Monday, December 21, 2020 /05:05PM/PFI Capital/ Header Image Credit: Gobal Financial Digest
The Nigerian Naira has lost close to 30% in value within the last one year, and more than 200% in the last 10 years. The situation has led to a spike in capital outflow, high unemployment, the alarming rate of inflation and other direct and indirect consequences associated with exchange rate crisis. While greater attention has been placed on COVID-19 as the root cause of the diverse economic challenges this year, the current FX situation should be looked at from diverse perspectives; primarily, the existing structural and policy challenges that have been limiting the country's FX earnings over the years and the COVID-19 induced shock on global energy demand.
The COVID-19 Effect
Earlier this year, because of restrictions imposed by countries when COVID-19 was declared a global pandemic, the fall in global energy demand put pressure on the oil price and we saw Brent down by about 57% closing below $20 per barrel. Nigeria, an oil-dependent country with over 81% export earnings from oil, had earlier benchmarked the oil price at $60pb in the 2020 budget with daily production estimated at 2.18mn barrels per day. The oil crisis forced a review of the oil benchmark to $28 per barrel. Consequently, the Nigerian government oil export between January and May contracted by about 77%. This put pressure on the FX reserve and led to the first devaluation of the year despite the $3.4bn loan from the IMF. The official exchange rate was reviewed from N306/$ to N360/$, while sales to the BDC was pegged at N379/$ and then followed by suspension of FX sales to the BDC with limited intervention across different FX windows.
Is COVID-19 the Main Factor behind the current FX Crisis?
While we cannot neglect the adverse impact of COVID-19, a look at the country's trade account last year shows that the country started a trade deficit run from Q4-2019 despite the moderately buoyant oil price in the year. From a N2.4trn trade surplus as of the 3rd quarter of 2019, the country recorded a trade deficit of about N500bn in the 4th quarter. Similarly, from the latest 3rd quarter trade data released by the NBS recently, the country recorded a N4.6tn trade deficit within the first 9 months of this year. Even with the COVID-19 restrictions on international trade, the country still recorded a 19% growth in imports despite a 37% and 38% decrease in crude oil and non-oil export respectively. This tells of the overarching consequences of structural inadequacy that has been limiting domestic production and thereby leading to trade deficit with unnecessary pressure on the currency. Despite the various intervention into the agriculture sector via the CBN Anchor Borrowers Program (ABP) and other development finance initiatives, the import of agricultural goods still increased by a whopping 109% compared to Q2-2020 with agricultural export dropping by 21% in Q3, 2020.
The backlog of FX Demand Putting Pressure on Reserve
From the review of the foreign reserve; as of May 2019, it was comfortably around $45bn due to fairly stable oil price in the year. However, we have seen a continuous decline as the CBN kept on defending the Naira at all costs. It is an indication that the issue actually started even before COVID 19. Notably, FX reserves had been depleted below 40bn before the end of 2019. In short, the first, second, and third devaluation are long overdue with added pressure from COVID-19.
Following the suspension of FX to the BDC and other FX operators in March, the backlog of FX demand from both manufacturers and foreign investors was estimated at $7 billion in June 2020. $2 billion was attributed to the manufacturers and $5 billion estimated for foreign equities investors and investors in the OMO bill who were queuing to repatriate their funds. As restrictions were lifted and economic activities improved in the 3rd quarter, demand pressure aggravated amid declining reserve and low prospects in oil price. As the major source of FX inflow in the I &E window and interbank segment, the CBN had no option than to devalue the currency again.