September 8, 2020
Following the drop in global crude oil prices and the economic shutdown caused by the COVID-19 pandemic, economies across the globe have been significantly impacted, leading to creative approaches to managing the situation for immediate survival and possible economic recovery.
Sadly, the Nigerian economy was also badly impacted by this crisis. Among other economic concerns, one of the biggest concerns for Nigeria is the sharp decline in Foreign Exchange (FOREX) earnings and the depletion of the foreign reserves caused by reduced oil and non-oil exports.
Considering the above, the gradual resumption of economic activities in Nigeria and the resulting increased demand for FOREX have put further strain on the reserves and affected the ability of the Central Bank of Nigeria (CBN) to meet the demand for FOREX. Hence, CBN’s review of the FOREX allocation framework to help address the critical needs of the economy has become critical, including mitigating areas of possible FOREX leakages.
One of the areas considered by the CBN as a possible source of FOREX leakages is the activities of Buying Companies (BC)/ Agents who act as intermediaries between the Ultimate Product Supplier (UPS) and the Nigerian businesses. In CBN’s view, this arrangement leaves room for potential over-invoicing, product mispricing and other mechanisms that increase the demand for FOREX by these local businesses for the payment of the intermediaries.
In order to address the perceived FOREX leakages arising from the activities of BC/Agents, the CBN recently released a Circular on 24 August 20201 titled “Destination Payment for all FORMs M, Letter of credit and other forms of payment”.
In this Article, we review the Circular by examining the economic and commercial rationale of having the intermediary arrangements such as centralized procurement companies and trading companies, and review how Transfer Pricing (TP) could potentially help the CBN to achieve its objectives of mitigating potential over-invoicing without adversely disrupting local businesses and the economy, especially during a recessionary period.
Details of the Circular
An extract from the Circular reads:
“As part of continued efforts of the CBN to ensure prudent use of our foreign exchange resources and eliminate incidences of over-invoicing, transfer pricing, double handling charges and avoidable costs that are ultimately passed to the average Nigerian consumers, authorised dealers are hereby directed to desist from opening Forms ‘M’ whose payment are routed through a buying company, agent or any other third parties”.
The Circular aims to limit access to FOREX to only transactions between local Nigerian businesses and the UPS, effectively boycotting the BCs/Agents to help mitigate FOREX leakages that may occur when transacting with intermediary companies. CBN’s expectation is that where the invoices that qualify for Form M processing are limited to invoices from the UPS, the pressure on demand for FOREX and therefore the Nation’s FOREX reserve may be reduced.
Unsurprisingly, the Circular has generated significant concerns and reactions within the manufacturing and trade industries, where a strict application of the Circular by banks could result in significant supply chain disruptions for the local businesses and adversely hurt two of the largest and most fragile sectors of the Nigerian economy. In particular, many businesses are questioning the applicability of this policy in light of their business realities.
While the CBN’s objective is valid, the decision to prevent payments to BC/Agents may be harmful to local businesses and anti-ease of doing business.
The Commercial Basis for Buying Companies/Agents
While there might be good reasons for the CBN’s concerns about BCs/Agents’ potentially over-invoicing the local businesses which puts additional pressure on demand for FOREX, it is equally important to note that there are valid commercial reasons why Nigerian businesses, similar to other global businesses, may have to purchase their products from intermediary companies. Some of these reasons are articulated below: