Emerging Market Storms? Dirt Off The Naira's Shoulder

Some deft footwork by the CBN has kept the naira stable. But for how long?

Since the start of this year, global financial markets have been rocked by aftershocks from tightening US monetary policy and a roaring US dollar. Hardest hit have been emerging market currencies especially the Argentine peso and Turkish lira which have tumbled 34 percent and 17 percent respectively in 2018 with the former triggering a US$50 billion IMF loan facility. The contagion has also swept African currencies with the South African rand and Ghanaian cedi down 9 percent and 6 percent since the start of the year.

But in spite of this storm buffeting global currencies, the naira has remained an oasis of calm across all segments with the official (NGN305/US$1) and Interbank & I&E (NGN361/US$1) largely unchanged while the parallel market has witnessed an appreciation to NGN361/US$1.

How has this happened? Well, for a start, all fingers are not equal. The rapid climb in crude oil prices over 2018 - now unexpectedly testing the US$80/barrel mark meant that Nigeria posted a nice current account surplus in Q1 2018 of US$4.5 billion. You have to go back to 2014 to see that kind of number for Nigeria. Included in that number is a strong rise in remittances - up 27 percent year-on-year to US$6 billion - which suggests the growing brain drain in recent years (Oh Canada!) is positive for the external account (we will come to the story of emigration another day). This positive fundamental picture, plus recent Eurobond sales and, to a large extent, strong foreign portfolio inflows allowed the Central Bank of Nigeria (CBN) grow its foreign currency reserves to US$47 billion. Backed by the comfort of the reserves picture, the CBN was able to easily deal with any dollar demand. Indeed, the CBN’s body language has consistently been bullish on the exchange rate.

Or has it?

It’s not a devaluation if you don’t call it one

Though the I&E and official exchange rates grab all the media and analyst attention, sandwiched between these two rates is the NIFEX rate which is the rate at which CBN’s weekly interventions in the foreign exchange market occur. This rate opened the year at NGN331 before steadily depreciating to NGN347 as at July. So why has the CBN quietly devalued the rate of its interventions? It would appear that this move was intended to ward off the growing practice of exchange rate shopping by Nigerian manufacturers who were now selectively waiting for interventions at NGN331, as against buying at the sufficiently liquid interbank/I&E window rate of NGN361. Thus, when the US dollar tantrum drove a short-lived drop in US dollar inflows to the IE window, the CBN realized that it was facing demand pressures on two fronts - foreign investors looking to exit Nigeria via the I&E window and local manufacturers now increasingly focused on the lower NIFEX rate.

Faced with the option of underwriting both segments at different rates, it appears the CBN elected to begin raising the NIFEX linked intervention rate as a way of pushing some of that demand away from its balance sheet. This is now resulting in a convergence of rates. Indeed, adjusted for interest rate charged to manufacturers by banks to fund foreign exchange purchases for imports, the two rates appear to have converged. Admittedly in hindsight, it now appears that CBN’s decision to widen the margin to bureau de change operators and to increase US dollar availability to retail end use in recent months was part of a strategy to prevent panic arising from fears that NIFEX devaluation would lead to wider devaluation. Indeed, it appears the CBN now seems to understand the power of the parallel market rate in shaping expectations and forcing NGN appreciation at the segment is working to dampen fears over potential weakening. Well played, CBN

But not so fast

With the official exchange rate unchanged at NGN305 ostensibly to keep fuel prices stable, there remains underlying uncertainty over when full convergence will occur and in what direction. As the political season moves into full gear, the default policy setting of Nigeria’s economic managers is to ensure that all economic variables switch into neutral/static gear. As such any bets of official to I&E convergence are off till after the elections, as long as the external accounts remains healthy which is likely going to be the case given the strength in oil prices.

After the elections, the realism on the need to raise fuel prices and the increased grumbling from state governors about the need for more naira in their monthly allocations from the federal purse is likely to cascade into an upward adjustment in the official rate to the I&E.

Hopefully, the external balance remains supportive when this occurs, otherwise good luck to whoever is the CBN governor then.