Naira Risks Fresh Devaluation as FX Policy Washout
Nigeria’s foreign exchange policy, in all ramifications, has failed to make the local currency strong enough to compete in FX markets, with a widening gap between official and parallel market rates, widening FX spread and creating arbitrage opportunities.
Investment experts have formed a consensus that holding naira assets is a heavy risk adventure for investors due to a steep inflation rate in the country and serial devaluation of the local currency. Also, there is a limited investment option to protect the purchasing power of naira as the fixed income market offers negative real returns.
Practically, all government financial market instruments expose naira assets to high inflation amidst worsening economic conditions unexplainable by Nigerian macroeconomic conditions. MarketForces Africa Research gathered that devaluation will worsen household finance and could have negative effects on employment, the price level in the short term.
Naira traded at N416.50 per dollar at the investors’ and exporters’ foreign exchange window on Friday, and it was run down to N584 at the parallel market as CBN failed to keep to market intervention strongly, dollar supply was reduced amidst FX scarcity.
Maintaining a stance on its overvaluation, some analysts are positive that the local currency will be devalued further, though CBN has initiated moves to attract dollar inflow by rebates to Exporters and encouraging remittance.
Nigerian naira weakness has been worsened by the rising headline inflation rate which printed at double-digit mid of 15.70% in February, according to the National Bureau of Statistics amidst a 33.3% unemployment rate in the country.
In the consumers market, Naira is buying less of every goods and service, tempering volume demand as households seek substitutes to alleviate pressures. Central Bank of Nigeria adopts a multi-tiered foreign exchange policy to stem naira from free-falling but the local currency has consistently been under market pressures due to heightening demand, lower supply.
Naira, local currency for an import-dependent largest economy in Africa with lower dollar inflow than expended has persistently stayed under pressures – losing left, right and centre across FX markets.
The premium or spread has been a business for a large number of people the market tags as speculators, a creation of fail system following series of sampled unorthodox monetary policies. Still, Naira is less valuable than it was when Godwin Emefiele accepted the job to lead Africa’s largest economy’s monetary policy.
Setting a tall ambition has been the pattern for the monetary authority despite all variables pointing in a different direction. Some analysts note however it is better to try, a different policy strategy that could work eventually with permutation and combination by the policy authority.
MarketForces Africa reported that at February’s Bankers’ Committee meeting, the CBN revealed plans to halt FX supply to the local banks after it halted dollar supply to Bureau de Change by the end of 2022. Foreign currencies traders told MarketForces Africa that the decision will leave a vacuum in the dollar and other major currencies supply chain and the winner would be market speculators.
FX inflows to the Investors and Exporters Window declined by 7.3% month on month to US$1.06 billion in February from USD1.15 billion in January – the lowest since June 2021 when transaction volume printed at US$966.80 million, according to Cordros Capital.
Analysts attributed the decline to a 35.2% month on month and 2.3% month on month drop across the foreign and local sources. On the local sources, Cordros Capital highlighted that CBN’s FX supply to the Investors and Exporters FX window dipped 9.2% month on month to US$299.40 million; a decline to the lowest since April 2021 when it supplied US$143.20 million.
In the parallel market, Nigerian local currency was sold for N594 and often cross the line when demand pressures build. To douse market tension, Central Bank has often claimed it has a buffer to meet FX demand but this has proven to be untrue –severally.
In a commentary, CardinalStone noted that Nigeria reels from sustained FX illiquidity, with repatriation-related demand largely undermined by unorthodox policy measures. READ: Naira Rises as Analysts Anticipate Devaluation at Investors Window
“This multi-year FX impasse has resulted in notable responses from Deposit Money Banks (DMBs) and the Central Bank of Nigeria (CBN) in recent months”, the multi-asset investment firm said.
In particular, it noted that DMBs have moved to adopt some or all of the following measures: temporary suspension of international ATM withdrawals and POS payments and the downward review of spending limits on cross-border payments.
