The Central Bank of Nigeria (CBN), at its latest meeting on Thursday, ruled out further devaluation of the naira, citing inflationary risks and the prospect of economic instability.
| People are exploiting the difference between the official and parallel markets in Nigeria|
Former CBN governor Sanusi’s hallmark legacy was to ensure FX stability, citing the lack of FX hedging tools for manufacturers and its benefits for the poor given Nigeria's dependence on imports. The CBN under Godwin Emefiele has attempted to maintain this policy.
However, the CBN has been forced to devalue the currency twice, once in November and again in February.
Currency markets, however, continue to bet on the near- to medium-term devaluation. The naira is already trading outside of the central bank's target range of N160 to N178 set in November. The parallel market rate in Nigeria is now at N243 to the dollar, a 23.4% depreciation of the naira compared with the official rate of N197.
Non-deliverable forwards have priced in the weakening of the currency, with contracts to be honoured three months now quoted at 211.50/214.50 (an 8.3% depreciation); for six months 226.25/230.25 (15.9%); and for 12 months, 243/249 (24.9%).
Further devaluation of the currency is unavoidable, say market observers, given weak capital inflows, market pressures and the lack of fiscal and monetary co-ordination. In addition, foreign-exchange restrictions in place by the central bank are now beginning to harm GDP growth in Nigeria. The IMF has predicted that GDP growth for 2015 will be around 4.8% form 6.3% in 2014.
“Despite the central bank’s current resolve, markets believe that the CBN will eventually succumb to pressures and devalue the currency,” says Samir Gadio, head, Africa strategy at Standard Chartered.
“It may not happen in the immediate short term, but an adjustment is due.”
Yinka Odeleye, executive director at Union Capital, a local Nigerian securities firm, adds: “There is a lot of arbitrage happening, from goods to Eurobonds; people are exploiting the difference between the official and parallel markets in Nigeria."
Since oil prices plummeted by nearly 60% at the beginning of 2014, before recovering slightly this year, Nigeria has seen oil export receipts decline dramatically.
In 2013, oil revenue hit N1.98 trillion, before falling to N1.82 trillion in 2014. African Alliance predicts that oil revenue for 2015 will be N1.40 trillion, representing a 23% decline year-on-year and accounting for 49% of government’s total revenue, down from 58% and 66% of total revenue in 2014 and 2013 respectively.
As a result, pressure on the currency has been mounting. To shore up dollars and prevent further depletion of the country’s reserves, the central bank has in effect devalued the naira by 22% since last November. The key interest rate has remained at an all-time high of 13% since November 2014 and cash reserve requirements are at 31%.
Nigeria's FX reserve position remains healthy. As of July 7, Nigeria’s external reserves had risen slightly to $31.89 billion from $29.1 billion as at the end of June. Foreign currency reserves were $37.3 billion in June 2014.
“The central bank has even gone as far as effectively regulating imports by banning companies from accessing the official foreign-exchange market to buy certain goods including frozen chickens, tomato paste, tinned fish and rice, which can all be produced in Nigeria in order to maintain foreign-exchange reserves,” says Union Capital's Odeleye.
“The central bank is doing all it can to tighten monetary policy, but further currency devaluation remains unlikely in the short term, especially given the uncertainty with fiscal policy.”
In March, after Nigeria’s presidential election, markets rallied with the news that president Goodluck Jonathan had quietly conceded his leadership to Muhammadu Buhari. But since then, Buhari is yet to select a cabinet and any momentum built up after his election as president has subsided.
Yields on Nigeria’s 2023 Eurobond on April 1, just a few days after Buhari was elected, rallied to 5.9% and market capitalization at the Nigeria Stock Exchange (NSE) gained N904 billion to close at N11.621 trillion. As of July 23, yields were up to 6.5% and market capitalization of the NSE was N10.656 trillion.
“Foreign investors will likely remain wary of Nigeria until there is more policy certainty and there has been some level of devaluation of the currency, and I think it won’t be until the naira trades around 220 to the dollar in the interbank market that foreign investors will fully return to Nigeria,” says Odeleye.
Gadio adds: “Even though international investors want a piece of Nigeria, they will stay away, because, right now, they can expect to make a c.10% loss on the FX side since devaluation is likely to happen.”
In June, JPMorgan announced it would eject Nigeria from its Government Bond Index (GBI-EM) by the end of the year unless the government would be able to restore liquidity to FX markets and allow investors the ability to make transactions as easy as possible.
If dropped, funds tracking the index would be forced to drop Nigerian bonds, which could result in weighty capital outflows and raise borrowing costs for the government.
|Samir Gadio, head,|
In June, it looks as if this was down to 1.59% and the last I heard it had fallen by another 24 bps to 1.25% of the index.
“The really interesting thing, however, is that Nigeria did have six bonds in the index, and recently one was removed. In most cases, bonds that have been removed are usually replaced, but in the case of Nigeria, it wasn’t. This suggests that JPMorgan is unwilling to increase Nigeria’s weight in the index in any case.”
But a removal from the index won’t be a big shock to Nigeria, says Gadio, adding: “If neutral to the index, Nigeria's allocation would amount to around $2.6 billion.
“Besides, the market is underweight Nigerian bonds relative to the index. So fundamentally, this will not make much difference to the country, although it would certainly weigh negatively on onshore confidence and we may see bond yields overshoot."