The evolution of the foreign exchange market in Nigeria up to its present state was influenced by a number of factors such as the changing pattern of international trade, institutional changes in the economy and structural shifts in production. Before the establishment of the Central Bank of Nigeria (CBN) in 1958 and the enactment of the Exchange Control Act of 1962, foreign exchange was earned by the private sector and held in balances abroad by commercial banks which acted as agents for local exporters. During this period, agricultural exports contributed the bulk of foreign exchange receipts. The fact that the Nigerian pound was tied to the British pound sterling at par, with easy convertibility, delayed the development of an active foreign exchange market. However, with the establishment of the CBN and the subsequent centralisation of foreign exchange authority in the Bank, the need to develop a local foreign exchange market became paramount.
The increased export of crude oil in the early 1970s, following the sharp rise in its prices, enhanced official foreign exchange receipts. The foreign exchange market experienced a boom during this period and the management of foreign exchange resources became necessary to ensure that shortages did not arise. However, it was not until 1982 that comprehensive exchange controls were applied as a result of the foreign exchange crisis that set in that year. The increasing demand for foreign exchange at a time when the supply was shrinking encouraged the development of a flourishing parallel market for foreign exchange.
The exchange control system was unable to evolve an appropriate mechanism for foreign exchange allocation in consonance with the goal of internal balance. This led to the introduction of the Second-tier Foreign Exchange Market (SFEM) in September, 1986. Under SFEM, the determination of the Naira exchange rate and allocation of foreign exchange were based on market forces. To enlarge the scope of the Foreign Exchange Market Bureaux de Change were introduced in 1989 for dealing in privately sourced foreign exchange.
As a result of volatility in rates, further reforms were introduced in the Foreign Exchange Market in 1994. These included the formal pegging of the naira exchange rate, the centralisation of foreign exchange in the CBN, the restriction of Bureaux de Change to buy foreign exchange as agents of the CBN, the reaffirmation of the illegality of the parallel market and the discontinuation of open accounts and bills for collection as means of payments sectors.
The Foreign Exchange Market was liberalised in 1995 with the introduction of an Autonomous Foreign Exchange Market (AFEM) for the sale of foreign exchange to end-users by the CBN through selected authorised dealers at market determined exchange rate. In addition, Bureaux de Change were once more accorded the status of authorized buyers and sellers of foreign exchange. The Foreign Exchange Market was further liberalized in October, 1999 with the introduction of an Inter-bank Foreign Exchange Market (IFEM).
Structure of Nigeria’s Foreign Exchange Market
The Nigerian foreign exchange market has witnessed tremendous changes. The Second-tier Foreign Exchange Market (SFEM) was introduced in September, 1986, the unified official market in 1987, the autonomous Foreign Exchange Market (AFEM) in 1995, and the Inter-bank Foreign Exchange Market (IFEM) in 1999.
Bureaux de Change were licensed in 1989 to accord access to small users of foreign exchange and enlarge the officially recognised foreign exchange market. Exchange rates in the Bureaux de Change are market determined. A parallel market for foreign exchange has been in existence since the exchange control era. It has been established that scarcity in the official sector and bureaucratic procedures necessitated the growth and development of the parallel market.
The Foreign Exchange (FX) market is the largest market by transaction volume within the Nigerian financial markets landscape. The Nigerian official FX market consists of three (3) dealing segments:
- The Central Bank of Nigeria (CBN) Auctions – Primary Market
- OTC Dealing – Secondary Market
- Bureau-de-Change – Cash Market
While the CBN remains the single largest supplier to the market and therefore leads market direction, the OTC market is the critical market with many suppliers and market makers. Various products are offered in the Nigerian FX market including Spot, Forwards, Swaps and Options. The USD/Naira ($/N) currency pair is the most traded in the market, however, Market Makers also deal some crosses including, Canadian Dollars (CAD), Swiss Francs (CHF), Euros (EUR), Pound Sterling (GBP), Japanese Yen (JPY) and South African Rand (ZAR).