Expect Increasing FX Rates Convergence in Coming Months

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Monday, August 09, 2021 / 1:02 PM / by CardinalStone Research / Header Image Credit: PxFuel


The Debt Management Office (DMO) announced the appointment of transaction advisers for the issuance of Eurobonds as part of the new external borrowing of $6.2 billion provided in the 2021 Appropriation Act. This disclosure follows the recent news of the IMF's approval of $650 billion in Special Drawing Rights (SDR). From this, Nigeria is expected to be allocated c.$3.4 billion based on its quota contribution and economic standing.


The SDRs are not actual currencies but assets through which IMF members can improve their balance of payment positions by exchanging all or some of their allocations for freely usable currencies of other member countries. They can also be used as a basis for seeking concessionary debt facilities from the IMF. However, given lessons from the previous year, we favour refraining from utilising our SDR allocation until a rainy day. To this point, given elevated oil prices and the increasing likelihood of a successful Eurobond issuance, we do not think that Nigeria is in a dire situation to warrant a full SDR drawdown.


In assessing the materiality of the recent developments, we note that the combined planned foreign borrowing of $6.2 billion and SDR allocation of $3.4 billion amount to c.68.1% of our 2021 current account deficit forecast and 28.7% of Nigeria's FX reserves of c.$33.5 billion. Thus, there is a strong likelihood that the FX liquidity position of Nigeria will improve before the end of the year if these inflows materialise.

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We highlight some of the potential impacts of the expected reserve accretion on markets below:

  1. The spread between the parallel market and the I&E rates is likely to materially narrow in the coming months. This narrowing spread should primarily reflect sharper corrections in the parallel market rate, which is currently substantially higher than our fundamentally derived NGN/USD rate. We also expect some retail demand to flow away from the BDCs to deposit money banks, which have been recently mandated to meet legitimate dollar needs.
  2. The need for an aggressive mop-up of banking system liquidity will likely taper on projected improvement in the near-term FX liquidity position.
  3. As a consequence of points 1) and 2), we expect yields to remain near current levels until Q4'21, when the fiscal authority may have to increase issuances ahead of the N593.9 billion bond maturity in January 2022. The apex bank may also be cautious ahead of the pre-election year 2022. These, and the opportunities to earn better returns on bank placements, continue to support a short-duration strategy.
  4. The expected improvement in FX liquidity could provide some support to equities. To this point, improvements in FX conditions could positively impact sectors such as manufacturing, as FX-induced inflationary worries subside and pressures on real consumer income taper. More so, companies that rely heavily on imported raw materials or require FX for routine plant maintenances may get some reprieve.

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