Nigeria Agrees to Pursue Exchange Rate Unification

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Wednesday, July 08, 2020 / 10:12 AM / by FDC Ltd / Header Image Credit: Punch

 

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In the past few weeks, the monetary and fiscal authorities have made policy pronouncements to the effect that Nigeria is likely to achieve a unified exchange rate as against the current practice of multiple exchange rates. It is widely believed that the sudden conversion of the monetary policy making bodies to accept the unification is at the instance and persuasion of the multilateral bodies especially the IMF and the World Bank.

 

This is good news for the markets and investor sentiment. At a time of dwindling revenue, the Nigerian economy needs all the help it can get. Exchange rate unification around the investor and exporter window (NAFEX rate) will lead to an adjustment of the official rate to N386, while the parallel market is expected to gravitate towards that rate. Most forex transactions are conducted at the IEFX window, with the CBN as the major supplier. It also brings the naira closer to its fair value. Using the purchasing power parity as a rough estimate this brings the exchange rate around N400/$. This move is expected to reduce arbitrage activities and speculative attacks against the naira.

 

Implications

So far in Q2, the average daily turnover at the IEFX window is $43.22mn, compared to $345.01mn in Q1 which is indicative of the dearth of forex. Different figures have been bandied about on the volume of the forex demand backlog. Irrespective of what the actual demand is, the fact still remains that there are shortages. Indeed one would ask where the demand is emanating from especially as schools are closed (so international tuition to an extent has been put on hold) and international travel remains suspended. But what of the investors that are stuck with naira cash and want to repatriate their funds?

 

The antsy over whether the naira is trading at its fair value or if the external reserves level is sufficient to meet outstanding obligations has heightened uncertainty in the markets. The CBN's announcement that the reserves level is "comfortable to meet obligations" should smooth many ruffled feathers.

 

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Also, now that there is more clarity on the CBN's exchange rate stance, it should boost investor confidence. However, a note of caution- there are outstanding obligations and when nilled off puts the net external reserves level below $20bn (about 5 months of import cover).

 

In addition, Nigeria still faces a serious problem with respect to its sources of forex which remain constrained. Oil prices will remain low, probably below $50pb for the rest of 2020. Coupled with reduced oil production, forex revenue from oil receipts will be limited. Another source of forex, Diaspora remittances, will decline sharply due to the rising rate of unemployment and contraction in the global economy. The Minister of Finance has said no Eurobond issue this year. However the drawdown on multilateral loans from the likes of the IMF and World Bank should provide some buffer.

 

Increased FAAC funds

State governments will benefit from an exchange rate unification around the NAFEX as they will be receiving more naira. This should offset the impact of reduced oil sales and tax revenue due to the contraction in economic and business activities. Also, the fact that the government has stopped the payment of gasoline subsidies should ease the fiscal burden.

 

Why the Naira may not Crash

There are certain assumptions we have based our projections on. These are as follows:

  • Terms of trade decline of 6%
  • External reserves cover after discounting $5bn backlog and $6bn swaps gives a 6.5months cover
  • A money supply mop up of 4.78%
  • Exchange rate liquidity mop up of 9.72%
  • There is a possibility that the REER could be anywhere between N400-N420/$
  • Fear, uncertainty and speculation not factored in

 

Based on the above, the unification of exchange rates is expected to lead to a depreciation of 9.72% of the official rate towards the IEFX rate. This will in turn mop up about 4.78% of liquidity (N1.35trn). The total naira liquidity reduction of 14.5% is expected to lead to an appreciation of the parallel market rate towards the range of N400- N420.


Proshare Nigeria Pvt. Ltd.

 

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