This Selected Issues and Statistical Appendix paper presents an assessment of Nigeria’s past economic reform efforts—in particular the program supported by the 2000–01 Stand-By Arrangement (SBA). The paper also reviews weaknesses in the current fiscal management framework in Nigeria and proposes reforms to further strengthen the budget process. It describes weaknesses in the current public debt management framework and the government’s reform strategy. It highlights the reform implication and addresses further actions that will be needed to put the government’s domestic debt reform strategy on a solid foundation.


This Selected Issues and Statistical Appendix paper presents an assessment of Nigeria’s past economic reform efforts—in particular the program supported by the 2000–01 Stand-By Arrangement (SBA). The paper also reviews weaknesses in the current fiscal management framework in Nigeria and proposes reforms to further strengthen the budget process. It describes weaknesses in the current public debt management framework and the government’s reform strategy. It highlights the reform implication and addresses further actions that will be needed to put the government’s domestic debt reform strategy on a solid foundation.

VI. Nigeria’s Exchange Rate Regime—Experiences and Options for Further Reform53

A. Introduction

164. Despite numerous attempts at reform over the past two decades, Nigeria’s foreign exchange market continues to be characterized by (i) a relatively inflexible official nominal exchange rate, (ii) a high degree of market segmentation, and (iii) significant administrative and documentation requirements. Nigeria is among a select few countries that still maintain multiple foreign exchange markets. While the introduction of the Dutch auction system (DAS) in July 2002 represented an improvement over the previous system, it has had limited success in facilitating greater market determination and reducing market segmentation.

165. The effectiveness of previous reform efforts has been undermined by a host of factors, including (i) the challenges in selling the government’s oil revenues to the market in a non-distortionary manner, (ii) the fear of floating and an inherent desire for a strong and stable nominal exchange rate, and (iii) inconsistent monetary and exchange rate policies alongside fiscal dominance.

166. This paper aims to identify the reforms that need to be considered in unifying and improving the efficiency of the foreign exchange market, and allowing for more flexible determination of the exchange rate. This issue has recently gained importance. During the 2004 Article IV consultation discussions, the authorities indicated a desire to consider further steps in liberalizing and unifying the foreign exchange market. By reviewing the main lessons from past attempts to reform Nigeria’s foreign exchange market (Section B) and reforms undertaken by selected comparator countries that have successfully achieved unification (Sections C and D), this paper aims to identify key institutional structures, reform options, and sequencing issues that the authorities may need to consider (Section E).

B. Lessons from Nigeria’s Foreign Exchange Market Reform Attempts

167. Nigeria has experimented with various exchange rate systems and undertaken several liberalization measures over the past two decades (Box VI-1). While some effort was made to improve the functioning of some segments of the foreign exchange market (such as introducing an interbank foreign exchange market and liberalizing surrender requirements), the reforms had limited success in unifying the foreign exchange markets and facilitating greater market determination of the exchange rate.

168. The reform efforts, more broadly, were undertaken in an environment in which fundamental macroeconomic imbalances and governance issues were not addressed. Inconsistent fiscal and monetary policies resulted in periods of exchange rate misalignment. Also reflecting an inherent fear of floating, the authorities resorted to non-market measures—such as administrative controls and restrictive foreign exchange regulations—when the exchange rate came under pressure. Excessive reliance on controls and restrictions, as well as other distortionary and intransparent intervention practices by the Central Bank of Nigeria (CBN), precluded the exchange rate from responding to underlying market conditions and created widespread incentives to transact outside the official market, providing significant scope for rent-seeking and abuse. Weak governance practices in the banking system, such as systemic misreporting and violation of foreign exchange controls and prudential regulations as well as regulatory forbearance, also undermined the reform efforts.

Evolution of Foreign Exchange Markets in Nigeria (1986–2002)

1986-1992: Dual Exchange Rate Transitional Arrangement and Unification:

The dual exchange system, introduced in September 1986, comprised an administered exchange rate (for oil exports and certain public sector transactions) and a second composite market, of both a central bank auction for commercial banks and a floating interbank market. The interbank exchange rate was initially limited to a 1 percent margin above the previous auction,1 but was liberalized in 1987 to allow the interbank rate to diverge from the auction rate. At the same time, the auction changed from a marginal, to a discriminative, bid system. The informal market merged with the interbank market, with the 1989 licensing of foreign exchange bureaus.

The legal foreign exchange markets were eventually fully unified in March 1992, when banks and other authorized dealers were freed to determine the interbank rate, and the Central Bank of Nigeria (CBN) participated as a direct supplier of foreign exchange to the interbank market.

1993-1995: Administered Exchange Rate:

Following a brief return to an auction system in March 1993, the authorities reimposed a quantity allocation mechanism in April 1993 and abolished the interbank market in January 1994. Initially, the official rate was pegged at Naira 24.9 per US dollar, revaluing from the latest auction rate of naira 30 per U.S. dollar. It was then repegged at around Naira 22 per US dollar in April-July 1993, before settling at naira 21.9 per US dollar. The CBN’s weekly foreign exchange allocations were distributed among authorized dealers on the basis of sectoral shares.2

1995-2002: The Autonomous Foreign Exchange and Interbank Foreign Exchange Markets:

In February 1995, the authorities introduced another dual system, consisting of an autonomous foreign exchange market (AFEM) and an official exchange rate fixed at Naira 21.886 per US dollar. The official rate applied to CBN purchases of the government’s foreign exchange receipts and selected public sector transactions. All other transactions occurred at the AFEM rate. AFEM demand was restricted by documentation requirements on uses of foreign exchange, and supply was administered to effectively ‘set’ the AFEM rate close to the interbank and parallel market rates. In early 1999, the official rate was abolished and the CBN moved to daily interbank sales. However, transactions remained subject to significant constraints: banks acted only as intermediaries between the CBN and retail customers, foreign exchange bought from the CBN could not be sold among banks, spreads were constrained to one naira, and banks were required to report to the CBN on the utilization of foreign exchange.

