The exchange rate or the external value of the naira is the most important price in the Nigerian economy. Hence, a lot, from the inflow of foreign investment to how much domestic industries invest and how many Nigerians are employed, depends on how the Central Bank of Nigeria manages the exchange rate.
The Arbiterz webinar, “The Naira in 2021, Optimizing Choices for Growth“, organised in partnership with Cordros Capital, examined which foreign exchange management policies are optimal for boosting investment, growth, and jobs while forecasting which policies the Central Bank of Nigeria (CBN) is most likely to pursue.
The event, organised with the support of Eagle Global Markets and The Association of Bureau de Change Operators of Nigeria (ABCON), generated interest amongst retail and institutional investors as well as analysts and the business community.
Robertson urged the CBN to focus more on controlling inflation. “If the central bank can get inflation to 3 percent and sticks there, then in ten years the naira could be 400/450 naira per dollar. So it’s all about inflation and the central bank’s success in fighting inflation.”
In his opening remarks, Femi Ademola, Executive Director, Cordros Group stated that it was not the intention of the organisers and participants in the webinar to engage in a finger-pointing exercise. Rather, they will discuss options for bringing stability and liquidity to the foreign exchange market.
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The Naira “way too strong”; overvalued by 20/30%
Charlie Robertson, Global Chief Economist at Renaissance Capital, an investment bank focussed on emerging and frontier markets, in his keynote address, noted that the Nigerian economy has been going through a rough patch since 2014 when the price of oil crashed. He explained that a persistently high inflation rate means a persistently weak currency.
According to Robertson, using the Real Effective Exchange Rate (REER) methodology, an approach used to determine the value of a currency vis-à-vis a basket of other currencies based on the relative trade balance, the naira is overvalued “by a good 20 to 30 percent “. He warned that with persistent inflation, the naira would depreciate to N1,000 per dollar in the next ten years.
Robertson urged the CBN to focus more on controlling inflation. “If the central bank can get inflation to 3 percent and sticks there, then in ten years the naira could be N400/N450 per dollar. So it’s all about inflation and the central bank’s success in fighting inflation,” he added.
Rencap’s Chief Economist proposed a current account surplus i.e. a devaluation that limits the demand for dollars and hence imports, as the solution to Nigeria’s foreign exchange woes. According to Robertson, “if you run a current account surplus, dollars are pouring into your country, so even if people or individuals don’t have savings, the country has savings because of the current account surplus”. He linked Nigeria’s low savings rate to high fertility.
But Roberson said that though the naira is overvalued, Rencap analysts do not expect the CBN to allow the Nigerian currency to depreciate to between N500 or N600 (to the dollar), mirroring the extent of recent devaluation in Angola and Kazakhstan. Rather, he predicts the CBN exchange rate will slide to N429/$1 by the end of 2021.
America Will Invest More Abroad
With returns on American government bonds hovering around 1%, Robertson expects that investment will flow into dollar assets in emerging markets in pursuit of yield. He explained that with the exit of President Donald Trump and a lessening of trade wars, American firms will invest more abroad. This would weaken the dollar, thus stimulating the flow of investment into emerging markets. Emerging markets will also enjoy historically low-interest rates on dollar debts.
Nigeria will however not benefit from low-interest capital flowing into emerging markets because the naira is overvalued. Robertson explained that fund managers would be failing their “fiduciary duty” to their clients if they invested in Nigerian assets due to Nigeria’s foreign exchange management policies which make it difficult for foreign investors to repatriate funds.
Illustrating how easy and cheap it has become for emerging markets to raise funds, Robertson cited the case of Peru, a country that had three presidents in December 2020 selling a 100-year bond at 3.3 %. He said Pakistan, Angola, and Egypt will find it easy to borrow because they have signed IMF programmes, explaining that an IMF programme is “a big mark of approval, it signals that you are safe.”
Rencap’s Chief Economist said that if Ghana can manage the consequences of its December 2020 elections, investors would prefer putting money in Ghana than Nigeria.
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Full Webinar Video
Farewell to maverick policies: reforms could take the naira to N410 against the dollar
During the panel discussion, the chief executive of Financial Derivatives Company, Bismarck Rewane, expressed the confidence that Nigeria is steadily returning to orthodox economic policies. He said that between 2015 and 2019, Nigeria’s macroeconomic policy was based on the belief that “capitalism is an agenda of exploitation of the Nigerian economy” and an erroneous belief that having a strong currency is the same thing as having a strong economy. He noted that it is a strong economy that produces a strong currency.
Rewane expects Nigeria to have more orthodox economic policies in 2021, and also expects the economy “to see the benefits of some policy decisions that were made in 2019-2020 in terms of subsidy removal or reduction”. He expects a “shift towards more market-determined naira.”
