Worst Case Scenario - Naira

Forex
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Tuesday, January 27, 2015 2.38PM / Sriram Sekhar, Smartadvisors / India

  

The Naria has been declining again, and only a short while after the CBN devalued the currency, it is now trading at almost N200 to the USD. This brings to question, what is the worst case. Sadly, the $1=N200 equation is upon us, and given the overall bleak economic output, fueled by the dropping oil prices, there seems unlikely to be any improvement in the situation even in the medium term.



A declining Naria spells trouble for a country who relies heavily on foreign investments - apart from the petro dollars that are drying up, as well as for businesses, a majority of whom have operations outside the country. Various CBN measures such as reducing overseas borrowings, devaluing the currency, increasing the interest rates, buying currency, etc. have not had any meaningful impact on the currency, and given the economic situation facing the government, it is unlikely that the CBN has any more firepower to prop up currency.

The sectors that are likely to be most hit in the near term are banks that have overseas exposure - both in terms of business as well as borrowings from foreign banks, as well as those who have interests overseas and are net importers of services. Foreign investors are also likely to flee the country, as there is a likelihood of capital controls in the offing, meaning that other sectors which were relying on foreign capital to grow, will also be hit. Only net exporters will benefit from the falling Naira, although how long their economies of scale will remain is in question.



For the common man, there is likely to be a spate of price increases across the table, with goods and services becoming dearer, with more layoffs in the offing. In our view, a falling Naira combined with the oil prices dropping is a double edged sword that is likely to cause substantial damage to the Nigerian economy in the near term. Apart from this, the likelihood of bad debts on retail loans will increase, meaning lower loans will be given out to the public, in turn reducing the amount of money in circulation, leading to more inflation, and as a result more economic problems. As we can see, the money supply (M0 - i.e. Amount of cash and cash equivalents) in the economy has gone up substantially in Jan 2015 - meaning that there is a lot of fear in people minds about the future of the economy, and many people will be converting money to dollars or other safe currencies if possible. 


The falling Naira can be the brink of the iceberg, and the CBN is almost certain to devalue it to N200 per USD. This can have serious economic repercussions as outlined above, and could take years to set the economy right.

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