1/ Individual banks’ participation was limited—5 percent of total funds offered for the 3 largest banks and 3 percent for other banks—to address concerns about large banks cornering the market.2/ 50 percent (later 60 percent) for manufacturing inputs, 10 percent for agricultural inputs, 30 percent (later 20 percent) for finished goods, and 10 percent for service payments.

Early attempts at foreign exchange market reform, 1986-2002

169. The reform process began in the mid-1980s after the naira had become increasingly overvalued under the fixed exchange rate regime following a successive period of expansionary macroeconomic policies (Table VI-1). Initially, the authorities responded by tightening exchange and import restrictions (import prohibitions and discriminatory import licensing rules). However continued large macroeconomic imbalances, increasingly segmented foreign exchange markets,54 and a weakened international reserve position prompted the authorities to announce a medium-term structural adjustment program in early 1986,55 a major component of which was to establish a new exchange rate system. This commenced a more than two decade period in which there were essentially three attempts to reform the foreign exchange market in Nigeria before introducing the DAS in mid-2002.

Table VI-1.

Macroeconomic Indicators, 1981—2002

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Sources: IFS, WEO and staff estimates.

Data on parallel market rates are patchy and constructed from different sources. Data through 1991 are based on WP/93/36. Data for 1992–97 are based on period average data recorded in the staff’s database. Data for 1998 onwards are end of period data recorded in the staff’s database.

170. While the dual exchange system introduced in September 1986 fostered a rapid depreciation of the real and nominal effective exchange rates (Figure VI-1) and a narrowing of the parallel market premium (Table VI-1), it had two significant shortcomings. First, the auction rate for selling the government’s foreign exchange earnings to the interbank market was prone to being officially administered by the CBN, hampering market competition. Second, as the majority of government-related transactions occurred at the more appreciated administered exchange rate, this impeded interbank market development. Documentation requirements and regulatory restraints also inhibited interbank market competition,56 which constrained adjustment of the official rate beyond the initial depreciation and the scope for unifying the official and auction rates.57 Limited progress on liberalizing external transactions did not permit a more rapid reduction in the parallel market premium. While some capital and current transactions were liberalized as planned, import and export restrictions were retained for a number of items, and most capital transactions remained subject to the approval of the Ministry of Finance.

Figure VI-1.
Figure VI-1.

Nominal and Effective Exchange Rate Developments, 1986—2002

Citation: IMF Staff Country Reports 2004, 242; 10.5089/9781451828948.002.A006

171. The period of exchange market unification in 1992 was short-lived. In the face of ballooning inflation, declining non-oil export volumes and renewed pressure on the external accounts, the authorities returned to an administered exchange rate (1993-1995). The major objective was to minimize importation costs by administratively determining the exchange rate, and strictly controlling both quantity and type of imports and exports through import bans, high tariffs, and a licensing mechanism.58 However, inflation continued to accelerate, the real effective exchange rate appreciated substantially (Figure VI-1), the current account remained under pressure and reserves stagnated. By 1994, the parallel market premium exceeded 200 percent; more than 10 times the premium in 1992 and a level not seen since the mid-1980s (Table VI-1). While some measures were introduced in an attempt to direct demand away from the parallel market,59 this system presented numerous opportunities for rent-seeking and abuse. Behavior in the parallel market reflected both a spillover of unmet legitimate market demand as well as illicit transactions (including suspected abuses for capital flight). In early 1995, the authorities concluded that attempts to stabilize the naira by administrative means had been ineffective.

172. The return to a dual exchange system (1995-2002) was similar to the experience of the late 1980s. Regulations and accepted practices limited dealings among market participants and impeded the effective functioning of the market. The autonomous foreign exchange market (AFEM) was not a “market” in a typical sense. Documentation requirements restricted demand and the CBN, as the sole recipient of the government’s oil receipts, was in a position to administer supply of foreign exchange. The interbank market was quite small, but continued to operate, aided by non-oil export surrender requirements and periodically allowing transferability. At the same time, banks were frequently precluded from dealing amongst themselves using foreign exchange obtained from the CBN, thereby formally segmenting the interbank market. Purchases of foreign exchange for both current and allowed capital transactions required supporting documentation (for which banks were responsible), and retail customers who did not satisfy reporting requirements could only deal legally with foreign exchange bureaus60 or illegally through the parallel market.

173. The more depreciated AFEM rate initially facilitated a moderation of import volumes, which—complemented by an improvement in non-oil primary fiscal deficit in 1995-96—allowed some rebuilding of foreign exchange reserves (Table VI-1). However, non-oil export volumes faltered as the real exchange rate continued to appreciate (Figure VI-1). Despite some reduction in access to foreign exchange at the official rate, its overvaluation proved highly distortionary.61 Continued advocacy of the official rate and intransparency of transactions afforded by the multitude of rates, implied considerable opportunities for economic rents. There were also continuing concerns about capital flight using foreign exchange derived mainly from public resources. Although the margin between parallel market and AFEM rates was typically 5 percent or less, a premium in the order of 250-300 percent still existed between the official and parallel/AFEM rates.

174. The elimination of the official rate and move to daily AFEM sales in early 1999, supported by the restoration of transferability of funds, helped improve the functioning of the AFEM and interbank market, as reflected in a dramatic narrowing of the parallel market premium. However, this too was undermined by a return to more imprudent macroeconomic policies. The real effective exchange rate also began to lose ground as lax fiscal and monetary policies once again allowed inflation to accelerate. After narrowing to around 5 percent in 1999,62 the parallel market premium again climbed to over 20 percent in mid-2001 reflecting both the spillover of demand pressures and the continued regulatory incentives to divert transactions to the parallel market to circumvent the high level of market regulation. With the CBN reluctant to allow the exchange rate to depreciate in the face of demand pressures, gross international reserves came under pressure.

The current Dutch auction system (July 2002 to present)

175. Faced with persistently high demand for foreign exchange and rapidly declining international reserves, the authorities ceased direct sales to the interbank in July 2002. The new official retail DAS was intended to allow the exchange rate to adjust to market pressures and safeguard international reserves. Three other submarkets—the interbank, the bureau de change and parallel markets (Box VI-2)—continued along with the DAS.

