Nigeria’s External Reserves - Beyond The USD46bn Debate

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Tuesday, March 13, 2018 /06:25 PM / Cordros Capital

Nigeria’s external reserves have featured frequently on the pages of national dailies and other media platforms in recent time. Unlike the case in 2015 and 2016, wherein every headline about the reserves contained such words as “decline”, “drop”, “fall” etc., the situation thus far in 2018 has been underpinned by “steady accretion”. Great stuff, no doubt!

Earlier this week, the CBN spokesman, Isaac Okoroafor, added more colour to the picture, issuing a statement that the reserves had hit a 5-year high of USD46 billion as at the close of business on Friday, March 9, 2018. Proud of the development, the corporate communications expert took the news to the Twitter community, where the veracity of the statement became a subject of debate. It is safer to conclude that the reported figure refers to the actual number for the referenced date, hence the variation from the available data on the central bank’s website which captures the 30-day moving average of the reserves. Well, that is not the crux of this note.

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Source: CBN, Cordros Research estimates

From whatever perspective, the external reserves is growing, thanks to (1) rising oil earnings (higher oil prices and production volume have been supportive), (2) strengthening foreign portfolio inflows, catalyzed by the stable operations of the I&E FX window, (3) proceeds from external borrowings (recall the USD2.5 billion Eurobond that was issued last month, (4) slower pace of CBN intervention in the currency market (USD1.45 billion monthly average thus far this year, compared to circa USD2 billion monthly average within March-May 2017), (5) the apex bank’s continued efforts at discouraging unnecessary imports, and to be fair (6) decent inflows from non-oil exports. Clearly, the monetary authority is walking the talk of deliberating growing the foreign reserves – which it expects to hit USD60 billion in 2019 under prevailing anchors.

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Source: CBN, Cordros Research

Our base case outlook scenario – as highlighted in our Nigeria 2018 Outlook report “Looking Beneath the Surface” – for the naira in 2018 assumes an external reserves position of USD47 billion (on a 30-day moving average basis). We were of the view that under this scenario, the CBN is unlikely to implement material changes to its FX policy, and forecast the local currency will hover around NGN360-NGN365/USD and NGN363-NGN368/USD in the I&E FX window and parallel market respectively. But at the current run rate of average cumulative monthly growth of 4.84%, we estimate the reserves to hit our forecasted target during H1-18, thus making the case for our 2018 best case reserve projection of USD56 billion, at which level we expect the central bank to adopt more market friendly FX reforms. The big question then is “will the naira reflect the steady accretion to the reserves by way of notable appreciation”?

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Source: CBN, Cordros Research

Proshare Nigeria Pvt. Ltd.
Source: CBN, Cordros Research

Our expectation is for the LCY to strengthen to NGN340/USD and NGN345/USD in the I&E FX window and parallel market respectively, under a USD56 billion external reserves. For that to happen, we highlighted the following conditions (1) stable oil price and domestic production continue to impact on trade balance, (2) the FGN raises the USD portion of the proposed borrowings for the fiscal year to fund the deficit in the budget, and (3) investors’ confidence in the I&E FX window strengthens amid sustained economic growth and further FX reforms, thereby bolstering portfolio inflows. Are the aforementioned conditions likely? Our answer is in the affirmative. However, we reckon the above-mentioned as a necessary condition for NGN appreciation. A sufficient condition will be more direct efforts by the central bank to increase the volume of USD supplied (we estimate at an average of USD2.5-USD3 billion monthly, from current average of USD1.4 billion) at its frequent interventions. Such move, in our view, should help channel a proportion of parallel market demand to the official window. For instance, we are aware manufacturers still get less than 50% of their total legitimate FX needs via the official window while the balance is sourced at alternative sources.

That said, we note recent indications from the CBN governor that there is a deliberate attempt by the bank to keep the naira exchange rate in the I&E FX window at current levels. In our view, the aim of that is to (1) keep local assets attractive to foreign investors and further support the CBN’s efforts at growing the reserves, and perhaps (2) further stimulate exports. The possibility of that stance changing anytime soon remains to be seen, particularly amid the non-confirmation of nominees to the Monetary Policy Committee (MPC) by the National Assembly – which has made it difficult for the Committee to meet, as it cannot form a quorum. More so, the CBN chief appears to have achieved his desired level of exchange rates convergence in the economy, hinting that, the fact that most transactions are being settled around the NGN360/USD levels suggests rates unification.

Over the rest of 2018, we weigh political-related risks to the stability of the naira as modest. While we do not totally rule out the likelihood of (1) a number of foreign investors staying on the sideline towards the final quarter of the year, as the race for the 2019 general elections gathers momentum, and (2) increased naira liquidity – on election-related spending – increasing demand for the dollar, we see the apex bank in a comfortable position to continue its support for the LCY via its interventions in the currency markets. That will bode well for the business environment (particularly manufacturers, service providers, and traders) and investing community. By implication, we look for healthy activities in the equities market and fixed income space.

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