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OUR FOREIGN EXCHANGE BAZAAR OF THE NIGERIAN NAIRA

By

Mobolaji E. Aluko, PhD

alukome@aol.com

         Burtonsville, MD, USA           

SUCCESS STORIES OF THE DUTCH AUCTION SYSTEM (DAS)

On Wednesday, February 25, 2004, the one-hundred-and-fifty-fifth (155^th) session of the Nigerian Naira bazaar since its latest inception on July 22, 2002 - and the 15^th session of 2004 -  was held in Abuja  under the auspices of the Central Bank of Nigeria (CBN).  Otherwise respectably known as the Dutch Auction System (DAS), that bazaar’s outcome was that the Naira appreciated by 15 kobo, from was the 45^th  one N135.15 (at the 154^th session) to the US dollar to N135.00.  This particular appreciation over a 19-month period in the midst of 78 depreciations and 31 stable sessions since July 22, 2002, leading to an overall depreciation of  900 kobo (7.14%) since the initial exchange rate of N126 to the dollar on the starting DAS date.

QUOTE

http://www.thisdayonline.com/archive/2002/08/17/20020817bup01.html

The Dutch Auction System is popularly used as a bidding method on those internet auction sites that claim to sell everything from a new heart to diamonds. In this format the seller places one or more identical items on sale at the same time listing a minimum required price. Bids are ranked in order of price, then quantity, and lastly time. These auctions are timed events usually lasting either hours or days. Bidders submit the number of items they want and how much their bid per item is. The final selling price in this type of Dutch auction is determined by the lowest of the winning bids.

Another name for it is the descending-price auction, commonly known in academic literature as the Dutch auction. It is the technique used in Netherlands to auction produce and flowers (hence, a "Dutch" auction). It uses an open format rather than a sealed-bid method.

In Nigeria, the DAS bidding takes place on Mondays and Wednesdays. The minimum bid amount by an authorised dealer is $100, 000.00 and the currencies of transaction are the naira and the United States dollar. The CBN announces every Tuesday and Thursday the result of each auction and the official exchange rate. Nigeria is not alone in using the Dutch Auction System.

 

Dutch auctions have been used to finance credit in Romania and for foreign exchange in Bolivia, Jamaica and Zambia. In America the national treasury sometimes uses it to sell its new treasury notes or treasury bonds. The Treasury opens up all bids and determines the lowest acceptable bid price. All successful bidders pay this stop-out price.

An example could make it clearer. Let's say the Central Bank has 20 million US dollars on sale and the minimum selling price for a dollar is N20. Buyers can ask for as much as they want as long as it is not lower than $100, 000. Five companies bid N30 for one dollar each and ten others bid N50 for one dollar. These fifteen companies will want different quantities of dollars. Some would be bidding for $6 million, while others would be bidding for $20 million. Because the ten companies bid higher than the other five, they will definitely be guaranteed foreign exchange. But all fifteen companies will pay N30, the lowest successful bid. It is this minimum price that becomes the Central Bank's exchange rate. Anyone who wants to buy a dollar from the central bank will pay N30.

UNQUOTE

Table 1 shows the entire history of those foreign exchange mechanisms in Nigeria since 1958, while Table 2 gives figures of foreign exchange market movements since 1995 which I have put together from various sources -  with a few gaps in information.

When one recognizes that in the 19 months preceding the commencement of the DAS auction, the Naira had depreciated from N106.19 (from end of December 2000) to N125.65 to the US dollar on July 19, 2002 (an 18.3% depreciation), a claim of relative success can be made that the latest DAS has cut by more than half  the haemorrhaging of the Naira.

There is another issue that we need to look at with respect to DAS:  the premium of the parallel market over the official rate.  In December 2000, the parallel rate (N121.83) was 14.7% higher than that of the official one (N106.19).  In the latest DAS auction of February 24, the official marginal rate was N136 while the  parallel market rate was N141,  just 3.67% higher,  and amounting to more than a one-third cut relative to the pre-DAS period.
 

BUT AT WHAT PRICE STABILITY AND CONVERGENCE ?

