Nigerian Naira and Kenyan Shilling overvalued say Renaissance Capital

Johanneburg, South Africa (Capital Markets in Africa) — Renaissance Capital finds the Kenyan shilling to be especially vulnerable but believes the Nigerian naira should weaken more than the shilling. Sub-Sahara African (SSA) currencies have in recent months come under significant pressure. Of eight SSA currencies we analysed, we found the Kenyan shilling to be especially vulnerable (as it is an overvalued currency that depreciated by less than the EUR/$). However, Nigeria’s limited policy space, implies the naira should weaken more than the shilling. Macro imbalances and dollar strength place overvalued currencies at risk of sizeable depreciations, and imply the undervalued Ghanaian cedi and Tanzanian shilling, may remain so, for longer. KES is especially vulnerable We found the Kenyan shilling (KES) to be one of the most vulnerable to a significant depreciation. This is because it is overvalued (given the deviation of its real effective exchange rate (REER) from the 10-year average) and its depreciation was smaller than the EUR/$ depreciation. The KES vulnerability explains the 300-bpt rate hike in recent weeks, by Kenya’s central bank. We believe policy tightening will slow the KES depreciation, but it will not halt it because weak exports, growing imports and a slowdown in financial inflows will weigh on the currency; as will US rate hikes that are due in the short term. Our Kenya REER suggests that the KES is c. 20% overvalued. We believe ongoing monetary tightening will keep the KES from hitting 120/$1. We thus revise our YE15 shilling forecast to KES109/$1 vs KES100.7/$1 previously. Limited policy space increases NGN’s vulnerability The naira (NGN) is also c. 20% overvalued but because its depreciation was in line with the EUR/$1 depreciation, it is less vulnerable than the KES, by our parameters. But given that Nigeria’s monetary policy is already exceptionally tight and fiscal policy is contractionary, we see little scope for further policy tightening to defend the NGN. Plugging of leakages may be improving FX reserves ($31.9bn on 7 July, according to the central bank). But as long as the price of the biggest source of FX inflows, oil exports, remains low, we are reluctant to attach any significance to this. Plus reports of pent up FX demand ($4bn, is one estimate from discussions with local banks) implies liquid FX reserves are lower than the official number. This is why we see the NGN depreciating by c. 18% to NGN235/$1 (vs 7% for KES) over the next six-to-12 months.