Tag Archives: foreign exchange

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Much Ado About FX (Part III of III): Why Does It Matter?

If you are just joining the party, it will help to go through:

  1. What is an Exchange Rate?
  2. The Mechanics of the Nigerian FX Market

Now to the final part…  Meet the Wazobia family.

The Wazobias love the good things of life.  They are very exuberant – work a bit and party hard; some say they work to party :)!  They have a lot in their backyard, but they don’t produce much.  They have a lot of land and seeds, but they do not produce enough food to eat; they prefer to buy food and groceries from their neighbors.  They have a well of black gold, which they fetch from and sell to other families.  A lot of essential commodities can be extracted from this black gold, including the fuel the Wazobias use to generate electricity and power their vehicles and machines.  The Wazobias have not bothered to extract these by themselves; they find it more convenient to sell the black gold to their neighbors, and then buy these essential fuel commodities from their neighbors when they need them.  Every time the Wazobias produce something and sell to their neighbors (exports), they earn xZollers.  Every time they buy something from their neighbors (imports), they spend xZollers.  Doing business amongst themselves, they spend their local currency, the Waz.

This black gold was very expensive for most of the last decade.  Consequently, the Wazobias had been swimming in xZollers.  The Wazobias did not utilize these earnings to educate themselves or develop their capacity to: grow their own food, make their own tools, medically treat themselves, and produce their own fuel.  Instead, the Wazobias bought even more items from their neighbors, including basic grocery items.  Their neighbors loved them because of the amount of business they always brought.  The exchange rate between the xZoller and the Waz remained stable because every time a Wazobia needed to obtain xZollers to make a purchase of goods and services from their neighbours, no matter how frivolous the purchase, the xZollers were made available from the Wazobias’ large (and seemingly never-emptying) store of xZollers.

About 18 months ago, the fortunes of the Wazobias changed – the price of their black gold dropped!  It was not a small “don’t worry it is just a dip and will pick up soon” type of drop.  It was an over 70% decline over about 12 months, with 50% of the decline occurring in less than 6 months.  Remember that the Wazobias earned the bulk of their xZollers from this black gold.  As they had not invested in being able to be self-sufficient, i.e. produce things by themselves for themselves, the Wazobias found themselves in an unenviable position of having to still go to their neighbors to buy almost everything they need.  Now they needed a lot more xZollers than they could earn as they did not have much else to sell to their neighbors other than black gold.  As a result, it has become more expensive for the Wazobias to obtain xZollers as it has become rather scarce.

In order to conserve the few xZollers now available, the elders of the Wazobia family decided to impose restrictions on who could come and buy xZollers at a preset exchange rate (official market).  They pre-set the exchange rate so as to minimize the cost-increase impact (inflation) on the Wazobia family. There were other members of the Wazobia family (the Cartel) who had their own stores of xZollers obtained from various sources – some legal, some illegal.  The Cartel decided to capitalise on the scarcity of xZollers to make a lucrative market of their own (parallel market).  Some of the members of the Cartel were even able to access the official market; but instead of utilising the xZollers they obtained from there for the purpose they indicated, they placed them for sale in the parallel market.  As we all know, the scarcer an item is, the more expensive it will be; this is called the law of demand and supply.  Due to the restrictions placed by the elders, more and more Wazobias trooped to the Cartel to obtain xZollers to enable them keep up with the taste for their neighbor’s goods and services that they had grown accustomed to.  Not surprisingly, the parallel rate is now much higher than the official rate.

The Wazobias’ story is the story of Nigeria:  the black gold is our crude oil, the Waz is our Nigerian Naira, and we are currently an import-dependent nation.  The elders of the Wazobia family represent the CBN, and the neighbors are Nigeria’s trade partners.

If this series has served its purpose, then these news articles should be easy to digest :):

 

Were you able to make sense of the news articles?  Do you still have any questions about any aspect of the Nigerian FX market?  Got any recommendations on how the Wazobias can get out of this quagmire?  We look forward to reading from you: a comment in the box below or an email to comments@finomics101.com.

