CBN Requires 6.24% of External Reserves to Offset FPIs -CSL
Godwin Emefiele, CBN Governor

CBN Requires 6.24% of External Reserves to Offset FPIs -CSL

Following the Central Bank of Nigeria (CBN) plan to phase out sales of open market operations (OMO) bill to non-residents, CSL Stockbrokers has estimated that the apex bank would need over 6.24% of its external reserves to offset matured portion of foreign portfolio investments (FPIs).

In a statement credited to the CBN Director of Monetary Policy, Hassan Mahmud, the Bank would phase out after the settlement of current obligations, the offering to non-residents of the “Open Market Operations bills.”

“However, Mahmud did not give a time frame. This decision, in effect, is ending an era headlined by a desperate chase of the greenback”, CSL Stockbrokers stated.

CSL Stockbrokers said the question on the minds of many analysts is how this will affect the foreign exchange management system in Nigeria given that FPIs investment in OMO bills are a significant source of foreign exchange for the country.

It added that the CBN’s Open Market Operations is an avenue through which the Bank manages system liquidity and interest rates as part of its core monetary mandates.

However, OMO bills’ offering to non-residents had commenced as a backdrop of the 2015 oil-price collapse, which led the Nigerian economy into a recession.

It said at the time, the CBN, in a bid to source more dollars to improve the foreign exchange reserve and stabilize the foreign exchange market offered attractive rates which peaked at 18.6% on the 358days instrument in 2018.

Thus, foreign portfolios (FPI) sighted opportunities for carry trade, leading to the influx of ‘Hot Money’.

The investment firm said asides from the pressure the transactions have placed on the cost of liquidity management for the CBN, last year, the Nigerian economy witnessed firsthand how a switch in sentiment could shake the essence of issuing the bills ab initio.

As a backdrop of the pandemic’s outbreak, the global demand for crude-oil had plunged, leading to a drastic drop in crude-oil price – a significant source of the Nigerian government’s foreign exchange receipt- in 2020.

In hindsight, analysts expressed the Naira’s weakness might have evaded headlines save for the activities of FPI, who sought to repatriate their funds to ‘safety’.

Recall, the CBN had limited participation in the OMO bills space to just deposits money banks and Offshore Investors in Q3 2019.

CSL Stockbrokers said the move ushered in the depressed yield environment in 2020.

Meanwhile, 2021 has seen a significant dip in the value of OMO issuances, seen in the 86.81% year on year drop recorded on 11 February, 2021.

The investment firm explained that the recent plunge in value of allocations points to a deliberate decision by the Bank to reduce the sale of OMO bills.

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The bid-to-cover ratio of 3.75x further explains things in 2021, given it was 0.75x in the corresponding period in 2019.

“If implemented, we believe this bodes well for the CBN, given the impact on the cost of liquidity management for the Bank.

“Our analysis showed that FPI holding in the OMO market has averaged 53% in the last two years.

“Meaning, at the current outstanding OMO obligation of N1.66tn, the CBN would require a little over 6.24% of its external reserves (US$34.99bn) as of March 1 2021, to offset FPIs portion of due maturities”, CSL Stockbrokers said in a commentary.

In a similar development, capital Economics said the reported (but unconfirmed) devaluation of one of Nigeria’s exchange rates would help to improve the public finances, but it would keep already strong price pressures elevated.

“We doubt that the latest tweak in Nigeria’s FX market will culminate in a fully flexible, unified naira any time soon”, the firm explained in a research report.

Godwin Emefiele, the governor of the Central Bank of Nigeria (CBN), suggested in a conference speech on Friday that the official naira exchange rate has been devalued by 7% against the dollar, from 381/$ to 410/$.

Pundits hope this would close the gap between the official rate (used for government transactions) and the Nigerian Autonomous Foreign Exchange (NAFEX) rate (used by commercial entities including investors and exporters).

