Unsettled FX forward contracts by CBN raise concerns, worsen investor confidence, slow economic growth

The Central Bank of Nigeria’s (CBN) unsettled Foreign Exchange (FX) forward contracts have become a cause for concern among analysts in the financial service sector. 

The persistent delays in delivering the promised foreign currency have not only worsened investor confidence but also contributed to the slow economic growth in the country. 

However, the actual delivery of the foreign currency is postponed until a future date, which could be 90 days, 180 days, or even 360 days forward. These contracts are crucial for companies as they rely on the timely delivery of foreign currency to settle their offshore obligations, such as Letters of Credit (LC).

The Consequences of Delayed Deliveries: When the CBN fails to deliver the promised foreign currency on the agreed-upon date, it directly impacts the ability of businesses to meet their obligations. 

This delay not only disrupts their operations but also puts them at risk of defaulting on their foreign currency-denominated loans.

 Additionally, it negatively affects their credit scores, making it harder for them to secure future financing and expand their operations.

The persistent delays in delivering FX forward contracts have significantly eroded investor confidence in Nigeria’s financial markets. 

Investors, both domestic and foreign, rely on stable and predictable foreign exchange policies to make informed investment decisions.

 The uncertainty surrounding the timely delivery of foreign currency has made investors hesitant, leading to a decline in foreign direct investment (FDI) and portfolio investments.The unresolved FX forward contracts have had a detrimental effect on Nigeria’s economic growth. 

With businesses struggling to meet their offshore obligations, trade activities have been hindered, resulting in reduced imports and exports. This, in turn, has contributed to a slowdown in economic growth and hampered the country’s overall development.

To restore investor confidence and stimulate economic growth, it is imperative for the CBN to address the issue of unsettled FX forward contracts. The central bank should prioritise timely delivery of foreign currency to businesses, ensuring that they can meet their obligations and maintain a healthy credit score.

 Additionally, implementing transparent and consistent foreign exchange policies will go a long way in attracting investors and fostering economic stability.

The unsettled FX forward contracts by the CBN have become a pressing concern for analysts in Nigeria’s financial service sector. The persistent delays in delivering foreign currency have not only worsened investor confidence but also hindered economic growth. 

“So, if the CBN fails to deliver, it means those companies will not be able to deliver FX to its offshore bank for importation of goods. When there is a default, the cost on that transaction will increase and that may affect the bottom-line. It could also mean that subsequently, those companies may not be able to access such transactions or credit, as confidence would have been eroded,” said an analyst who pleaded anonymity.

In his opinion, Uche Uwaleke, professor of Capital Market at the Nasarawa State University Keffi, said FX forwards is a binding contract between two parties to deliver FX in the future at an exchange rate agreed to in advance.

“Failure to settle or deliver FX forward on the agreed date amounts to breach of contract and could lead to litigations and loss of confidence, which are capable of scaring investors,” he said.

Abiodun Keripe, managing director, Afrinvest Research & Consulting, said the major nexus is the dependence of the economy on key imports across sectors.

“Take for instance, there are material items required for infrastructure and manufacturing projects such as iron and steel which manufacturers have to import. The Ajaokuta steel mill is non-functional until date. Where manufacturers and importers have locked their FX demands through forwards, and settlements are delayed, it results in the inability of importers to fulfil their obligations as at when due. Also, it creates a negative perception from the view of our trading partners” he said.

Some estimates put the FX backlog at between $6 and $10 billion, which equates to less than 10 percent of the country’s external reserves.

Data from JPMorgan Chase & Co. compiled by FSDH Research showed that FX forwards stood at $6.8 billion (N3.2 trillion) as of 2022.

CBN used to sell about $200 million in FX forward contracts every two weeks but soon ran into troubled waters as dollar inflows dried up and a dollar demand backlog swelled.

Nigerian businesses from manufacturers to equipment importers, who have been on a long queue for dollars, are not the only ones worried about the backlog, which is also undermining foreign investor confidence in the CBN’s move to float the naira in June 2023.

Stakeholders are wondering why the apex bank is not able to tap into its external reserves to settle the contracts.

The foreign exchange reserves have declined by 7.79 percent year-to-date to $33.22 billion as of October 12, 2023 from $36.03 billion recorded on January 3, 2023, data from the CBN website indicated.

The pressure on external reserves is largely as a result of high demand for foreign currency to meet debt servicing, goods imports and service payments, limited investment inflows due to weak confidence, and limited inflows from crude oil sales due to oil theft, according to a report by FSDH Research.