“In our view, these reactions may have been linked to a likely reduction in CBN dollar supply, despite the apex bank’s earlier reassurances of its determination to meet genuine dollar demand (through the banks) after the halt of sales to BDCs in July 2021”.
That said, the CBN’s introduction of the RT200 FX Programme, aimed at realising $200 billion over the next 3-5 years (average of $40.0 billion per year), offers some hope of a stronger regulatory drive to arrest the crisis over the medium term.
CBN anchored the programme on a need to diversify Nigeria’s export earnings from a strong reliance on hydrocarbon-related inflows. In a review, CardinalStone sees Nigerian DMBs have switched to a more proactive mode, primarily geared towards controlling the pace of growth of their FX liabilities.
This drive underscores the ubiquitous setting of new comfort levels for FX transactions that are likely to reduce the rapid accumulation of FX obligations and provide legroom for treating backlogs, the multi-assets investment firm said. The firm added that the recent switch could also inadvertently protect the net FX positions of DMBs, leaving leeway for revaluation proceeds in the event of naira devaluation.
“We believe the CBN’s decision to diversify Nigeria’s export earnings is a step in the right direction, given the historical dependence on volatile FX sources such as oil and FPIs”.
However, CardinalStone said the aim to grow export earnings to $200 billion over the next 3 to 5 years appears overly optimistic; as the scheme assumes that non-oil exports would grow 7.3x from the 10-year average of $4.9 billion in each of the next five years.
“Our cautious position on this target is primarily hinged on the structural impediments within non-oil that the apex bank could find difficult to resolve on its own.
“To expound on the premise, we first note that Nigeria’s non-oil sector FX proceeds are principally derived from manufacturing and agriculture, wherein structural issues outside the scope of the CBN have mostly constrained activities”, the firm said.
Citing an example, analysts stated that despite an aggressive monetary intervention, growth in the Agric sector has remained capped between the 2.0% to 3.0% band due to insecurity malaise since 2015.
CardinalStone analysts noted that the current band is even significantly lower than the mean 4.2% growth recorded between 2011 and 2014, which coincided with lesser CBN interventions and more tolerable security conditions.
CBN rebate scheme makes analysts guess whether the move is admission to potential de-facto naira devaluation. In a separate circular, the CBN released the operating guidelines for the rebate scheme, designed to incentivise the repatriation of non-oil sector export proceeds through the Investors and Exporters FX Window.
The scheme introduced a tiered rebate of N65 for every $1 sold to Authorized Dealer Banks (ADBs) for third-party and N35 per dollar sold for personal use.
“In our view, this N35/N65 rebate suggests a potential switch of CBN’s exchange rate tolerance band -for most transactions- to N450 – N480, which may be interpreted as a backdoor devaluation and a pointer to continued multiple exchange rate regime”, CardinalStone said in the report.
Analysts at CardinalStone said coincidentally, the lower band of the range is consistent with the 1-year Non-Deliverable Forwards (NDFs) rate of N449.7 — a key indicator of future currency expectations — and 2.3% higher than the firm’s communicated blended fair-value estimate of N440/$.
Despite the CBN’s efforts, CardinalStone analysts think that the parallel market rate at N578 per dollar, which continues to trade at a premium, will likely disincentivise exporters from selling foreign currencies proceeds at the Investors and Exporters FX window.
Hence, the underlying issues of non-supply of FX to certain classes of demand (which has been the primary driver of parallel market pressures) may still need addressing.
Reacting to the decision by the apex bank to half FX supply to banks, analysts at CardinalStone said the move is likely to drive banks to focus on other FX sources, such as increased transactions with export-oriented businesses, FX swaps, and Eurobond issuances.
“While the CBN’s plan justifies the need for accelerated credit exposures to export-oriented sectors, we believe that banks will remain cautious to avoid a deterioration in asset quality.
“We opine that the decision could cause banks’ recent reduction of cross-border transactions limits to linger. We also see scope for banks to increase rates offered on domiciliary accounts”, CardinalStone said in its report. #Naira Risks Fresh Devaluation as FX Policy Washout
