CBN’s Naira intervention cost spike six times

Nigeria’s leading independent multi-assets investment management firm, CardinalStone revealed in a note that interest expense incurred to defend Naira by the Central Bank of Nigeria (CBN) in 2018 alone is over six times the average interest expense recorded in the 4 years leading to 2017.

The firm stated in a note that in view of Nigeria’s weak current account position, and the sustainability implications of the currency defense, it believes the Central Bank of Nigeria will have to weigh the monetary and opportunity costs of defending the currency at some point.

To defend the currency following the devaluation in mid-2016, the CBN increased its issuances of open market operations (OMO) bills from N4.2 trillion in 2016 to N7.7 trillion in 2017 and N17 trillion in 2018.

It remarked that between financial years 2017-2019, the CBN issued N35.8 trillion at an average stop rate of 15.1%, which translates to an associated interest expense of about N5.4 trillion in the period.

“Our interest expense estimate is corroborated by total interest expense of N4.2 trillion reported in CBN’s financial statements of 2017 and 2018 combined (2017: N1.3 trillion; 2018: N2.9 trillion)”, the firm added.

The finance and investment experts noted that in addition, the CBN also raised the frequency of OMO auctions and its issuance of long-dated securities (300 days and above), thus directly competing with FGN bond issuances and raising the cost of debt of the FGN.

“Clearly, there is significant cost involved in defending the currency and the costs can manifest in monetary and opportunity cost terms.

“For context, the interest expense incurred by the CBN in 2018 alone is over 6x the average interest expense recorded in the 4 years leading to 2017.

CBN’s 2018 interest expense is also about 75.0% of Federal Government’s actual retained revenue and 1.6x the amount spent on capital expenditure in the same year”, Cardinalstone reckoned.

Cardinalstone stated that against the backdrop of weak GDP growth and poor FGN revenue mobilization, the CBN may begin to ponder the opportunity cost of its currency defense on long term growth objectives of the country and the sustainability of these interventions.

“Evidently, in order to avoid reserve depletion, the CBN is likely to incentivize foreign portfolio managers to roll over existing investments with higher rates at the detriment of the real sector”, it added.

The firm stated interest rates are likely to increase even further in coming years, when developed economies reach an inflection point in their economic cycles and begin to experience robust growth, leading to a normalization of interest rates.

“The sustenance of this regime will not only leave the foreign reserves more vulnerable to foreign capital flight, but also imply that devaluation at a later date would be of a higher magnitude given consensus expectations of double-digit inflation in the next two years.

“Thus, while the CBN is not under immense pressure to devalue in the next 6 months given the current level of its foreign reserves, the risks in favour of naira repricing are now materially higher.

“The recent constitution of a pro-market economic advisory council by President Buhari may also leave the devaluation discourse on the table in the near-to-medium term”, Cardinalstone harped.

Naira has been largely stable in the foreign exchange market since the introduction of managed float regime by the apex bank.

Some pundits added that currency arbitration has been reduced drastically, though foreign investors are wary that naira has not actually finds it true value in the global currency equation.

In its view, CardinalStone said: “We see the main costs of defending the currency to include the cost of issuing CBN treasuries at attractive yields, the direct cost of interventions in secondary markets, and the opportunity cost of defending the currency”.

CBN’s Naira intervention cost spike six times


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