Ahead of the 2015 general elections in Nigeria, Africa’s largest economy, increased political risk and dwindling appetite among emerging markets investors for frontier assets have put the country’s currency under pressure, the Bloomberg Africa FX report has revealed.
The situation has depleted the country’s foreign exchange reserves, with policy makers now left with a difficult decision to make: either allow the currency to move in a wider range against the dollar or raise interest rates. But Nigeria’s Central Bank Governor Godwin Emefiele had promised to stabilize the Naira without plying either routes.
Forex reserves fell to $37.8 billion from $43.6 billion over the first quarter of 2014, according to Central Bank of Nigeria (CBN) data. Leading Emerging Markets & Frontiers investment bank, Renaissance Capital (RenCap) had in a report in February forecast an $8 billion drop in foreign reserves in 2014 to $35 billion.
“FX reserves are down 20 percent year-on-year and there have been heavier interventions, which suggest it is unsustainable,” says Shilan Shah, Africa economist at Capital Economics. Shilan added that “You can’t keep defending the currency at its current peg indefinitely.”
First Real Test
In his presentation upon assumption of office in June, governor of Nigeria’s apex bank Godwin Emefiele promised to work towards reducing interest rates. “We shall pursue a gradual reduction in interest rates,” the former CEO of Zenith Bank – one of the country’s largest banks – said at the time. The plan, according to him had a tenure of five years, but noted that nothing concrete would happen until after the 2015 elections.
Emefiele acknowledged that “reducing the interest rate and maintaining the exchange rate are very daunting twin goals,” but said the CBN was determined to achieve the goals. He said he would continue holding onto the exchange rate and ensure the Naira is not devalued. The currency was last devalued in 2011 following an $11 billion drop in foreign reserves.
“If forex reserves fall to $30 billion, ceteris paribus, our naira econometric model forecasts a sharper depreciation to NGN168/$1 at YE 14…the new CBN governor may be compelled to adjust the naira exchange rate band to NGN160-170/$1,” RenCap said in its report. The current exchange rate is N165.68/$1.
The CBN governor is facing his first real test since assumption of office, with the possibility of significantly increasing Nigeria’s forex reserves very low. This is largely due to falling global oil price, now at just over $81 per barrel and predicted by Goldman Sachs to fall to $70 per barrel in 2015. Crude oil is Nigeria’s top foreign exchange earner and the government had recently presented a budget with oil price benchmarked at $78 per barrel.
Oil and gas make up more than 90 percent of exports, providing the critical source of Nigeria’s foreign exchange. A collapse in oil prices could lead to the same in Nigeria’s foreign exchange which is crucial to imports.
The storm may be over…
Francis Beddington, an economist focusing on Africa also noted in the Bloomberg Africa FX Report that some of the pressure on the Naira can be attributed to rise in liquidity flowing into the domestic banking sector. The repayment of bonds by the Asset Management Company of Nigeria, created by the government to take non-performing loans from the balance sheets of domestic banks, led to a surge of liquidity in the system.
Although the election cycle has begun in Nigeria and terror attacks still continue in the country’s North East, investors believe the worst pressures on the Naira might be over, at least for now.
“If you add up the amount of foreign investment in the bond market and the equity market in Nigeria, it’s probably about $24 billion, give or take,” says Jonathan Chew, chief investment officer at specialist Africa investor Imara. “That is a fair flood of foreign exchange reserves, if everyone decided to leave together. February is probably the time when that would have happened and a lot of money did leave. But they seem to have come through that now.”
Nigeria is expected to work on ramping up its non-oil exports as global oil prices continue to fall. Its primary focus however will be to shore up its forex reserves.
Part of the information above first appeared in the Bloomberg Africa FX report.