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CBN’s new remittances policy could boost dollar flows to the parallel market by US$9.52 billion-Analysts

Godwin Emefiele
Godwin Emefiele, CBN Governor

By Audrey Lotechukwu

MON 15 MARCH, 2021-theGBJournal- It may seem tempting to assume that the Central Bank of Nigeria’s (CBN) has written a totally perfect remittances policy with the “Naira 4 Dollar Scheme” which is geared towards achieving exchange rate convergence.

The scheme provides N5.00 for every US$1.00 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.

This is seen broadly as another attempted incentive for senders and recipients of Diaspora remittances and the evidence presented points to that conclusion. Besides, the belief is that the policy will only works if the incentive lasts far longer than the current two-month pilot phase. Cordros Securities analysts feel the design will also be more effective if the distribution channels are enhanced, such as expanding post offices and microfinance banks’ service offerings to include acting as remittance agents while targeting remittance-rich areas.

The significant downside risk to this policy is that the incentive could increase the money supply, fueling existing inflationary pressures.

For analysts at Cordros Securities, given that the incentive is meant to increase remittances’ inflow, the ultimate goal is to improve the US dollar supply to the parallel market and could actually boost dollar flows to the parallel market by as much US$9.52 billion.

Cordros assumption is based on CBN data which showed that remittances into the country averaged US$23.89 billion between 2018FY and 2019FY. Simultaneously, the 2018 Western Union Global Usage and Attitude Survey stated that recipients of remittances in Nigeria spent 57.0% of their inflows on essential services.

‘’We have assumed that this percentage eventually flows into the parallel market as supply, given that the recipients will have to change the FX to local currency (LCY). If we assume the pre-pandemic average remittance of US$23.89 billion as the actual amount expected to flow into the country after introducing the scheme, this implies US$13.57 billion (57.0% spent on essential services) will flow into the parallel market in exchange for local currency.’’

However, given some recipients could still choose to exchange their FCY for LCY at the banks for convenience, not all of the US$13.57 billion will flow to the parallel market. As a result, we have factored in an error term of 17.0% (or USD4.05 billion) as the proportion exchanged with the local banks/IMTOs. Consequently, we arrived at 40.0% (or USD9.52 billion) as the final proportion that will potentially find its way into the parallel market as supply.’’

Again, the CBN’s dollar sales is estimated to have averaged US$38.31 billion between 2018FY and 2019FY. For 2020FY, Cordros estimates that the apex bank sold a total of US$27.47 billion.

‘’Comparing both values, we estimate US$10.84 billion went to the parallel market in 2020 in the form of demand. We, however, acknowledge that not all the deficit would have gone to the parallel market in 2020. Some demands would have reduced or disappeared given the impact of the COVID-19 pandemic on the citizens.’’

This prevailing view is helped by the high transaction costs associated with official remittances channels as well as the wide gap between the official and parallel market rates, and extended delays associated with receiving funds through IMTOs and direct local banks. All of these combine to drive recipients to the parallel market for the optimum price.

The most obvious open argument against the workability of the policy is the huge divergence in the exchange rate.

Study conducted by Cordros showed that in countries such Pakistan, Bangladesh, Mexico and even Kenya where the remittances policy has worked, their currencies trade at about the same value in formal and informal markets. And the narrow currency gap between the official and unofficial currency market is believed to have significantly contributed to the remittance growth recorded, particularly in 2020. The study showed that with the narrow currency gap, Mexico  recorded remittances growth of +11.4% to USD40.61 billion in 2020FY), Kenya +10.6% y/y to USD3.09 billion in 2020FY, and Bangladesh (+19.7% y/y to USD21.90 billion in 2020FY.

‘’On a balance of factors, given the limitations highlighted above, 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,’’ Cordros analysts said.

The analysts said 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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