Could New FX Window Breathe Life into the Naira?

South Africa’s slide into recession may be dominating the headlines, but it’s not the only drama unfolding on the continent. Across the border in Nigeria, the naira is taking centre stage, says FXTM’s Research Analyst, Lukman Otunuga.

Dollar liquidity on the Nigerian market is famously poor. While oil exports were pouring out of the country, it wasn’t a material issue but, post 2014, it has been a major problem. The Central Bank of Nigeria (CBN) has been working overtime to sustain liquidity, funneling $413.5 million into the currency market as recently as mid-June.

Nigeria is heavily reliant on foreign imports to supply household items and food. Producers have to be paid, often in dollars and euros, and both are in short supply. Most large businesses are inclined to hold on to any hard currency that comes their way. The result is a parallel market (black market), used by SMEs and individuals to trade smaller sums of typically a few thousand dollars or less. It is one of at least five currency markets in Nigeria.

The scarcity of foreign currency created a crisis in 2016 that lasted into the first quarter of 2017. It actively limited imports and Nigerian banks were forced to extend maturities to ensure trade obligations were met. In February, the Naira plummeted to a record low on the parallel market, reaching 520 against the dollar as liquidity issues continued to hit the country hard.

Since the currency crisis, CBN has been doing all it can to encourage the flow of foreign currency into the banking system. While economic growth is still negative the contraction has slowed. In the first quarter of 2017, Nigeria’s Gross Domestic Product (GDP) contracted by –0.52% (year-on-year) in the first quarter of 2017, however, according to the National Bureau of Statistics (NBS) the second quarter has showed a weaker contraction. This may be an indication that an economic recovery is on the cards.

Inflation is also being brought under control, declining to 17.24 per cent from May 2016 levels of 18.74 per cent. Nigeria’s external reserves rose to $30.28 billion by June 8, 2017, up from $26.59 billion in May 31, 2016. More good news is that Nigeria PMI (Purchasing Managers’ Index) rose to 54.4 in May 2017, the highest since December 2015. This had a direct influence over employment figures, triggering the biggest rise in ten months.

CBN forex management policies are at the center of its attempts to breathe life back into the Nigerian economy. The introduction of the ‘Investors and Exporters FX Window’ in April was part of this policy. This new futures market has given speculators and bond investors the option to move away from the traditional non-deliverable forwards (NDF) market (and its rigid ties to the central bank), and opt instead for a more flexible pricing mechanism – the Nigerian Autonomous Foreign Exchange Rate Fixing (NAFEX). Set around mid-day, NAFEX rates are determined by a poll of authorised bank dealers.

Currently, the Naira NAFEX fix is well below that of other markets. However, investors seem to be encouraged by its transparency, and the volumes transacted through the window are growing. While the majority of orders are still small, Reuters reports that, as of June 2017, $2.2billion had been swapped through it. In Nigeria, the outlook is positive, with Fitch reporting that the new trading facility has eased liquidity pressures on its rated banks. Most crucially of all for the now import-dependent economy, it could facilitate trading in Naira.

That, of course, will depend on a myriad of factors. There are concerns that the health of the fledgling I&E FX window would be fatally impacted by another decline in oil prices and the resulting illiquidity. Recent CBN activity is another potential issue. The bank attempted to narrow the gap between the official and parallel market rates by selling a reported $4 billion between February and May, but these types of measures are unsustainable long-term. Both issues are likely to weigh heavily on investors’ minds, however, for the moment at least, the outlook for the Naira remains if not quite positive, at least guardedly optimistic.

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