176. In the second half of 2002, the decline in international reserves abated and the nominal exchange rate depreciated by around 7 percent, helping essentially halve the parallel market premium to below 10 percent by end-2002. Despite the nominal appreciation, the real effective exchange rate was relatively stable as inflation stayed in double digits, on account of expansionary fiscal policies and accommodative monetary policies.

177. However, for much of 2003, the CBN demonstrated a reluctance to let the nominal exchange rate adjust in the face of mounting demand pressures fueled by still lax fiscal and monetary policies. Consequently, the real effective exchange rate showed signs of turning upwards in line with inflationary pressures. In response to rising demand, the CBN increased supply to the auction, resulting in a drain on international exchange reserves at a time when all other major oil exporters were building reserves.63 However, as demand pressures continued to build in the second half of 2003, further increases in sales had only limited success in resisting the depreciation.64 Although pressure eased somewhat in December, the marginal DAS rate ended the year more than 8 percent depreciated relative to end-2002.65 Yet with increased supply to the DAS, the parallel market premium remained relatively stable at around 8–9 percent for much of 2003.

The Current Structure of Nigerian Foreign Exchange Markets1

There are currently four foreign exchange markets in Nigeria: (i) the official Dutch auction system (DAS), (ii) the interbank market, (iii) the Bureau de Change market, and (iv) the parallel market. In addition to these markets, the CBN also opened its Travelex window2 in mid-2002.

The Dutch Auction System is a sealed bid, multiple price auction. Auctions take place twice a week, with the CBN announcing the offer amount the day before the auction and results the day after. Successful bids are satisfied at the bid price and the marginal rate is the market clearing rate. The DAS only supplies the retail end of the market, with funds purchased from the CBN to be used for eligible transactions only, and banks required to submit documentation establishing their clients’ eligibility.3 Funds obtained in the DAS are not transferable to the wholesale interbank market. In 2003, participating banks averaged around 60 (on occasion, as many as 75 banks participated) and sales amounted to US$9¾ billion.

The Interbank Foreign Exchange Market (IFEM) exchange rate is freely negotiated among authorized dealers, with no margin or restrictions over the DAS rate. Foreign exchange is obtained from sources other than the CBN, including foreign oil companies and non-oil exports. The IFEM grew rapidly—by around 30 percent—after the surrender requirement for private oil companies to the CBN was abolished and IFEM sales rose from US$¾ billion in 1998 to over US$1 billion in 1999. Most recent estimates put IFEM sales in 2001 at US$1½-2 billion and between US$2-3 billion in 2002 (or around 20-30 percent of DAS sales). This apppears well below the rate of interbank relative to retail turnover even in those countries where the interbank market is considered relatively small (at less than 50 percent of bank-customer level turnover).

The Bureau de Change (BdC) Market is a relatively small spot market, dealing with foreign exchange obtained from the private sector only. No documentation is required for buying or selling. There are around 250 registered BdC, although less than 15 were thought to dominate the market in 2002. Sales are not reported formally, but were estimated at US$250-500 million in 2000. Individual transactions are officially limited to US$5,000, although the limit is often circumvented and there have been reports of transactions in excess of US$100,000.

Parallel Market: This is an illegal, but tolerated, market used to finance undocumented imports (to avoid customs duties or import bans) and restricted capital transactions. Given its informal nature, estimates of the market’s size are subject to a wide degree of uncertainty. However, banks involved in the market are thought to range between 10 and 30 (and, as a sanction, the CBN had periodically suspended banks’ foreign exchange operations) and most common estimates put annual sales around US$4-6 billion, but other estimates are as high as US$7-8 billion.

1/ CBN Annual Report (2001), Moser (2003), Canales-Kriljenko (2004), and Geadah and others (2001).2/ The ‘Travelex’ windowcovers legitimate foreign exchange demand related to overseas travel expenses, with sales of around US$240 million in 2003.3/ For example, the official foreign exchange form for authorized imports (Form “M”) must be registered with an authorized dealer (in duplicate) and certified by the negotiating bank. Exporters must submit original copies of the bill of lading, with evidence of payment of the relevant administrative charges, to the collecting bank.

178. Reflecting the reluctance to let the nominal exchange rate respond to market pressures, there has been a weak relationship between excess demand and changes in the marginal rate (Figure VI-2). Therefore, in practice, many of the limitations of the earlier reform attempt and incentives for operating in the parallel market persist:

  • transferability of funds between the DAS and interbank markets is prohibited;

  • export proceeds for non-oil exporters must be repatriated within 90 days from the date of shipment of the goods;

  • documentation requirements for purchases of foreign exchange for both current and allowed capital transactions are highly burdensome;

  • the authorized maximum sale of foreign exchange by Bureaus de Change is limited, but often circumvented in practice; and

  • trade restrictions, namely import bans, have increased over the last 12–18 months.

Figure VI-2.
Figure VI-2.

Dutch Auction Operations, July 2002 – December 2003

Citation: IMF Staff Country Reports 2004, 242; 10.5089/9781451828948.002.A006

179. The DAS also suffers from the same fundamental limitation as the 1986 hybrid system. As the sole supplier to the market, the CBN has scope to de facto administer the rate. This departure from stated policy was evidenced by the behavior of the marginal DAS rate for the first 8–9 months of 2003, and the decline in international reserves despite near record oil receipts. Continued divergences between the various foreign exchange markets in Nigeria, therefore, reflects both the conduct of macroeconomic policies and institutional factors that segment the market. Moreover, the prevalence of multiple exchange markets and rates in Nigeria leads to inefficiencies and disincentives, imposing direct and indirect costs on the economy.

C. Motivation for Exchange Market Unification and Reform

180. During the 1980s and 1990s, many Fund members—developing countries, in particular—undertook reforms to facilitate foreign exchange market unification and the adoption of more market-determined exchange rates.

181. While nearly half the Fund’s membership maintained dual markets or had active parallel markets in the early 1970s, the number has fallen significantly since. At end-1997, 43 member countries had multiple exchange rate systems, of which 30 where classified as giving rise to multiple currency practices under the Fund’s jurisdiction.66 Results of the 2001 Survey on Foreign Exchange Market Organization revealed that “multiple foreign exchange markets exist in only four” of the 91 respondent countries.67 Other reports suggest that, by 2001, only 9 of the Fund’s member countries maintained multiple exchange markets.

