Undervalue Naira Exposes US Dollar Assets to FX Clawback

Undervalue Naira Exposes US Dollar Assets to FX Clawback

The Naira depreciates to N769.25 per United States (US) dollar at the investors and exporters window. Bank of America (BofA) has estimated that the local currency is now undervalued after a decision to float the rate.

That suggests that foreign currency denominated assets are facing possible exchange rate clawback when Nigeria’s FX dusts settled. In contrast to the previous narrative when holding assets in foreign currency became a strategy for safeguarding investors’ wealth, at the current rate, the naira has been noted to be undervalued by market consensus.

It thus means that keeping funds in US dollars may come at a risk should the apex bank flood the market with more foreign currencies in its vault. This could reduce exchange rate pressures which have triggered negative pricing across the forex markets.

Also, an improvement in fx inflows will support the naira to regain lost value across the market, however, analysts believe there is a need to drive export growth in 2023 to benefit from a decision to unify exchange rates.  

In an email chat, LSintelligence Associates said the existing pressures on fx inflows have not reduced as a result of the import-dependent nature of the Nigerian economy, and lack of comparative production advantage.

“A country with record import to feed more than 200 million citizens cannot have strong currency – it’s not a rocket science”, research analysts at the firm told MarketForces Africa

Naira is expected to reclaim value with a favourable balance of payment, which could only come if the growth-starved Africa’s largest economy develop an appetite for exporting than spending scarce dollar asset on imports.

BofA said in its update that the naira is expected to claw back to N700 in 2023, and in 2024, exchange rate projection range from N650-680 per greenback at the investors’ and exporters’ FX window.

Investors with US-denominated assets could have their value declined in naira terms should the local currency push back from the exchange rate curve to N680 per dollar estimated by Bank of America.

MarketForces Africa gathered that the downside risk to fx asset holdings was reduced on account of foreign currency shortage in the country. Experts said forex market pressures will only subdue when the apex bank settled backlogs owed to foreign investors.

“We are still cautious on local markets and wait to engage when FX distortions are cleared- multiple rates, restrictions, and positive real rates”, BofA said in its update to investors last week.

On Friday, the Naira depreciated by 0.82 per cent when compared with N763 which it exchanged for the US dollar before the Eid-el-Kabir holiday that began on June 28.

FX traders said there is currently a mismatch between demand and fx supply in the market. The local currency is heading toward unification and has pegged on the same points at the parallel markets – albeit- intermittently.

Traders said the open indicative rate closed at N758.52 to one dollar on Friday. In the global market, prices of crude oil continue to face pressures from weak economic data. Nigeria’s crude oil was sold at $2 below dated Brent, and there were cargoes that remained unsold due to a slide in demand in India – one of the top consumers of global crude oil volume.

Meanwhile, an exchange rate of N841 to the greenback was the highest rate recorded within the day’s trading before it settled at N769.25. A total of 263.45 million dollars was traded at the investors and exporters window on Friday

In the open market, the Naira depreciated by N3 to N773 per greenback from N770. On weekly comparison, the Naira appreciated by 92 kobo as more funds inflow hit the system to close at N769.25/$1 from N770.17.

In its market report, Cowry Asset Management said the Naira at the forward contracts market weakened across all forward contracts against the dollar for another week except for the 12-month forward contract which gained against the dollar by 5bps to close at N878.26/$1.

Turning to Nigeria’s external reserves, there was a decline in gross position as global crude oil prices continue to swing sideways. FX reserves declined by USD86.76 million on a weekly basis to close at US$34.22 billion.

Bank of America Global Research said in an update that US dollar to naira pair has moved from overvalued to undervalued, estimated the local currency fair value of 680 per USD from N580 previously.

However, BofA Tatonga Rusike, an economist covering Sub-Saharan Africa said in an update that naira is now undervalued. Rusike said the naira US Dollar pair is likely to trade above this level, with a year-end 700, and a return to 650-680 in early 2024.

“The caution is a transition time, aligning rates, and still unlocking more USD into the formal market will take some time. When the dust has settled, the value of the naira should be stronger and appreciating”, BofA predicted.

According to the Domestic and Foreign Portfolio Report of the Nigerian Exchange (NGX), total transactions on the local bourse increased by 68.9% to NGN322.92 billion in May from NGN191.21 billion – its highest level since May 2022 when it printed at N607.25 billion, Afrinvest said in a note.

Meanwhile, domestic transactions accounted for 88.5% of total transactions worth N322. 92 billion, grew by 56.4% to N285.75 billion while foreign transactions (11.5% of market transactions) also printed higher at N37.16 billion from N8.47 billion in April.

The investment firm said notably, net foreign transactions (N17.86 billion) settled at their highest level since December 2017, likely due to investors’ optimism about reforms from a new administration.

“…while foreign investors are likely to adopt a wait-and-see approach in the near term, we expect to see improvement in foreign participation over the medium term. >>Nigerian Treasury Bills Yield Rises to 7%

“Our expectation is hinged on the policy pronouncements and reforms by the current administration, undoing the policy mistakes of the past eight years”, Afrinvest said. #Undervalue Naira Exposes US Dollar Assets to FX Clawback