Frequent interventions by the Central Bank of Nigeria and other emerging economies give a wrong signal about the strength of the local currency, the International Monetary Fund (IMF), has cautioned.
The Central Bank of Nigeria intervenes in the local foreign exchange market by selling to banks, who in turn sell to businesses and individuals. The CBN spends $16 billion annually to keep the naira’s value from collapsing.
In a joint report released at the weekend by IMF Director, Monetary and Capital Markets Department, Tobias Adrian; Director of the Fund’s Research Department; Gita Gopinath and Director of the Strategy, Policy and Review Department Ceyla Pazarbasioglu, the trio said that while flexible exchange rates can act as a useful shock absorber in the face of capital flow volatility, they do not always offer sufficient insulation.
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They stated that the impact of the interventions by the regulatory bank is harmful when access to global capital markets experience a hitch or market depth is limited.
The report quoted Fund as saying “Persistent interventions might feed a (false) sense of security about future exchange rate developments that leads firms or households to take on more foreign currency debt, thus increasing balance sheet vulnerabilities.”
The IMF team stated that in a continuous effort to assist nations to manage untable cross-border capital flows, it has taken a major step toward a new analytical macroeconomic framework that can shape appropriate policy responses.
IMF analysis suggests that there is no “one-size-fits-all” response to capital flow volatility, nor is it a case of “anything goes” or that all policies are equally effective.
“Optimal policies depend on the nature of shocks and country characteristics. For instance, the appropriate policy response in a country with less developed financial markets and large foreign currency debts may differ from that of a country that does not have foreign currency mismatches on their balance sheets, or those that can rely on more sophisticated (deep and liquid) markets”.
“Generally, in countries with flexible exchange rates, deep markets, and continuous market access, full exchange rate adjustment to shocks remains appropriate.