182. A key motivation underlying these trends has been to enhance an economy’s ability to deal with shocks and promote allocative efficiency of the foreign exchange market by reducing or eliminating market segmentation and the incentive to transact in parallel markets. A recent study68 found that macroeconomic performance was weaker in countries with dual or multiple exchange rates, irrespective of the type of regime—fixed or floating. Between 1979 and 1999, annual average per capita growth in countries with dual or multiple exchange rates was about 0.6 percent, compared with 1.8 percent for countries with unified rates.

183. In addition, developing countries have tended to move to market-determined exchange rate regimes.69 The share of developing countries with flexible exchange rate regimes is estimated to have increased from around 10 percent in the mid-1970s to more than 55 percent by the end of the 1990s.70 Experience suggests that the desire for a strong and stable nominal exchange rate has often contributed to a loss of external competitiveness, balance of payments difficulties, distortions in the allocation of foreign exchange, and the emergence of parallel markets and administrative foreign exchange control.71 In recognition, countries have moved toward more market-determined exchange rate regimes, which has facilitated the economy’s ability to adjust to external or domestic stocks. It has also helped countries reduce their dependence on exchange and trade restrictions, while at the same time allowing authorities to undertake reforms and put policies in place that help improve the country’s economic performance and external competitiveness.

D. Issues for Oil-Exporting Countries

184. Oil-exporting countries have followed the same trend. Their experience in unifying their foreign exchange markets and their mechanisms for supply of foreign exchange are particularly instructive for Nigeria. Most of these countries have to contend with dominance of oil export receipts, yet multiple or segmented markets have virtually ceased to exist. In 2001, of the 19 major oil-exporting countries, only Nigeria, the Islamic Republic of Iran, and The Socialist People’s Libyan Arab Jamahiriya had multiple exchange markets. The latter two have subsequently unified their exchange rates leaving Nigeria as the only major oil exporter with multiple exchange markets.

185. Of those countries that are similarly placed in terms of reliance on oil export proceeds (Box VI-3), the unification processes in Iran and Algeria (Box VI-4) provide useful examples of particular challenges—and potential pitfalls—in supplying foreign exchange to the market where the vast majority of oil proceeds accrue to the government or are surrendered to the central bank. Reforms were introduced in both Iran and Algeria with the aim of foreign exchange market unification (Box VI-4).

  • In both countries, the central bank now sells the government’s oil export proceeds directly to the interbank market and there are no surrender requirements for non-oil exports. The administrative allocation of foreign exchange for authorized imports was eliminated and all import-related foreign exchange demand channeled through the interbank market. Also, separate bureau de change markets were eliminated, with all travel-related foreign exchange sales channeled through the interbank market.

  • Before moving to full interbank market intervention, Algeria took the intermediate step of holding daily fixing sessions with a limited group of robust commercial banks. It also announced regularly its intervention policy in order to enhance transparency and predictability of its actions.

  • However, while the move to direct interbank market sales allowed foreign exchange market unification in Iran, in practice a free float is impeded by the concentration of crude oil receipts with the government and relative dominance of the central bank. This is compounded by the lack of depth of the financial sector and administrative impediments to its further development. The Algerian interbank market suffers from similar market inefficiencies.

Exchange Arrangements in Selected Oil-Producing Economies

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Sources: IFS, staff estimates, Annual Report on Exchange Arrangements and Exchange Restriction (2003).

E. Operational Considerations and Options for Nigeria72

186. The ultimate objective of foreign exchange market reform in Nigeria should be to unify markets and allow the interbank market to become thevehicle for allocating foreign exchange in the Nigerian economy. In looking to identify necessary steps and priorities for further reform, past experience provides some fundamental lessons.

  • The institutional framework (in this case exchange controls and regulations guiding the operations of various foreign exchange markets) should not be used as the primary means of fostering exchange rate stability (nominal or real). Lack of financial discipline would likely undermine macroeconomic performance irrespective of the exchange rate regime, so prudent macroeconomic policies are an essential pre-condition for a successful exchange market reform, and alleviating the burden currently placed on foreign exchange regulations and administrative controls.

  • Segmented markets are likely to persist where legal or institutional factors prohibit or impede transactions among participants. Therefore, the authorities need to make a firm commitment to unification and allowing the interbank market to play the primary role in allocating and setting the price for foreign exchange.

  • As unifying foreign exchange markets could result in some overshooting of the exchange rate, the authorities need a strong commitment not to reverse course in response to the short-term adverse consequences. Unification should be carried out as part of a comprehensive stabilization program, with consistent monetary and fiscal policies to limit the adverse impact of unification on inflation.

Foreign Exchange Market Operations in Selected Oil-exporting Countries

Developments in the Islamic Republic of Iran represent a useful comparator for Nigeria. Previously the Iranian exchange rate system had been heavily controlled and, like Nigeria, featured multiple exchange markets with associated exchange restrictions and import controls. Earlier reform efforts achieved significant simplification of the exchange system, but failed to achieve unification.

  • Prior to March 2002, the exchange rate system consisted of two official rates: (i) a fixed official rate, which applied mainly to imports of essential and government imports, certain priority government projects and public external debt service, and (ii) an effective Tehran Stock Exchange rate applied to non-oil exports and imports maintained by the Ministry of Commerce.

  • The two official rates were unified in March 2002 and the value of the rial is determined in an interbank market. Under the new foreign exchange system (i) the central bank intervenes directly in the interbank market, (ii) there are no non-oil export surrender requirements, (iii) the procedure of allocating foreign exchange for authorized imports was eliminated, and (iv) the distinction between internally and externally sourced foreign exchange deposits has largely been eliminated.

However, Iran’s financial markets remain relatively underdeveloped and rates of return are administered.1 Along with the concentration of crude oil receipts with the government and relative dominance of the central bank, these factors have complicated the adoption of a free float.2 Nevertheless, Celasun (2003) argues that an exchange rate regime that allows for nominal exchange rate movements in response to oil price shocks would be “beneficial in terms of dampening economic fluctuations and promoting growth” in Iran.

