Naira Outlook Uncertain as Illiquidity, Weak Usable FX Reserve Unsettles Reform
The Naira witnessed FX market-wide gain amidst a claim that the local currency is currently undervalued. While staying on the upside, the naira is suffering from a lack of FX market intervention.
According to information obtained from the FMDQ platform, where daily exchange rates are quoted, the Naira appreciated by 0.39%, closing at ₦1,602.75 per US dollar at the official market on Friday. In the parallel market, the naira closed at ₦1,595 per greenback, according to a channel check.
The naira is estimated to be grossly undervalued. However, the market is currently suffering from forex liquidity strong enough to boost the local currency’s strength against the dominant foreign currency.
The apex bank recently injected the US dollar into the market to support the supply side after a long holiday from the autonomous forex market. Its FX intervention has slowed due to a lack of a strong buffer to boost the supply side.
The Central Bank of Nigeria (CBN) faces a significant liquidity crisis in supporting the naira, as nearly $20 billion of its $33 billion in foreign reserves is tied up in various derivative deals, according to the Economist.
In February, Olayemi Cardoso, CBN Governor said the naira is grossly undervalued. Supporting this, Goldman Sachs estimated that the exchange rate will appreciate to N1200 per US dollar within 12 months.
A naira bull, Financial Derivative Company, estimated N910.01 as the real value of the local currency, though the exchange rate settled at an average of N1600 per greenback in the official window.
Naira’s misfortune is attributed to a sustained scarcity of the US dollar and other foreign currency inflows into Nigeria. Nigeria was bullied to devalue the naira strongly in June 2023 in what some analysts call fast and furious for the prevailing market condition.
The authority had just removed fuel subsidies, which further worsened price instability. Despite devaluation, foreign investors stayed away from the economy, causing the naira to record its worst-ever loss of value in history.
The CBN intensified its effort to make the naira stable, but this has failed due to a weaker FX supply side. In a macro note, Fitch analysts highlighted low net reserves and weaknesses in the exchange-rate framework as constraints on the sovereign’s credit profile in November 2023, when it affirmed Nigeria’s rating at ‘B-’ with a stable outlook.
“We believe the large MPR increase on February 26–27 and accompanying moves to raise the cash reserve ratio for commercial banks to 45% from 32.5%, are steps towards containing inflation,” the global rating firm said.
Fitch expects the CBN to continue tightening policy in the near term, which seems necessary to more fully control inflation as rapid credit and money-supply growth suggests a still-loose monetary context.
“Such a tightening will still face implementation challenges, partly due to the potential for countervailing political pressure. However, without further sizeable monetary tightening, it may be difficult to achieve macroeconomic stability – real interest rates remain negative, deterring inward portfolio investment,” it said.
Fitch projects the rate of inflation to rise further in 1H24, before moderating in 2H24. This partly reflects base effects as well as our assumption that the naira’s depreciation will slow in 2024, compared with 2H23, before a stabilisation of the currency by year-end.
“We believe the currency’s sharp depreciation since mid-2023, including the large loss of value in January, and slow monetary policy response has raised inflation expectations, with security challenges in the north-east of the country and higher transport costs also adding to price pressures.”.
With limited dollar sources in the short term, the central bank will continue to struggle to meet its foreign exchange needs, Deloitte said in a macro update.
A member of the Big 4 accounting firm stated that other sources of foreign exchange supply, such as non-oil exports, external financing, and diaspora remittances are unlikely to satisfy demand in the short run.
Last week, Nigeria’s FX reserves increased by USD209.89 million to close at USD34.42 billion Also, the naira appreciated by 1.5% to N1,602.75 at the Nigerian Autonomous Foreign Exchange Market, with total turnover decreasing by 41.6% to USD743.54 million on Thursday, according to Cordros Capital Limited.
Analysts said trades were consummated within the N1,425.35 – N1,650 per US dollar. “We highlight the CBN’s initiatives aimed at stabilising the naira, which encompasses addressing FX backlogs, increasing domestic interest rates to make naira-denominated assets attractive, and supplying dollars to BDCs.
“These efforts are beginning to manifest positive outcomes, as evidenced by the decreased naira volatility observed in the foreign exchange market. Although the apex bank has yet to fully clear the FX backlogs due to persistently low forex supply, we hold the view that the volatility of the naira will remain subdued in the short term.
“This expectation is underpinned by reduced currency speculation supported by the CBN’s ongoing monetary tightening measures and improved liquidity resulting from the uptick in forex inflows from foreign portfolio investors”, analysts at Cordros Capital Limited stated.
Elsewhere, the price of oil declined over demand uncertainties. Brent crude dropped by 0.13% to settle at $85.31 per barrel, and WTI crude also experienced a 0.01% decrease, reaching $81.25 per barrel. #Naira Outlook Uncertain as Illiquidity, Weak Usable FX Reserve Unsettles Reform
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