Happy new year all! “See” you in 2016 🙂

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image courtesy happynewyears2016.net

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Foreign-Exchange

Much Ado About FX (Part II of III): Nigeria’s FX Market Mechanics

In the first part of this “Much Ado About FX” series, we got to know what an exchange rate is, how it is derived, and some of the participants in the FX market.  Now to the operational nitty gritty of how the FX markets in Nigeria work.

Anyone looking to buy or sell xZollers in Nigeria has three options to choose from:

  • The official market, aka Bureaux de Change (BDCs)
  • The parallel market, aka “Mallams”
  • The private market, aka “Paddy”

The Official Market

Also called the Interbank Foreign Exchange Market (IFEM).  Due to the scale of its export-related activities, the FGN, through the CBN, is supposed to have the largest store of xZollers in the country (see Part I for background).  This makes the CBN the biggest seller of xZollers in the market.  The CBN, however, does not sell xZollers directly to end users (they used to, but they stopped in February 2015); they provide xZollers wholesale to BDCs, who in turn sell to the end users, making their profit by selling at a slightly higher rate than they received from the CBN.

A Bureau de Change (BDC) is essentially any business where people can exchange one currency for another.  BDCs are usually located at banks, travel agencies, and airports (source: Wikipedia).

The BDCs are heavily regulated by the CBN, which determines (among other things):

  • the amount of xZollers they can receive on any specific day
  • the applicable exchange rate(s) they can buy or sell xZollers
  • who they can buy xZollers from or sell xZollers to
  • the amount of xZollers they can maintain in their respective accounts

So, anyone who meets the CBN’s conditions can buy or sell xZollers in this official market.

The Parallel Market

Whenever there is a restriction to the access of a critical resource, a black market usually develops.  According to Investopedia, a black market is

Economic activity that takes place outside government-sanctioned channels. Black market transactions usually occur “under the table” to let participants avoid government price controls or taxes … In the financial context, the biggest black market exists for currencies in nations with strict currency controls.

Due to the strict controls placed by the CBN in the official market, a publicly accepted black market, commonly referred to as the Parallel Market, exists.  The traders in this market are popularly called “Mallams,” which is a term used to refer to men from the northern part of Nigeria;  historically most of them are from this region.

In addition to the absence of CBN controls in this market, some of the reasons the Parallel Market is patronised are:

  • there are more friendly hours; xZollers can be bought or sold at 10pm on a Wednesday or 7am on a Sunday
  • it aids anonymity; no form of identification is required, government-issued or otherwise
  • it is fast; a transaction can be completed in as little as 60 seconds with both parties happily on their separate ways afterwards

Historically there have been times when the “parallel rate” (the exchange rate in the Parallel Market) has been <5% higher than the “official rate” (the exchange rate in the Official Market).  At times like this when the CBN restrictions are very tight, the parallel rate could be up to 150% higher than the official rate.

The Private Market

Simbi wants to go to Phuket, Thailand for a much-needed time away.  She needs to buy some xZollers to take along for her room & board and other incidentals.  Her cousin, Jide, recently received some xZollers as a birthday gift from his mum.  Jide needs to exchange these xZollers for Nigerian Naira so he can go to the computer store and buy the laptop he has been wishing for.  Simbi mentions to Jide her travel plans and her need for xZollers while on a visit.  Jide very excitedly informs her that he has some xZollers he needs to exchange.  Simbi cannot believe her luck, and they immediately agree on an exchange rate; Jide gives Simbi the xZollers, and Simbi transfers the agreed-upon amount of Nigerian Naira to Jide’s bank account.

This is the Private Market.  The buyer and the seller know each other, privately agree on a rate, and transact their FX trade outside of the other two markets.  The buyer is the seller’s “paddy” and vice versa.  The volume of transactions that can take place here is negligible relative to the other two.

Hope this helps with your understanding of the mechanics of the Nigerian FX market.  Next week, in Part III, we shall go into the “whys”:

  • why is the CBN taking the actions it is taking?
  • why are the banks taking the actions they are taking?
  • why is the parallel rate so far away from the official rate?
  • why is it so hard for me to obtain foreign currency?

