The exchange rate at the Investor and Exporter window (IEFX rate) crossed the N400/$ threshold again after a one day spell on December 31, 2020. In the last one week, the IEFX rate has been gradually shifting towards N400 after hovering around N393-N394/$ for almost five weeks. The average turnover at this window has declined by 0.8% to $56.85mn in the first eight trading days in February, compared to $57.31mn in January. Meanwhile, the parallel market appears stuck at N478-N480/$.
The IMF has released its Article IV review on Nigeria reiterating its position on the need for an-other devaluation of the naira, which is overvalued by at least 18% and by as much as 27%. According to the IMF, this would ease external imbalances and clear the dollar backlog. The federal government on the other hand is of the view that another naira devaluation will further stoke inflationary pressures. Bear in mind that in 2020, the CBN adjusted the official exchange rate twice from N306/$ to N360/$ and then N380/$.
Nigeria's Macroeconomic Challenges Compounded by Policy Uncertainty
The Nigerian economy is challenged by rising inflation (last reported at 15.75% in December 2020), negative growth of 3.62% and high unemployment (27.1% as of Q2'20) and poverty. These have been compounded by exchange rate pressures, which have contributed to the rise in headline inflation through an increase in the import bill and an erosion of the real purchasing power of consumers. The real income of the average Nigerian has depleted by at least 25% in the last one year.
There have been calls for the adoption of a flexible exchange rate and a unification of the multiple exchange rates in the Nigerian forex market. But so far, what has been done is to ensure more convergence, with the premium between the parallel and IEFX rate reduced to N78 from as much as N110(November 2020). The CBN has had to ration its forex supply due to reduced forex in-flows exacerbated by the impact of the covid pandemic on diaspora remittances and export earnings.
It is clear that the CBN is more inclined to address the issue of price and exchange rate stability with the use of more orthodox means and controls. The plethora of circulars released by the CBN ranging from the repatriation of export proceeds to diaspora remittances and more recently cryptocurrency transactions, may be rubbing off negatively on international investors who are uncertain of the policy environment in the country and what circular may be released next. Foreign portfolio inflows into Nigeria have declined sharply partly because of covid but maybe more importantly because of policy ambiguity.
We expect the CBN to reduce its forex rationing especially with oil prices trading at $60pb. Also, with money market interest rates trading above 10% for the first time in about five months, it means that liquidity in the banking system is reducing and the demand for dollars can be curtailed.
The CBN may give in to a managed depreciation rather than a one-off devaluation, i.e. a crawling peg that would effectively allow the naira to trade within a band. The crawling peg could be based on the Nigeria-US inflation differential, currently around 14.35%. This will increase transparency for investors and reduce uncertainty. It should also help bring inflation under control.
In addition, it will lead to an appreciation of the parallel market rate towards N440/$, especially if the apex bank increases its forex supply at the IEFX and retail and wholesale forex markets. The costs of imported goods sold in the supermarkets are already priced at the current parallel market rate. As forex supply improves and manufacturers can access dollars and increase their output, we should see a correction in consumer goods prices in the medium to long term.