Maneuvering the naira and devaluation posers
The word “volatility” has been recurring in any mention of crude oil price and the Nigerian foreign exchange (forex) market, especially at the parallel segment. This has been so since this round of oil price shock that started from June 2014 till date.
Consequently, there have been several policy actions and reactions, with the nation’s stock of forex reserves depleted to a record low, stoking high level speculations from both local and international investors. Currently, the reserves have rebounded to $29.4 billion.
According to a note from Afrinvest Securities Limited to The Guardian at the weekend, the local unit has since then, shed 46.5 per cent and 66.3 per cent at the interbank and parallel markets respectively, leading to a spread between the two rates reaching an all-time high of N215 last week. This has however, moderated significantly with the latest round of policy last week. Specifically, the parallel market rate rebounded to N460/$ as at Friday.
The mix of political and economic considerations has also played out in the forex market. While the President is opposed to the devaluation of the currency, the first attempt by the Central Bank of Nigeria to liberalize the exchange was moderate and international investors remained adamant in doing business with the country, asking for more.
It is quite clear that forex challenges, particularly the massive disparity between the official and parallel market exchange is to blame for the cost-pushed inflation, passed through foreign items, while also effectively repelling foreign direct investment.
Last week, nearly eight months after the introduction of flexible exchange rate policy, the regulator, perhaps in response to a call by the National Economic Council and in its consideration for a more flexible forex market structure that would close the gap between interbank and parallel market rates, issued a new directive.
The new strategy sought to increase forex allocations to retail users- Basic/Personal Travel Allowances, school and medical bills abroad. Shockingly, the market has recorded great calm for the first time in one full week of activity in more than six months.
To achieve this, CBN has increased its daily supply of forex to the interbank market from $1.5 million to $6 million to ensure that the retail users get more and in the last one week, have sold about $600 million in forwards contracts, after reducing the tenor from 180 days to 60 days.
Although the move has driven interbank lending interest rate high to 113 per cent, before moderating to about 14 per cent at the weekend, as bank’s scramble for available Naira to pay for the forex bids auctioned by CBN, the exchange rate at the parallel market has fallen significantly from the record high of N520/$.
A sub-Saharan Economist for RenCap, Yvonne Mhango, said: “There are chinks of light in Nigeria’s outlook…Forex reserves have risen over 20 per cent to $29 billion and a more comfortable CBN has this week announced changes to its forex policy and injected more dollars into the local market. Since Monday (February 20), the parallel market rate has strengthened,” she said.
Indeed, the success of CBN’s aggressive intervention and moderation in demand in the unofficial market have so far led the Naira to post its biggest one-week rally in more than three years- 13 per cent gain in the parallel market in one week, from a N520/$ (pre announcement) to a three-month high of N460/$ (post announcement) on Friday, as speculators with short Naira positions sold off.
The new optimism, which the Minister of Finance, Mrs. Kemi Adeosun, said is riding on the back of increasing external reserves, stable crude oil prices and rebound in oil production to 2.2 million barrels per day, is being subjected to sustainability questions.
Investors are still raising their bets that a more flexible currency regime would soon come, after the latest policy shift, which came almost at the same time, when Adeosun told CNBC Africa, that the foreign exchange system is “sub-optimal” and will be “fine-tuned.”
According to Bloomberg report, Naira forward contracts maturing in three months rose 3.9 percent to N371 against the dollar on Tuesday, the highest close since November 11, 2016, suggesting the currency will depreciate about 15 per cent (N371) at the official market in that period from N315.5. Six-month contracts also climbed to N396.5.
For analysts at Afrinvest, three fundamental issues are raised. Is the Naira rally in the parallel market a clear signal for sustainable fundamental change in sentiment? Does the country have enough dollar liquidity to sustain pace of interventions for commercial transactions in the interbank and retail end users? Will the fundamental change in current account dynamics (a major determinant of long run exchange rate) encourage the CBN to relax its currency peg – a decision, which could buoy capital account activities and autonomous supply of forex liquidity?
“Full liberalization is still some way off. It may be one of a few steps on the road to a lot more flexibility and clearing the backlog of demand for dollars,” Ayomide Mejabi, who works with the Nigerian unit of Standard Bank Group Limited, said.
CBN has on many occasions repeated that it is independent of the government, but there is a suspicion by analysts that President Buhari’s firm rejection of Naira devaluation has influenced its decision-making and a currency expert and Research Analyst at FXTM, Lukman Otunuga, is one.
According to him, although it is visible that the CBN is willing to release its grip on the Naira and accept a weaker exchange, it seems unlikely that the currency will be fully floated.
Otunuga said that though Monday’s new forex policy, which sought to make dollar available for the “elite” at 20 per cent above the official rate is already easing some pressures, it does little to solve the major problem of multiple exchanges.
“Nigeria’s five adopted exchanges continue to add to the uncertainty with both firms and investors constantly left confused. The CBN has found itself in a position where the Naira may be poised to weaken regardless of what it does.
“The bearish combination of depressed oil prices, foreign exchange scarcity and tepid economic fundamentals continue to expose the Nigerian economy to downside risks.
“With speculations already heightened over the Central Bank of Nigeria devaluing the Naira in a bid to create liquidity and stability, it becomes of question of when, rather than if a devaluation will occur and I this new policy could be viewed as the first course.
“Although a devaluation may weaken the Naira, in the short term the stability, transparency and increase in foreign investment when the dust has settled could support the economy in the longer term,” he said.
For Afrinvest’s analysts in their Weekly Market Update: “In our view, while the implementation of the revised forex market guideline has been greeted with much optimism, we do not believe this move can sustainably address the lingering forex liquidity challenges in the economy without relaxing forex rate peg and review of list of items ineligible for forex transactions in the parallel market.
“Personal and Business travel allowances, school fees and medical fees have been estimated to account for less than 20 per cent of total forex demand in the country hence there is still a large volume of demand (particularly the 41 ineligible items) that could pressure rate at the parallel market.
“It is hard to make an exact call on direction of rate, but it is unlikely the parallel rate will breach the N500/$ mark again in the shorter term as a more dollar liquid CBN will not shy from further interventions.
“Our medium term conviction remains that maintaining the interbank rate at current peg will lead to deterioration in current account as more demand surfaces. We reaffirm our view that increased flexibility will be needed in order to allow restore investor confidence and boost autonomous FX supply.”