Nigeria – Will they or won’t they?

LONDON (Capital Markets in Africa) —  In recent weeks, investors in Nigeria have become increasingly perplexed about whether there will be a naira move before the end of 2015. On one hand the NDF market seems to indicate that there will be a move. And the consensus forecast for the value of the naira at the end of 2015 is NGN215:US$1, so in a rare show of unanimity economists seem to agree with the NDF market. On the other hand, the Central Bank of Nigeria (CBN) has firmly kept the naira trading at just below NGN200:US$1 on the Interbank Foreign Exchange Market (IFEM) since early March and introduced a series of new rules and regulations which seem to indicate that it has no intention of allowing any move in the naira at any time soon. Part of the reason why the NDF market is increasingly pricing in a naira move, is that these new CBN rules and regulations have pushed the parallel market exchange rate much weaker. Unable to source foreign exchange from the IFEM market for a wide range of goods, importers have moved to the parallel market with the Bureau de Change (BDC) exchange rate moving as low as NGN240:US$1 this week. Meanwhile, the CBN continues to argue that while it looks at the parallel exchange rate, it still thinks it is a marginal market for meeting demand for foreign exchange and given the thinness of the market the recent move is not reflective of true market fundamentals, but due to a market panic. The way we think of the current situation in Nigeria is a stand-off between the market and the central bank. And what we are acutely aware of is that these stand-offs can last for some time. This reflects the fact that the positions of the two protagonists – the market and the central bank are quite different – and the CBN appears unwilling to change its position in a hurry. This reflects a number of factors. On the one hand the CBN thinks that the naira has already moved enough since late 2014 to account for the weaker global oil price. It also seems to think that much of the demand for foreign exchange is speculative and does not reflect underlying fundamentals. And as we have consistently argued there is no real lobby for a weaker naira in Nigeria from policy makers or politicians. In fact, the opposite is probably true: most believe a stable naira is good for the economy and country. In addition, we also think the CBN believes it may be able to re-build foreign exchange reserves in the coming months. These have already stabilised in recent months. Moreover, having already managed to “reclaim” US$2.1bn from NNLG to help fund a partial fiscal bail out of the states, the CBN thinks further reclaimed funds may also come to light in the coming months allowing it to more aggressively rebuild reserves. And if reserves were to go back up to US$35bn plus in the coming months and it could clear some of the foreign exchange backlog currently in the market, the pressure on the CBN to devalue would ease. On the other hand the market points out that if you look at measure of the real exchange rate in Nigeria, the naira move since late 2014 has not reversed the real appreciation since 2011. So the market feels that the depreciation to date has not fully taken into account the fall in the oil price since late 2014. Moreover, this is clear from the fact that Nigeria will run twin fiscal and current account deficits in 2015. The market also argues that foreign exchange reserves have only stopped falling because the CBN has allowed shortages to build up in the market which represents fundamental, not speculative demand. And that banning obtaining foreign exchange on one market just shifts the demand to another, it does not abolish it. At various times the CBN has sent out contradictory signals about the parallel rate: historically it has stressed its desire to limit the differential between the IFEM and the parallel rate to under 5%, whereas now it stresses its lack of relevance. We still think this stand-off will be broken around October. Hopefully with a substantive Finance Minister in place, we think that the preparations for the 2016 budget will highlight the revenue shortfall facing the government. And while medium and long-term solutions to resolve this can be announced, in the short term one obvious fix is to allow a further modest weakening of the naira. And with the new Finance Minister in place, the decision will be a joint one between all the relevant parties: the CBN, the presidency and the Ministry of Finance. But the possibility of the stand-off continuing into early 2016 cannot be discounted. We think there is a 40% chance of this actually occurring. And this probability would rise substantially if foreign exchange reserves were to rise in the coming months. Arguably history shows that in countries like Nigeria with a strong policy fixation on nominal exchange rate stability, while currency moves do occur in response to market forces, when they eventually occur they are usually not as large as the market expects. By David Cowan, Managing Director & Africa Economist, Citigroup