“But it would still leave both rates about 17% stronger compared to the latest parallel market quotes of 480/$”, Capital Economics wrote in the report.

The firm said if confirmed, the move would simplify Nigeria’s multiple exchange rate system by essentially merging the official and NAFEX rates.

“Although we suspect some degree of fragmentation would remain. It is worth noting that the devaluation has not been confirmed at the time of writing”, it added.

For example, it was noted that the website of the CBN continues to quote the official exchange rate at 379/$ as of yesterday.

Capital Economics said so far at least, there is no anecdotal evidence of the CBN’s FX sales rate to confirm or deny the move.

However, at face value, it seems unusual that the central bank is undertaking the devaluation given the rise in oil prices.

“The key is that the official and NAFEX rates are far stronger than our estimate of the fair value of the naira, which is closer to the parallel market rate”, Capital Economics added.

It said one explanation for the move is pressure from multilateral institutions, which have urged Nigeria to take steps towards a freely-floating, unified naira for some time.

“Insufficient progress on currency reforms appears to be holding up a $1.5 billion loan from the World Bank, which Nigerian policymakers may be hoping that the latest FX tweaks will help to get over the line.

“Other explanations could be at play too. Devaluing the official rate would improve the public finances.

“A weaker official exchange rate would push up the local currency value of key oil exports, and with it, the government’s oil revenues.

“Indeed, we estimate that, all else equal, a 7% devaluation of the naira would increase government revenues by around 0.2%-points of GDP”, the economics firm explained.

It noted this would make Finance Minister Zainab Ahmed’s job of preparing a supplementary budget to finance the country’s vaccine roll-out easier.

In its report, Capital Economics maintained that positive implications for the country’s balance of payments position may not be as large.

“Non-oil exports that would benefit from a weaker currency make up less than a third of Nigeria’s total exports (with oil, which is priced in US dollars, accounting for the remainder).

Experts said a weaker exchange rate would probably do little to encourage import substitution, as various exchange rate windows are used by importers – including the NAFEX and the parallel rates that have not fallen as much as the official exchange rate.

“Even so, prices of imported goods are likely to rise, keeping inflation elevated”, Capital Economics added.

Headline inflation stood at a nearly four-year high of 16.4% year on year in January and Capital Economics expectation is for inflation to stay around this level until the tail end of this year.

“Taking a step back, we doubt that the latest devaluation of the naira will mark a meaningful shift in Nigeria’s exchange rate policy.

“We’ve flagged before that Nigerian policymakers appear reluctant to loosen their grip on the currency”, the firm explained.

“In its latest Article IV report, released last month, the IMF noted that “the Nigerian authorities did not agree with the need for additional exchange rate adjustment”.

Capital Economics explained that a lack of official confirmation of the devaluation hardly inspires confidence.

“Worse still, Governor Emefiele reportedly outlined plans to strengthen the currency just a day after his comments about the weakening of the official exchange rate.

“A multitude of FX restrictions aimed at defending the currency’s value remain in place, including prohibiting exporters who fail to repatriate proceeds from banking services.

“The upshot is that Nigeria’s heavily managed exchange rate regime is here to stay”, Capital Economics.

“We remain comfortable with our view that policymakers will continue with their piecemeal approach to the currency, only letting the naira weaken when pressure mounts.

“Our end-2021 forecast for the NAFEX rate remains at 425/$, and we have now revised our official exchange rate forecast to 425/$ as well (from 400/$)”, it explained.

Experts said evidence is growing that this FX policy has failed to keep inflation stable, which policymakers pin their support on. Nigeria will probably be stuck with high inflation for the foreseeable future.

By their thinking, so long as the threat of further devaluations is present, investors will be wary of putting their money into Nigeria.

As a result, Capital Economics said the authorities will continue to rely on capital controls and import restrictions to sustain the balance of payments position at the expense of disruptions to activity and weak economic growth.

CBN Requires 6.24% of External Reserves to Offset FPIs -CSL