Analysts admitted there is over an six-month backlog of the forward contracts and that is undermining investor confidence.

“The settlement default by CBN from earlier months’ forward transactions is not good for confidence, and it has been a probable factor in the parallel market overshooting,” Razia Khan, managing director, Chief Economist, Africa and Middle East Global Research, Standard Chartered Bank, said in an emailed response to BusinessDay.

Responding to the development, Aminu Gwadabe, national president of Association of Bureaux De Change Operators of Nigeria (ABCON), said, “Investment follows infrastructure in a developing economy like ours. There is the Chinese slogan that says if you want to be rich build infrastructures like roads, and others.

“Considering our huge backlog which classified our economy as an extremely risky environment by international investors and the loss of confidence, it is really a serious challenge on our path to turn around our economy without the needed foreign finance sources.

“I believe with well-coordinated synergies between the monetary policies and the fiscal policies it will go a long way in providing the needed revenue for infrastructural developments.”

He said now that there is a stronger move on actualizing the unification of exchange rates, the CBN should abolish I&E window and seek for the legislation of the willing buyer and willing seller concept to allow for transparency, competition, market deepening and inclusion.

Furthermore, he said the unusual price ceiling of the I&E window rates can be a counter disincentive to the market participants if it is not allowed to reflect market realities.

“One cannot control the price mechanism but the interplay of supply and demand in the market does. The BDCs are meant to play the moderating and regulating third leg role of the market and therefore germane to democratize and centralize the markets for all participants in achieving sanity and exchange rate stability.

“The BDCs over the years have played the pass-through effect of the apex bank foreign exchange policies very effectively in 2006, 2010 and 2019/2020,” Gwadabe said.

According to the FSDH report, despite the exchange rate unification, FX inflows into Nigeria are lagging. On the other hand, the demand for foreign currency remains high thereby creating pressure on the exchange rate. In addition, limited access to FX in the official market (delays, backlogs, documentation requirements) is incentivising players to purchase FX in the black market.

One major goal of the external reserve is to support and maintain confidence for monetary and exchange rate management. Conventional rule of thumb to measure reserve adequacy argues that months of import cover should be at least three.

“Clearly, Nigeria does not have the luxury to defend the Naira. Therefore, further exchange rate depreciation should be expected in the coming months,” analysts at FSDH Research said.

However, the CBN last week, said it is committed to accelerating efforts to clear the FX backlog with existing participants and will continue dialogue with stakeholders to address the issue.

The apex bank said this as it restored the 43 items prohibited from access to foreign exchange eight years ago. The CBN on July 1, 2015 restricted the availability of foreign exchange to the importation of 41 items (later 43) which could be competitively produced within the economy.

“Importers of all the 43 items previously restricted by the 2015 Circular referenced TED/FEM/FPC/GEN/01/010 and its addendums are now allowed to purchase foreign exchange in the Nigerian Foreign Exchange Market,” the statement signed by Isa AbdulMumin, CBN’s director, corporate communications, said.

According to the statement, the CBN has set as one of its goals the attainment of a single FX market. “Consultation is ongoing with market participants to achieve this goal,” the CBN said.

Nigeria’s Central Bank said it will continue to promote orderliness and professional conduct by all participants in the Nigerian foreign exchange market to ensure market forces determine exchange rates on a Willing Buyer – Willing Seller principle.

The CBN reiterates that the prevailing FX rates should be referenced from platforms such as the CBN website, FMDQ, and other recognised or appointed trading systems to promote price discovery, transparency, and credibility in the FX rates.

As part of its responsibility to ensure price stability, the CBN will boost liquidity in the Nigerian foreign exchange market by interventions from time to time. As market liquidity improves, these CBN interventions will gradually decrease, the CBN said.

When he was confirmed as the CBN governor on September 16, 2023, Olayemi Cardoso said his immediate priority would be to work out ways to aggressively offset huge FX obligations as part of measures to attack the current naira downturn which has become a huge burden for the economy.

Muda Yusuf, chief executive officer of the Centre for the Promotion of Private Enterprise, said the move by the CBN will help to restore confidence in the foreign exchange market and the economy in general. He noted that the biggest challenge in the economy is confidence.

 ”We need to clear the backlog for investors to bring in money. It will help to boost the level of confidence and reduce speculative activities. It is a very significant thing that needs to happen. There will be more stability. It is a good development,” he said.