Naira Plunged despite Foreign Currency Intervention Sales
Naira plunged this week despite the Central Bank of Nigeria’s (CBN) foreign currency intervention sales.
Pressures on the naira increased in the parallel market yesterday as the United States dollar to Nigerian Naira ask rate depreciated by N3 or 0.65% to 465.
In the Investors and Exporters Window, the local currency continues to trade within a tight band, and closed flat at 386.00.
After a 0.4% year to date increase, the nation’s external reserves printed at US$35.81 billion.
Amidst expectation for improve foreign exchange supply into the market, naira has failed to gain momentum against United States dollar despite the CBN intervention sales.
Inability to meet demands at national autonomous foreign exchange rate market or official rates raised demand in the parallel market, thus steep exchange rates.
The local currency again plunged this week as global prices of oil trend awkwardly, just as accretion into external reserves stays weak.
Analysts explained that lower currency supply, trending below domestic demand was supporting factor for weak currency.
There have been backlog of demand that needs to be filled, analysts Julius Alagbe who is familiar with the currency market explained to MarketForces.
The apex bank had announced FX sale to the BDC segment on September 7th, 2020, six months after the Bank temporarily suspended sales to the segment due to international travel restrictions.
The move renewed currency traders of moderation in exchange rate as the CBN pegged direct quote to N386.
The pattern in the domestic market however showed that there may not be a short term or immediate reverse in exchange rate in favour of the local economy due to lower foreign currencies inflow into the economy.
With international travel in the equation, analysts explained that there is hope that foreign currencies would flow both ways.
Chapel Hill Denham in a note that in the absence of CBN intervention in the past six months, the exchange rate parallel market premium has widened to N117, with the parallel market trading at 477 against Investors and Exporters Window rate at 386.
The investment firm further explained that with the intervention sales, the CBN appears determined to narrow the spread substantially.
Planned move to achieve convergence in FX rates induced the CBN to peg BDC intervention rate at 384 and directed International Money Transfer Operators (IMTOs) to sell FX to Banks and the CBN at 382 and 383 respectively.
The CBN further instructed BDCs to sell dollar to retail end-users at no more than 386.
Analysts had hoped that resumption of FX intervention sale to BDCs would help ease the FX liquidity crunch in the economy.
In its note, Chapel Hill expressed caveat, having stated expectation that the intervention might not go far enough to completely eliminate the parallel market premium, for two reasons.
In its explanation, the firm said the CBN has halved the volume of sale to BDCs to US$10,000 per BDC with auctions to hold twice a week.
As at March 2020, there were 5,300 CBN licenced BDC operators.
Chapel Hill said: “Assuming all the BDCs subscribe for the bi-weekly auctions, the CBN will be selling US$106mn/week and US$423mn/month.
“This is substantially lower than the trend level of sale by the CBN to the BDC segment”.
CBN’s intervention sale to BDCs in 2019 and Q1-2020 summed up to US$13.6 billion and US$3.6 billion, implying a monthly average of US$1.1bn and US$1.2 billion respectively.
Secondly, it stated that the lack of FX liquidity in the official market and increase in FX restrictions may have pushed some demand to the parallel market.
Hence, to sustainably close to parallel market premium, the CBN will likely require a two-pronged strategy of ramping up sales in both the official (I&E Window and Wholesale/Retail FX intervention windows) and the parallel market, similar to the “shock and awe” tactic it employed in 2017.
The FX liquidity required to repeat such feat and converge all rates at C.386 is simply not available at the moment, even after accounting for the anticipated US$1.5bn World Bank loan.
External reserves stood at US$35.8 billion or 4.7 months of imports cover as at September, 2020.
Chapel Hill said when adjusted for SWAPs (US$8.6 billion in March) and external holdings of OMO bills (US$10.4 billion in March), the organic portion of external reserves is much lower at US$16.7 billion.
However, out of this the CBN has a substantial backlog of FX demand by manufacturers to clear.
Against this backdrop, analysts said they maintained that a substantial currency devaluation is inevitable to unlock liquidity in the FX market, and sustainably eliminate the parallel market premium.
How far the CBN is willing to go to defend the current de-facto FX peg is uncertain, Chapel Hill Denham noted.
The firm however stated that based on fundamental valuation using the long run real effective exchange rate, the fair value of the currency is between 430 and 450.
Although a bigger devaluation may be required to narrow the imbalances in the current account, analysts added.
“As we have mentioned in that past, Nigeria has had two episodes of export crash in the past two decades.
“Both episodes required large FX adjustments to rebalance the current account.
“Considering the magnitude of the current export shock, and the pre-existing imbalance in the current account, we believe that the about 5.5% year to date USD/NGN rate devaluation by the CBN is the first leg in several adjustments to come”, Chapel Hill said.
If the past is any indication of the future, the firm stated that about 20% – 30% currency adjustment will be needed to structurally rebalance the current account over the next one year.
Read more: CBN Moves to Converge FX Rates to Raise Average Price Level
Naira Plunged despite Foreign Currency Intervention Sales
