Nigeria's new FX policy - Implication & Impact @Friday

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Saturday, June 18, 2016 3:34 PM / CardinalStone Research 

Following the Central Bank of Nigeria's (CBN) decision to liberalise the exchange rate system, we detail our thoughts on its implication and impact on markets and the economy. Please see key highlights below. 

Who will qualify?

The new framework introduces a new entity called authorised FX primary dealers (FXPD)who would be registered by the CBN, to deal directly with the apex bank for large trade sizes (minimum lot of US$10 million) on a two-way quote basis. A bank must meet 2 of the 3 criteria listed below to qualify as primary FX dealer;

  • Liquidity ratio of 40% or more;
  • Shareholders' funds (unimpaired by losses) of at least N200 billion; and
  • Foreign currency asset of N400 billion or more. 

Based on Q1'16 numbers, we highlight (in bold) in the table below the banks that qualify in our coverage universe;

Implications on key coverage sectors

Banks with lower FX loan composition better positioned: With the new exchange rate framework, the banks would have to adopt a higher exchange rate for reporting which means risk weighted assets will increase following the conversion of foreign currency loans to local currency equivalents. Assuming capital is unchanged or not materially higher, the increase in risk weighted assets will reduce capital adequacy ratio for banks. In our view, the banks with the lowest exposure to foreign currency loans will be the least affected. By our analysis, at N300/USD Zenith, UBA, Guaranty and Access will be the banks that meet up with the regulatory CAR minimum of 16%.

Non-financials: Companies with FX earnings to benefit - all else constant:Following the currency adjustment, companies that earn a portion of their revenues in foreign currency will be positively impacted as each dollar earned abroad will now get them more Naira. Seplat Petroleum Development Company Plc should be the greatest beneficiary from this currency adjustment as 100% of their revenue is earned in dollars. Other beneficiaries include Lafarge Africa Plc, Dangote Cement Plc, and Okomu Oil Palm Plc which had earned 26.9%, 24.0% and 11.0% of their income in foreign currency as at Q1'16.

Macroeconomic Implications

Economy to restart gradually, manufacturing, others to pick up - With the liberalisation of the foreign exchange market, we now expect many manufacturing companies to find it relatively easier to source dollars to import essential raw materials. For many manufacturing companies, the difficulty to open letters of credit significantly hampered production, leading to steady decline in manufacturing output over the last 3 to 4 quarters (with the exception of Q4'15).

How will inflation respond? Whilst the new forex policy will see the NGN/USD rate depreciate substantially relative to the hitherto official rate of N199/USD, we do not envisage a concomitant increase in price levels.  Many businesses were already sourcing dollars at a significantly higher rate than the official N199/USD, which implies that the pass through effect of a higher exchange rate already reflected on price levels.

Monetary policy response and implications - A liberalisation of the foreign exchange market signals a restrictive monetary policy. We expect the CBN to use available monetary policy tools to limit liquidity in the financial system as a way to keep check on the exchange rate. Conventionally, an aggressive rise in the benchmark monetary policy rate would be expected. However, with the weak transmission link between the monetary policy rate and other interest levels (treasuries and bond yields) in the Nigerian economy, we do not envisage a drastic rise in the MPR. 

Please see link (cardinalstone website) to this Equity strategy Update. 


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