According to the economist, the naira’s fair value should be about N409/N410 to a dollar. “If you add the fear or speculative premium – the fear that policies could change – that’s about 20 percent, you get N470-N480.
“So we’re saying the fair value today, based on just demand and supply, could be about N410. Then with policies that are not predictable, you pay N475/N480. If the government accepts and begins to implement market reforms, you will see those rates begin to converge – N470 becomes N450, N440 and the other one stays at about N410,” he added.
Rewane urged the CBN to embrace a flexible exchange rate and abandon rationing of foreign exchange which is hindering investment. He noted there is an important difference between occasional adjustment of the exchange rate and changing the system through which the exchange rate is determined.
“What is required today is to adjust the rate to cover the gap you have – maybe N390 becomes N410 – and then accept the flexibility of the rate however it moves,” he said. “Once you have that and the market now knows that the exchange rate can move like the prices of diesel and petrol move, then everybody would begin to accept that the exchange rate is not fixed, that is the important thing.”
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CBN not ready for the market
Akinbamidele Akintola, Head of SSA Equity Sales at Stanbic IBTC does not believe that the Central Bank of Nigeria is ready to move towards a market system of arriving at the naira’s exchange rate which would see the naira shoot above N420/N430 to $1.
“I think there are many things you have to look at such as the increase in fuel prices, issues with labour, electricity tariffs,” he said. “I don’t think that in the near term, there is that propensity to want to move the currency beyond N420/N430. Officially, that is our outlook for the currency. I think fair value for my economic team is about N460 but that is different from what we actually think will happen”.
On international flows, the Stanbic executive revealed that a lot of clients were not able to get their money out in 2020. “As you know, with investors, liquidity is the watchword for everything.”
Akintola says clients are thus refraining from investing extra capital or buying equity in Nigeria. “I think for this year, I don’t expect to see any significant inflows coming to equities or fixed income not until there’s clarity on the ability to take money in and out of this country,” he said.
This leaves room for local investors, as opposed to foreign investors, to drive flows into the equities market, something Akinbamidele hopes will happen. “I hope Nigeria becomes more like Egypt where the flows that come into the equity market are more driven by locals as opposed to internationals. We need to believe in our market before the world believes in the market.”
CBN foreign exchange restrictions damaging the business environment
Meanwhile, the Director-General of the Lagos Chamber of Commerce & Industry (LCCI), Muda Yusuf, lamented the continued liquidity crisis in the forex market that is worsening the rate of divestment in the country.
Yusuf also lamented the “excessive focus on the demand management side of the foreign exchange market.” Instead, the focus should be on setting clear strategies that would encourage the inflow of foreign exchange into Nigeria.
“When you have a situation where you make a demand for forex either to import equipment or raw material and you get just 10-20 percent of what you requested for, what are you going to do with that?
“So, that is creating a lot of problems, it is creating a lot of uncertainty in the economy for investors and it is escalating the risk of divestment because when you are not sure when, how and at what rate you are going to get your foreign exchange, it constitutes a major problem for planning,” he said.
Yusuf, whose LLCI has very close relations with manufacturers, suggested that the uncertainty around access to foreign exchange created by the focus on rationing is more of a problem than the high cost of foreign exchange. He said that restrictions on accessing foreign exchange are pushing more manufacturers into adopting practices in the informal sector where players would always find ways to circumvent bad policies.
Yusuf urged the CBN to “normalise the situation so that we can have more transactions on the table”, warning against the futility of measures put in place to ration foreign exchange. “Right now, there are a lot of transactions under the table. You have an exchange rate, you pay a particular rate officially and pay another rate unofficially. These things are creating a whole lot of problems in the economy.”
Capital growth to aid the naira
Aminu Gwadabe, President of the Association of Bureau De Change Operators of Nigeria, called for decisions that will bring capital growth and investments through a change in mindset, which would help the fortune of the naira in 2021.
Speaking on the country’s exchange rate management, Gwadabe noted that the association was a critical stakeholder in the foreign exchange market. He noted that the Central Bank of Nigeria has gone some way in shifting from demand management to stimulating supply to ensure more inflow of foreign exchange.
Investors hedging against the naira
Abiola Adekoya, Lead Wealth Advisor at Artios Capital, noted that investors are being more cautious than before. She said the focus in 2021 is likely to be on wealth preservation for most. Investors will be seeking to diversify their portfolio, hedging naira assets.
“In 2020 there was a spike in local investors eyeing foreign markets. Foreign ETFs have become popular. Some platforms have made it easy for people to invest using naira, so they do not worry about conversion risk,” she said. “Technology has helped financial services providers to make more products and services available to the public across various classes of investors and assets.”
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