Algeria presents another interesting example. Prior to October 1994, the exchange rate of the Algerian dinar was pegged against a basket of currencies that was periodically adjusted. Then, as an intermediate step, the Bank of Algeria (BA) introduced a managed float through daily fixing sessions that included six commercial banks. That system was replaced in early 1996 by an interbank foreign exchange market. No margin limits are imposed on the buying and selling rates in the interbank market, although a narrow margin exists between the buying and selling rates of the BA. Surrender requirements are imposed on all crude export proceeds and 50 percent of non-oil export proceeds; the remaining share may be retained in a foreign currency account. As oil export proceeds from the state oil company revert to the BA, the latter remains the largest supplier of foreign exchange and plays a major role in the interbank market. Moreover, the deepening of the interbank market and strengthening of the role of other players in the market is constrained by several other factors, including: extensive capital controls against the build-up of foreign exchange exposure; other limits on foreign exchange use (e.g., ceilings for travel abroad); and extensive procedures for foreign exchange sales for service transactions.

Indonesia has had a floating exchange rate, determined by demand and supply in the market, since August 1997. Although the vast majority of the government’s foreign currency earnings from production sharing agreements with foreign oil companies are deposited with Bank Indonesia (BI), BI does not dominate in the interbank market. Oil and gas exports, of which less than half accrue to the government, represent less than 25 percent of total merchandise exports and a fraction of market turnover. In any case, BI tends to accumulate reserves through the government’s foreign currency earnings and only occasionally sells to (and never buys from) the interbank market.

The Azerbaijan National Bank (ANB) uses the exchange rate as the nominal anchor for monetary policy, which has in effect led to informal exchange rate targeting. Formally, the ANB determines the official exchange rate against the U.S. dollar every day, equal to the weighted average of all foreign exchange markets, including the auction and electronic interbank markets, the retail intra-bank market, and the bank note market in foreign exchange bureaus. The majority of foreign exchange transactions are retail or customer transactions, and the ANB is not the dominant market participant. Noncash exchange rates are determined five times a week in the foreign exchange auctions conducted by the Baku Interbank Currency Exchange, and exchange rates for cash transactions are quoted by licensed commercial banks.

The Central Bank of the Russian Federation announces daily an official exchange rate, based on the interbank market exchange rates. The exchange rate of the ruble is determined in a continuous interbank foreign exchange market, which electronically links exchanges across the country. The official rate is set equal to the previous day’s weighted average rate in the interbank market. The Bank of Russia operates directly in both the interbank currency exchanges and the over-the-counter interbank market, but is not the dominant player in the market.

1/Jbili and Kranmarenko (2003).2/Celasun (2003).

187. The nature of macroeconomic policy reforms in Nigeria is the subject of broader discussions between staff and the authorities not covered in this paper. There is, however, significant latitude for institutional reforms to unify foreign exchange markets and allow the CBN to adopt a more market-determined exchange rate regime. In considering reform options, several critical issues need to be addressed. First, how, as the dominant supplier of foreign exchange, should the central bank participate in and facilitate the development of the interbank market in a non-distortionary way. Second, while a functioning interbank market already exists in Nigeria, there is a need to consider how to improve the efficiency of the interbank market to allow it to play a role in allocating foreign exchange on a continuous basis.

The role of the CBN in supplying foreign exchange to the interbank market

188. The role of the central bank in supplying funds to the interbank market can be critical for the market’s development: it can both facilitate market making and provide liquidity. However, central banks should avoid becoming the market-maker. In the longer run, direct interbank transactions should be encouraged. However, the issue of market-making takes center stage in countries, such as Nigeria, where the central bank is the foreign exchange agent of the public sector which accounts for the majority of foreign exchange receipts.73

189. With the existing interbank market and well defined group of foreign exchange dealers, the CBN could sell and buy foreign exchange directly to the interbank market, as is the case in Algeria and Iran, as well as in most developing countries. Alternatively, an interbank auction could be considered in Nigeria to facilitate efficiency. However, it would be important that such a step be viewed as transitional, with the ultimate aim to move to an interbank arrangement.

Direct interbank market sales

190. The concentration of export proceeds with the CBN should not preclude it from directly selling into the interbank market. For instance, the Ugandan authorities decided that, despite the concentration of coffee export proceeds with the government, direct central bank participation in the interbank market would be the more efficient option.74 Apart from institutional factors—e.g., the depth and expertise of the financial sector—moving to a foreign exchange system centered on direct interbank market sales would be more consistent with a market approach and less prone to administrative interference. It would also provide for a continuous market—enhancing liquidity and reducing transactions costs—and would allow the CBN to distance itself from the political implications of setting or announcing a particular rate.

191. Streamlining restrictions on the use of foreign exchange outside the DAS, and merging the bureau de change and interbank markets would help pool resources across the entire foreign exchange market and ameliorate the CBN’s dominance. At the extreme, the authorities could consider decentralizing its supply of foreign exchange by selling directly to commercial banks, which would also support the role of banks as market-makers. However, this would not be ideal in Nigeria, as the dispersion of foreign exchange receipts among the levels of government75 could result in a coordination problem. Centralizing public sector foreign exchange operations with the CBN avoids lumpy foreign exchange sales that can disrupt the market. The critical issue to ensure that the CBN does not undermine the market-making role of banks will be a transparent and pre-announced intervention policy.

192. Moreover, where auction and interbank markets operate in parallel, the competitiveness and efficiency of each market can be undermined by restricting the transferability of resources. In particular, where trading outside the auction is limited or the exchange rate in the interbank market is prevented from fluctuating in response to demand and supply pressures, auctions can undermine interbank market development, foreign exchange market unification and the efficiency of foreign exchange allocation.76

Foreign exchange auctions

193. Alternatively, where institutional considerations—such as instability or concentration of foreign exchange flows, balance sheet and governance weaknesses in the banking system or collusive behavior among banks—are of concern, this may call for an alternative arrangement such as an auction system.77,78 An auction (Box VI-5) may facilitate efficiency and may sometimes provide a useful transitional arrangement, provided they are not restrictive and allow for the evolution of a proper interbank arrangement.