Part I provides a refresher on what an exchange rate is and how it is derived.  Do note that xZoller is being used here to represent primarily the U.S. Dollar, but it could also be any other internationally traded currency, like the British Pound or the Japanese Yen.

Still got questions about what you have read so far?  You can drop some lines in the comments box below or send an email to comments@finomics101.com.

Merry Christmas in advance!  As we celebrate the season, do remember that there will still be life next month and next year, so do not spend it all in December :).

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image courtesy express.co.uk

 

 

 

Much Ado About FX (Part I of III): What is an Exchange Rate?

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image courtesy unibank.com

A number of non-Nigerians wonder about the average Nigerian’s “fascination” with foreign exchange (FX) rates, and how when these figures sneeze (change), the entire Nigerian economic and financial systems seem to catch a cold.  Many Nigerians do not understand why this number currently seems to be in freefall, and I have heard a number of conspiracy theories related to this phenomenon.

To make sense of all this, let us try to understand what a foreign exchange rate, commonly referred to as “exchange rate” really is.

The xZoller

There is a product called the xZoller.  xZollers are used to purchase products and services from other countries.  Anyone leaving the shores of Nigeria has to purchase some xZollers to enable them conduct transactions in the other countries they visit.  xZollers are also what anyone selling products and / or services to customers in other countries would receive.  xZollers are a pretty neat nearly-essential commodity :).

Sellers

Nigerians and companies in Nigeria have a number of products that they sell to people and companies in other countries (i.e. exports), with the most notable being crude oil.  In exchange for these exports, we receive xZollers.  This means that private individuals, private companies, and the Federal Government of Nigeria (FGN) receive xZollers in exchange for their respective export trades; FGN also receives xZollers from some of its tax receipts.  FGN’s xZoller earnings are collected on its behalf by the Central Bank of Nigeria (CBN).  So, the CBN and other Nigerian entities in the export business receive xZollers as a part of their everyday business activities, hence are potential sellers of xZollers.

There is another major route through which xZollers make their way into the Nigerian economy: remittances from members of the diaspora.  When Nimi – a young Nigerian woman who has recently resumed her new job in Boston, Massachusetts in the United States after completing her university program at Harvard – sends some cash to her mum in Ibadan, Oyo in Nigeria through her cousin who came to visit, she is remitting xZollers to her mum, making Nimi’s mum a potential xZoller seller as well.

Buyers

As mentioned earlier, anyone who needs to purchase goods and / or services from any entity domiciled outside Nigeria will need to obtain xZollers to complete the transaction.  So,

  • Gbenga, who is in school in Toronto, Canada, will need to obtain xZollers to pay his school fees.
  • Zainab, who owns a manufacturing plant that requires a particular raw material that she obtains from Sydney, Australia, will need to obtain xZollers to pay her Australian suppliers.
  • Adamu, who purchases cars from a car manufacturer in Tokyo, Japan for resale in Lagos, Nigeria, needs to obtain xZollers to pay the car manufacturer.
  • Temi, who buys her office shirts from stores in London, UK, will need to obtain xZollers to pay the retail stores.

As we can deduce, there a lot of potential xZoller buyers.

Exchange Rate

Any of these potential xZoller sellers cannot transact business within Nigeria with their xZollers as the legal tender in Nigeria is the Nigerian Naira.  So, when the FGN wants to pay the salaries of the federal civil service workers, or Nimi’s mum wants to buy groceries for the house, they will need to find people who would like to acquire some xZollers by parting with some Nigerian Naira.  The seller and buyer would agree on how many Nigerian Naira will be exchanged for each xZoller, and this is what is called the exchange rate.

Now that we know what an exchange rate is, how it is derived, and some of the participants in the FX market, we are ready to delve into the mechanics of Nigeria’s FX markets (Part II), as well as the reason why their colds seem to impact Nigerians and the Nigerian economy so severely (Part III).  Do note that xZoller is being used here to represent primarily the U.S. Dollar, but it could also be any other internationally traded currency, like the British Pound or the Japanese Yen.

Any questions or comments would be most appreciated, and can be provided in the box below or sent to comments@finomics101.com.

Until next week when Part II comes your way, keep safe, and remember not to spend it all in December :).