availability of cheaper capital

• Availability of more sophisticated financial instruments o Better hedging instruments

• Will position the Naira as lead currency in the region Benefits from Rebasing the Naira

• New currency will give a psychological uplift to the country’s financial markets

–  –  –

• The need to exchange old notes for the new ones to be introduced will force hidden old notes into circulation o Can help bring those without banking privileges into the formal banking system

• Eliminates the enormous costs to the economy of handling massive quantities of notes

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By: Malcolm Gilroy and Idowu Ogedengbe

• Easier for foreign investors to convert to $; £ or € base Potential Dangers of Liberalization of Currency

• Once started this is an ongoing and irreversible process

• Information gaps are a major hazard o The absence of adequate information could foster an adverse credit selection process, which allows weak organization to survive longer (Because of the larger pool of credit available to weak companies they are likely to remain in business longer and they will still be weak and eventually fail but the failure will be on a much larger scale)

• Financial institutions balance sheets are more complicated; regulators and risk management officers need better skills Disadvantages to Rebasing the Currency

• Cost of conversion

–  –  –

• Statistics need to be rebased

• The poor often feel that it is excuse for raising prices and there is a threat of inflation

• The risk of economic turmoil if country’s financial system is not robust

• Accusations of money wasting

–  –  –

By: Malcolm Gilroy and Idowu Ogedengbe



• Confidence in the government and in their successor(s)

–  –  –

• Active and stable money and bond market s

• Convergence of the unofficial exchange rate to the official rate

• Active foreign exchange market

• Strong banking sector

–  –  –

• Compet ent Central Bank

• Strong foreign reserve position in order to dissuade short term raiders from attacking the new currency solely because they can and they can make money doing so

Let’s look at these ingredients in order:

Confidence in the government and in their successor(s) The last election may have had some flaws but there was a hand over of power from one democratic government to another. The institutions of the government and the economic reform process are still in place and appear to be waxing stronger.

-6- August 17, 2007 By: Malcolm Gilroy and Idowu Ogedengbe The country has been awarded a BB- credit rating, which we believe will be revised upwards before the end of next year and the country has been taken off the FATF list of countries that are not aiding the prevention of money laundering.

Confidence in the economy both present and future The GDP of the nation has grown enormously over the past 4 years as can be seen from the chart below.

–  –  –

This has resulted in the GDP per Capita increasing from $560 per person to over $1,000 per person. This is still well below the levels of South Africa ($5,770) or Brazil ($3,550) which represent economies that FSS2020 aims to emulate.

Inflation is stable and now below double digits. The biggest hurdles to keeping inflation in check and the economy bubbling along are the ability of Nigeria to rebuild its infrastructure, particularly power, in a timely

–  –  –

By: Malcolm Gilroy and Idowu Ogedengbe manner and its ability to strengthen the institutions of governance at all levels of government.

Active and stable money and bond markets The development of t he FGN bond market into a deep and well managed market is indisputable. Interest rates have consistently dropped as is shown by the chart on the Series 11 bond issued in July 2006 as a 3year bond with a coupon of 12½%. This was the first bond issued through the newly minted Primary Dealer/Market Maker panel and was the start of the official secondary market in federal government bonds.

Courtesy of Bloomberg The last year has seen no fewer than fifteen FGN issues worth in excess of N500 billion ($4 billion) auctioned; all of them were oversubscribed and the yield curve now stretches to 10 years and all tenors are below 10% as illustrated by the yield curve below.

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The Treasury Bills market has been slower to develop but is now operating. With the same dealers operating in this market as in the bond market it is reasonable to expect that by January 2009 the yield curves will be stable from overnight to at least 10 years.

With the benefit of strong government markets it is not reaching to expect the development of a corporate yield curve over the next year, indeed there have already been State Government bonds and Federal Mortgage Bank of Nigeria bonds issued and successfully placed over the last 6 months.

What remains is the development of a robust NIBOR (interbank deposit) market. This is a market currently being targeted by the CBN and the Money Market Association as a critical success indicator on the road to currency liberalization. It is essential to the success of the exercise that the NIBOR market be well traded and deep. To get there Nigeria banks need to approve and use much larger interbank facilities. This will help them with their asset and liability risk management as well as

–  –  –

By: Malcolm Gilroy and Idowu Ogedengbe lead to the development of the country’s capital market Convergence of the unofficial exchange rate to the official rate This has been successfully achieved as evidenced by the chart below. Our confidence in the new Naira stems partially from the attainment of this goal by the CBN.

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Active foreign exchange market The Naira market is as yet small and rather fragile with only local players as major participants. This is partially because the Naira is blocked and the majority of Dollars offered to the market come in the form of CBN Dutch auctions. However over the past 6 to 12 months with the convergence of the grey market to the official market there has been a significant uptick in the Dollar volumes available from the private sector.

–  –  –

By: Malcolm Gilroy and Idowu Ogedengbe the interbank markets. This will add significantly to the number of participants and the volumes in the market.

This init iative begins immediately. Once the Naira is floated it is reasonable to expect at least 100 foreign banks to be active participants in the currency.

Strong banking sector, from both the industry’s capital base and its efficiency The bank consolidation process has been an enormous success and there are now 24 banks in the country that have met the minimum capital requirements of N25 billion, indeed there are likely to be at least 8 banks by year end that have 4 times that number and all will be in the top 1000 banks in the world. The largest 5 banks are already in or approaching the top 500.

Their IT infrastructure has been strengthened and the speed with which cash can be transferred locally and internationally is now on par with developed nations.

The number of branches throughout the country and the number of ATMs is expanding rapidly and most citizens of Nigeria are now within reasonable reach of a bank branch. For instance UBA, Nigeria’s largest bank by assets according to Fitch and Agusto, has in excess of 630 branches and close to 1,000 ATMs, up from 420 branches and 70 ATMs at the end of 2005.

Competent Central Bank The CBN is working diligently to upgrade their capacity at all levels of the institution. There are banking schools in both Minna and Lagos at which employees are constantly being trained, however there is much work yet to be done and the Governor has challenged his

–  –  –

By: Malcolm Gilroy and Idowu Ogedengbe executive to deliver on this crucial element along the road to Convertibility and to FSS2020.

There have been challenges experienced in the delivery of a suitable IT platform from which to regulate and manage a more robust money market and payments system. The FGN bond and Treasury Bill markets have been adversely affected by the shortcomings of the RTGS and T24 systems. Short term fixes have been put in place by retaining the Nigerian Stock Exchange owned CSCS Clearing house to aid in the clearing of transactions but this is not a permanent solution and the CBN is under some duress to strengthen it s IT backbone before the advent of full convertibility. Once again this is a crucial element to the process.

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