  • Periodic foreign exchange auctions may allow a central bank to minimize the price impact of intervention and ensure it receives a “fair rate” for its foreign exchange.79 However, countries that have attempted to do this have often maintained heavy regulations and limits on transferability, which have constrained unification and impeded a deepening of the interbank market.

  • Where lack of trust or communications may hinder direct dealings between banks, which is often typical in markets characterized by high segmentation and lack of competition, an interbank fixing arrangement may facilitate interdealer transactions.80

Considerations for Foreign Exchange Auctions

By providing a transparent system of foreign exchange allocation, an auction may improve allocative efficiency. It can also be a viable option where financial markets are underdeveloped or thin. There are, however, two broad factors that can influence the efficiency and effectiveness of an auction market, and thus the prospects for exchange market unification:

  • Certainty and transparency of operations: Auctions are generally more susceptible to official interference or manipulation and, by undermining credibility and transparency, can produce suboptimal results. It is, therefore, important that the organizer commits, in advance, “to a set of rules governing the auction process which are revealed to participants. The organizer should possess the credibility to assure the participants that certain rules would be followed and not changed during the bidding process.”1 Clarity of rules should extend to the frequency of, and supply of foreign exchange to, each tender session.

  • Access to and competitiveness of the bidding process is equally important in realizing allocative efficiency. As with interbank markets, this will be influenced by the depth of the financial market, concentration of market power and access to tender sessions. For example, the allocation of foreign exchange may not be efficient where there is a high concentration of demand or supply of foreign exchange or where certain (namely public sector) transactions occur outside the auction system. Limiting the scope of transactions or restricting participation in the auction can substantially reduce the turnover of the auction market, limiting the auction’s ability to achieve a stable exchange rate and sustaining pressures for transacting in the parallel market.

While there is no one “right” type of auction, the nature of the auction (and its relationship with the interbank market where one exists) can be instrumental in influencing market conditions.

  • In retail auctions, where authorized dealers act on behalf of end-users and cannot transact among themselves, there is a formal impediment to integration with the interbank markets. If this results in a divergence between exchange rates in the two markets, it can raise doubts about the auction’s credibility. Participants in a wholesale auction, however, may bid on their own account or on behalf of customers, and all retail transactions are confined to the interbank market. Therefore, where there are no restrictions on the price relationship, demand and supply in the two markets can work in a complementary fashion and competition in both markets can be enhanced.

  • Under a discriminative, rather than marginal, price auction (as is the current system in Nigeria), successful participants, in paying the bid price, risk paying significantly more than the market clearing price. Unless there is sufficient transparency in the auction system to allow participants to reasonably gauge demand conditions, a discriminative price auction may inhibit market entry and lead to a continuation of the parallel market. Where an auction gives rise to spreads of more than 2 percent between successful bids, it can result in a multiple currency practice.

1/Kovanen (1994).

194. If an auction were deemed a necessary step in Nigeria, it should be (i) adopted as a transitional step, with a known exit strategy, (ii) conducted transparently and with clearly established rules, and (iii) based on a competitive bidding process. In particular, it should be clear that the main purpose of the auction (if considered necessary) would be to facilitate CBN’s interventions in the foreign exchange market and all retail transactions should be clearly conducted outside the auction market in the interbank/bureau market.

  • The amount sold to the market should be determined in advance (say a month ahead), relative to projected oil proceeds and likely demand, and consistent with the overall macroeconomic framework and targets on gross international reserves. The CBN could continue to auction dollars twice a week. However, at times the amounts auctioned have been relatively large and this has resulted in market volatility. More frequent (e.g., daily) auctions and smaller but equal amounts could be less disruptive to the market. Recent adjustments to Mexico’s rule-based foreign exchange mechanism were designed to smooth the amounts auctioned throughout the year.

  • Also, shifting to a wholesale auction may offer several advantages. Restoring the transferability of funds between the official auction and interbank market, and allowing commercial banks to use foreign exchange purchased from the CBN for interbank transactions, will promote integration of the two markets and unification of the exchange rate for legal transactions, as well as help increase the depth and efficiency of the market. However, convergence of the two rates should be achieved through unifying the markets and not through administrative measures. Therefore, the CBN should refrain from administrative limits on the margin between the auction and interbank rates. Moreover, a wholesale auction may involve a larger minimum bid requirement, which acts to encourage intermediation in the interbank market.

CBN operational rules and intervention practices

195. The effectiveness of either direct interbank market sales and an auction will require that the CBN establish (and disclose) the parameters within which it will conduct activities in the foreign exchange market. Moreover, the CBN will need to build credibility in its ability and willingness to adhere to those rules. As auctions can be subject to manipulation, it is important that the CBN commits to a set of well defined rules governing the auction process.

  • Supply of foreign exchange to the market—be it interbank sales or wholesale auction—should be anchored around a clear and firm reserve target that allows the exchange rate to respond freely to retail demand in the interbank market. For example, Mexico recently adopted a rule-based mechanism for supply to its daily foreign exchange auction aimed at a particular reserve accumulation path.

  • The CBN will need to develop operational guidelines for official intervention81 in the foreign exchange interbank market. That said, the interventions should be treated as exceptional transactions and should be clearly defined with the aim to smooth short-term exchange rate fluctuations or for reserve management purposes.

  • The CBN should also establish objective and transparent criteria for choosing counterparties for foreign exchange dealings.82 As an interim step, the CBN may only allow primary dealers (market-makers or those deemed to be sufficiently sound) to participate in an auction. If interbank trading is inhibited by primary dealers’ reluctance to deal with smaller or weaker banks, the CBN could consider holding periodic (say, weekly) fixing sessions.83 Over time, as smaller banks grow or become financially stronger, they could’ graduate’ to become primary dealers.

  • The transactions of final end users of foreign exchange should be confined to the retail interbank market between dealers—commercial banks and bureaus de change—and their customers. And, importantly, all official transactions should be treated as retail transactions effected in the interbank market. This will promote market deepening and unification. Exceptions should be kept to an absolute minimum, subject to specific and transparent rules about the circumstances under which transactions can occur outside the interbank market and the relevant exchange rate (for example, the weighted average in a discriminative price auction or the clearing price in a marginal price auction). There needs to be a clear commitment and signal that these transactions would not occur at a preferential rate.