At what price are this relative stability of the Naira and convergence of the official and parallel exchange rates?  This is evident from Table 2:

(1)    the increase in total foreign exchange dollars used in this mechanism:  $4.88 billion in 1999, $7.256 billion in 2000 and $9.659 billion in 2001 (the IFEM years)  then  $9.19 billion in 2002 and $9.846 billion in 2003 (the DAS years.)

      Actually, the TOTAL official forex inflow in 2001 was $15.7 billion and official outflow was $14.7 billion (net inflow was $1 billion); in 2002, the forex inflow      was $9.8 billion and outflow was $13.0 billion (net outflow of  $3.2 billion),       while in 2003, the inflow was $15.14 billion and the outflow was $16.34 billion (net outflow of $1.20 billion)  See Figures 1 and 2.

(2)    The reduction in external reserves during the same period: $5.45 billion in 1999, $9.263 billion in 2000, $10.439 in 2001  (the IFEM years) and then $7.70 billion in 2002 and $7.48 billion in 2003 (the DAS years.)  In mid-February of 2004, this has declined to $7.26 billion.

The effect of both of these two observations is a significant reduction in our balance of payments (BOP).  In fact, in Naira terms, according to the CBN,

QUOTE

http://www.cenbank.org/Out/annual/2002/Areport-02-1.pdf

“The external sector was under severe pressure in 2002 as the balance of payments swung into an overall deficit of N525.7 billion, or 8.9 per cent of GDP, from a surplus of N24.7 billion or 0.4 per cent of GDP in 2001.  Consequently, there was a substantial draw-down of the external reserves and deferred payments of scheduled debt service obligations. The current account recorded a surplus of N232.9 billion, which was more than offset by the deterioration in the capital and financial account position. The deficit in the capital and financial account widened from N211.2 billion in 2001 to N749.4 billion in 2002. In addition, the naira exchange rate depreciated from an average of N111.90 per US$1.00 in 2001 to N120.47 in 2002. The level of external reserves declined by 23.3 per cent from end-December 2001 level of US$10.42 billion to US$7.99 billion while the deferred scheduled debt service totalled US$1.93 billion. The level of external reserves could support 6.4 months of current foreign exchange disbursements, compared with 8.0 months in 2001. In terms of visible imports, the external reserves could finance 10.1 months of current imports.”

UNQUOTE

The advantage of stability (only relative; there was still Naira depreciation) and convergence in the face of serious balance of payment deficits without concomitant development gain is therefore very dubious.

POSSIBLE REASON:  MIS-ALLOCATION OF FOREX FUNDS ? – AND WHAT TO DO

Table 3 showing the sectoral allocation of foreign exchange usage indicates what might be STRUCTURALLY wrong, no matter the foreign exchange control regime employed.  The agricultural sector where most Nigerians reside has a foreign exchange allocation of only 3.6 – 8.3% over the period 1999 – 2003.  In this same period, an average of about 33% of foreign exchange allocation was spent on finished goods while the “invisibles” (expended on embassies, etc.) had 12% to as high as 30%, meaning that these two latter non-productive sectors made up as much as 50% of the foreign allocation.  The industrial sector was practically level at about 40% despite what might be increases in world materials/machinery prices.

It would therefore appear that even if the TOTAL forex used is at the same levels as currently expended, then a DELIBERATE re-allocation of our scarce foreign exchange in order to stimulate DOMESTIC PRODUCTION  particularly in the agricultural sector; to discourage IMPORTS OF FINISHED GOODS;  and to be more frugal about/critical in verifying INVISIBLE TRADE foreign exchange outflow would be advantageous to our foreign exchange and balance of payments situation.

I rest my case.

BIBLIOGRAPHY

 

Some DAS Write-Ups

http://www.nigerianmuse.com/essays/DASwriteups.htm

            TABLE 1:  History of Foreign Exchange Controls in Nigeria

Second-tier Foreign Exchange Market (SFEM); Unified Official Market (UOM); Autonomous Foreign Exchange Market (AFEM); Inter-bank Foreign Exchange Market (IFEM); Dutch Auction System (DAS)

Source:  http://www.cenbank.org/welcome.htm

TABLE 2:  RECORD OF DAS TRANSACTIONS

Sources: 

http://www.cenbank.org

http://www.citibank.com/nigeria/gcib/citinews/mktfc02.htm

http://www.cenbank.org/Dutch_Search.asp,

http://www.ibtclagos.com

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