Substantial Naira Devaluation Inevitable to Unlock FX Liquidity –CHD
Godwin Emefiele, CBN Governor (left) Bolaji Balogun, Chapel Hill Denham Chief Executive

Substantial Naira Devaluation Inevitable to Unlock FX Liquidity –CHD

As the Central Bank of Nigeria’s planned foreign exchange (FX) intervention sales set to commence, Chapel Hill Denham (CHD) has said that substantial naira devaluation is inevitable to unlock liquidity.

Exchange rate between autonomous and parallel market has peaked to about ₦117, which provides opportunity for unholy currency trading by racketeers.

This has been injurious to the Nigeria’s economy at the time when foreign investment flow into the economy has been very limited.

However, analysts explained that the apex bank has slashed weekly intervention volume by 61.55% to $423 million as against average sales of $1.1 billion in 2019.

However, Chapel Hill said the planned resumption of FX intervention sale to BDCs is welcomed, as it would help ease the FX liquidity crunch in the economy.

The firm explained that CBN intervention it might not go far enough to completely eliminate the parallel market premium, for two reasons.

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Recall that the apex bank hinted recently that it will begin weekly foreign exchange intervention sales as commercial international travel commences in September.

FX sale to the BDC segment is expected to begin September 7th, 2020, six months after apex bank temporarily suspended sales to the segment due to international travel restrictions.

Substantial Naira Devaluation Inevitable to Unlock FX Liquidity –CHD
Godwin Emefiele, CBN Governor (left) Bolaji Balogun, Chapel Hill Denham Chief Executive

Hadi Sirika, Nigeria’s aviation Minister said international travel will resume September 5th, 2020.

In the absence of CBN intervention in the past six months, Naira has plunged significantly with parallel market premium widened to ₦117, dollar has been exchanged at ₦477 as against Investors and Exporters Window rate of ₦386.

Analysts stated that the CBN appears determined to narrow the spread substantially, given that it has pegged its 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.

Analysts at Chapel Hill Denham reckoned that the CBN further instructed BDCs to sell USD to retail end-users at no more than ₦386.

The CBN’s planned resumption of FX intervention sale to BDCs is welcomed, as it would help ease the FX liquidity crunch in the economy.

Explaining the reason why the intervention will not go far, Chapel Hill said firstly, the CBN has halved the volume of sale to BDCs to US$10,000 per BDC.

Also, FX auctions will hold twice a week.

Meanwhile, analysts explained that as at March 2020, there were 5,300 CBN licenced BDC operators.

Chapel Hill stated that should all the BDCs subscribe for the bi-weekly auctions, the CBN will be selling US$106 million per week, which sum up to US$423 million per month.

“This is substantially lower than the trend level of sale by the CBN to the BDC segment”, analysts stated.

Analysts recalled that 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$1.1 billion and US$1.2 billion respectively.

Also, Chapel Hill said 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”, Chapel Hill said.

The firm said the FX liquidity required to repeat such feat and converge all rates at about ₦386 is simply not available at the moment, even after accounting for the anticipated US$1.5 billion World Bank loan.

External reserves stood at US$35.7 billion or 4.7 months of imports cover as at August 26th, 2020.

However, Chapel Hill said adjusting for SWAPs which was US$8.6 billion in March and external holdings of open market operations (OMO) bills of US$10.4 billion in March, the organic portion of external reserves is much lower at US$16.7 billion.

Of the sum, the CBN has a substantial backlog of FX demand by manufacturers to clear.

Against this backdrop, Chapel Hill maintains 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.

“However, 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”, Chapel Hill explained.

Explaining further, analysts stated that Nigeria has had two episodes of export crash in the past two decades.

The firm noted that 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 exchange rate devaluation by the CBN is the first leg in several adjustments to come.

“If the past is any indication of the future, we think about 20% – 30% currency adjustment will be needed to structurally rebalance the current account over the next one year.

“The dollar to naira outright forward rate including interest rate differential is priced at ₦470.

“This brings the implied forward rate to ₦435 excluding interest rate differential, which appears to be the more probable path for the I&E window rate”, Chapel Hill Denham explained.

Substantial Naira Devaluation Inevitable to Unlock FX Liquidity –CHD

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