Strengthening the existing market infrastructure

196. The existing interbank market in Nigeria functions relatively well. In general terms, the number of participants and their degree of sophistication is sufficient to foster a relatively competitive environment, especially if obstacles to the flow of resources between market segments are removed to allow market deepening (Box VI-6). Irrespective of the choice of market infrastructure foreign exchange reform efforts would be better served if some aspects of the interbank market and the CBN’s role in it were strengthened (in particular, by establishing a primary dealer network, abolishing regulations that inhibit efficient market operations, and strengthening the supervision of the interbank market).

  • The CBN needs to strengthen prudential regulations governing foreign exchange risk, including limits on foreign exchange working balances, open positions,84 and reporting requirements. The CBN will need to ensure that it has the requisite skills and institutional framework for prudential oversight. In this regard, plans to introduce the global bank reporting system (Globus) later this year, by providing an electronic interface between banks and supervisors, will allow banks’ open positions to be monitored on a daily basis. The CBN needs to continue to enforce sanctions for dealers that violate foreign exchange regulations (including operating in the parallel market and breaches of bureau de change transactions limits).

  • Typically, interbank markets are developed around authorized dealers, with some dealers acting as market-makers to maintain liquidity and continuous markets. The CBN should therefore work to establish a group of reputable primary foreign exchange dealers that have strong capital bases, and the capacity to manage foreign exchange risk and handle large transactions with ease. Moreover, zero tolerance for violation of prudential regulations should help address the concern that banks will retain foreign exchange and ensure it is channeled to the real economy.

  • In addition to dissemination of information by the CBN, there is a need to ensure that dealers have sufficient capacity and modalities for timely access to information on market developments and transactions to support informed decision-making. In this regard, access to a two-way quote dealing system is significant and, although not a fundamental obstacle, the replacement of telephones with screen-based dealing would enhance the conduct of foreign exchange deals and their settlement. If necessary, the CBN should work with authorized dealers to strengthen skills.

  • Nigeria will have to streamline its foreign exchange regulations and abolish regulations that inhibit efficient market operations (such as limits on foreign exchange spreads). In addition to plans to review the tariff structure, accompanying measures will be required to liberalize trade and exchange restrictions—including strengthening the customs administration, and streamlining administrative and documentation requirements—to lessen the incentive to transact outside the official market.

  • With foreign oil companies no longer required to surrender foreign exchange to the CBN and the consequent growth of the interbank market, there is no need to reinstate surrender requirements for foreign oil companies. With continued sound macroeconomic policies and further deepening of the interbank market, it should also be possible to unwind the requirements for non-oil export proceeds to be surrendered to commercial banks. If not immediately possible, this should be done over the medium term once official and interbank market unification has taken hold.

Features of a Well-Functioning Interbank Market

An efficient and well-functioning interbank market will typically be underpinned by the high degree of competition and genuine interdealer transactions, as well as transparency and communication.

A competitive environment requires a relatively well-developed financial system with a sufficient number of participants and volume of transactions.1

  • Appropriately designed prudential regulation and supervision that do not unduly restrict or impede effective rate setting can foster interbank market development provided that they focus on safeguarding the soundness of the banking system by (i) preventing monopolistic positions or destabilizing speculation, and (ii) reducing individual foreign exchange risk.

  • Freedom of market entry is central to facilitating competition and keeping buying/selling spreads to a minimum, so as to support a more stable and competitive market.

  • Like other asset markets, exchange markets need sufficient liquidity to function efficiently. Legal or institutional structures that impede transactions among participants and perpetuate incentives for transacting outside the official system, can slow the process of market deepening.

  • Surrender requirements that promote foreign exchange accounts within the domestic banking system—rather than formal surrender to the central bank—can increase the role of that market in the allocation of foreign exchange.2 However, reforms that reduce incentives for transacting in the parallel market or for retaining foreign exchange to hedge against risks, can promote the flow of funds to the interbank market, without formal surrender requirements.

As information gathering and unfamiliarity in undertaking transactions can be costly for dealers, central banks and clients, the wide availability of information can improve the efficiency of interbank market transactions.3 Regular access to exchange rates (for example, via an electronic exchange) is important for efficient pricing decisions by foreign exchange intermediaries. The clear and transparent communication of policies (including the central bank’s intervention policy) is necessary to building market confidence as well as promoting and reducing the cost of skill development and information sharing. Equally, the central bank’s ability to provide oversight and participate in the market depends on its own skill base and organizational structure, and access to information gathering and dissemination technologies.

1/Kovanen (1994), Quirk and others (1987).2/McDonald and Lum (1994).3/McDonald and Lum (1994), Quirk and others (1987).

F. References

  • Aghevli, Biijan B., and others, 1991, Exchange Rate Policy in Developing Countries: Some Analytical Issues, IMF Occasional Paper No. 78 (Washington: International Monetary Fund).

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  • Canales-Kriljenko, Jorge Iván, and others, 1999, “Nigeria: Reform of the Foreign Exchange Intervention Mechanism” (unpublished and confidential: Washington, International Monetary Fund).

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  • Canales-Kriljenko, Jorge Iván, and others, 2003, “Official Intervention in the Foreign Exchange Market: Elements in Best Practice,” IMF Working Paper 03/152 (Washington: International Monetary Fund).

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  • Canales-Kriljenko, Jorge Iván, 2004, “Foreign Exchange Market Organization in Selected Developing and Transition Economies: Evidence from a Survey,” IMF Working Paper 04/4 (Washington: International Monetary Fund).

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  • Celasum, Oya, 2003, “Exchange Rate Regime Considerations in an Oil Economy: The Case of the Islamic Republic of Iran,” IMF Working Paper 03/26 (Washington: International Monetary Fund).

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  • Enoch, Charles, 1998, “Transparency in Central Bank Operations in the Foreign Exchange Market,” IMF Paper on Policy Analysis and Assessment 98/2 (Washington: International Monetary Fund).

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  • Galbis, Vincente, 1993, “Experience with Floating Interbank Exchange Rate Systems in Five Developing Countries,” IMF Working Paper 93/36 (Washington: International Monetary Fund).

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  • Geadah, Sami, and others, 2001, “Nigeria: Exchange Market Unification” (unpublished and confidential: Washington, International Monetary Fund).

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  • Jbili, Abdelali, and Vitali Kranmarenko, 2003, “Choosing Exchange Regimes in the Middle East and North Africa” (Washington: International Monetary Fund)

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  • Johnson, Omotunde E.G., and others, 1999, “Nigeria: Improving Monetary and Exchange Market Operations: A Diagnostic Review for Technical Assistance” (unpublished and confidential: Washington, International Monetary Fund).

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  • Kovanen, Arto, 1994, “Foreign Exchange Auctions and Fixings: A Review of Performance,” IMF Working Paper 94/119 (Washington: International Monetary Fund).

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  • McDonald, Calvin, and Yin-Fun Lum, 1994, “Operational Issues Related to the Functioning of Interbank Foreign Exchange Markets in Selected African Countries,” IMF Working Paper 94/48 (Washington: International Monetary Fund).

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  • Moser, Gary, 2003, “Exchange Rate Systems: Recent Developments in Developing Countries and Nigeria,” paper presented to the 1st Annual Conference of the Money, Macroeconomic and Finance Research Group of the Money Market Association of Nigeria and published in The Nigerian Treasurer: Quarterly Journey of the Money Market Association of Nigeria, Vol. 10 No. 6, April-June 2003.

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  • Quirk, Peter J., and others, 1987, Floating Exchange Rates in Developing Countries: Experience with Auction and Interbank Markets, IMF Occasional Paper No. 53 (Washington: International Monetary Fund).

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Prepared by Karen Ongley.


The existence of several legal exchange rates besides the parallel rate complicates the picture substantially. Data for all rates in the early 1980s is not available. Moreover, the existence of multiple foreign exchange markets, with official transactions typically conducted at a more appreciated rate, provided significant scope for rent-seeking and abuse.


The adjustment program was supported by a 14 month Stand-by Arrangement with the Fund, approved in November 1986 following introduction of the new exchange rate system.


Banks’ access to the auction was essentially guaranteed based on market share rather than their bids.


Independently sourced foreign exchange was transacted that the market-determined interbank rate, but the resale of foreign exchange bought in the auction was restricted to a 1 percent margin over the auction price. This led banks to bid conservatively to avoid excessively depreciating the auction rate.


For example, foreign exchange bureaux, which had been dealing at freely negotiated rates since 1989, were limited to buying foreign exchange as agents of the CBN at the official rate.


Up to a maximum of US$2,500 and later US$5,000.


For example, there was considerable bias in favor of foreign procurement at the expense of local content and value added.


At the time, the authorities considered a 5 percent differential between the official and parallel rates as a “normal” premium for those seeking to avoid documentation requirements or import goods without incurring customs duties.


By mid-2003, demand and supply per auction were both around 30-35 percent higher than the year before, and the nominal exchange rate had depreciated by less than 1 percent since January 2003.


Demand and supply rose to unprecedented levels in November, and the marginal DAS rate depreciated sharply in November. Much of the demand pressure is thought to be driven by fiscal expenditure (including related to one-off events such as All Africa Games in October and the Commonwealth Heads of Government Meeting in December), but other likely factors include liberalization of the domestic retail petroleum products market and speculative pressures following a reduction in average daily sales in October.


Notably the spread on successful bids in the DAS widened late in the year. After remaining below 2 percent for much of 2003, the spread between the highest and lowest successful bids widened significantly to around 7 percent, exceeding the generally accepted multiple currency practice threshold (2 percent). However, spreads subsequently narrowed in December.


Swinburne and others (1999). For the 13 countries with multiple exchange rate regimes not classified as multiple currency practices, the spread between rates remained within 2 percent.


There is a large body of research examining the relative merits of fixed and floating exchange rate regimes. This paper does not attempt to re-litigate the issue.


This section draws on earlier technical assistance provided by the Fund in the areas of foreign exchange market intervention (Canales-Kriljenko, 1999), exchange market unification (Geadah and others, 2001), and improving monetary and exchange market operations (Johnson and others, 1999).


Quirk (1994).


Quirk (1994).


In addition to the Federal Government of Nigeria and 36 state governments there are over 700 local governments.


Galbis (1994), and Quirk and others (1987).


Auctions have provided a market-based method of determining the exchange rate in some countries (including Nigeria) and about half of all countries responding to the Fund’s 2001 Survey on Foreign Exchange Market Organization reported some type of auction market. Canales-Kriljenko (2004).


In fixing sessions, both demand and supply of foreign exchange are determined exogenously, and lack of prior surrender distinguishes fixing from an ordinary auction. A fixing arrangement is part of the interbank (retail) market, while the auction comprises the wholesale market. A fixing session can therefore deepen interbank market liquidity by ensuring that smaller banks or other sub-markets will have their demand and supply reflected in the fixing sessions via their trading with participants in the fixing session. Yet, by artificially centralizing transactions around the fixing sessions, the development of a genuine interbank market can be slowed. It is therefore important that participation in fixing sessions be optional and that no limits imposed on dealings taking place outside these fixings. The central bank can rely increasingly on the interbank market while simultaneously using fixing sessions. Johnson and others (1999) and Kovanen (1994).


Canales-Kriljenko and others (2003). Information on intervention activities need not necessarily be on a real time basis on day-to-day operations, but should at a minimum involve an ex ante statement of policy (Enoch, 1998).


For example, central banks often choose to deal only with financial institutions that are solvent, and provide information and market developments and conditions (Canales-Kriljenko and others, 2003).


The fixing session would act as a clearing house and facilitate trading within the interbank market and help stronger banks feel comfortable selling to smaller dealers.


Fund technical assistance has pointed to the more broadly used method of setting overall open position limits as a percentage, say 20 percent, of bank capital (Canales-Kriljenko and others, 1999).

Nigeria: Selected Issues and Statistical Appendix
Author: International Monetary Fund