A Review of the Nigerian Energy Industry

Currencies nosedive in oil economies

01 December 2014, Lagos – The unrelenting fall in the price of crude oil is taking its toll on the currencies of oil producing countries, leading to either outright devaluation or heavy depreciation of such national currencies

Companies in these countries that are exposed to foreign exchange denominated loans will be hard pressed to pay back those facilities as they are now compelled to source more local currencies to pay off such debt.

Financial markets 1For companies with foreign inputs they will also be forced to source more local currencies at higher volume to continue operation. The Central Bank of Nigeria CBN, said it devalued the naira to stem the continued depletion of the nation’s external reserve which serve as backup for the local currency to prevent Nigeria returning to the pre-1983 era of foreign exchange rationing.

Pre-SFEM settlement

It will be recalled that in 1982 when former president, Alhaji Shehu Shagari introduced austerity measures as a result of shortage of foreign exchange in the country, the CBN could not provide cover for money paid by private sector operators into its account to settle foreign suppliers. The loans eventually became sovereign.

About N2.6673 billion was paid by importers into the commercial banks that awaited foreign exchange cover from the Central Bank. A large portion of the money had been paid into the banks in 1983.

At the time, about N1.4285 billion was paid to the Central Bank, while the balance of N1.2388 billion which represents the advanced deposits paid by importers against letters of credit was outstanding with banks.

The backlog was caused by foreign exchange scarcity, which hit the country as the nation’s reserve was depleted and could not pay for one month of imports.

Accordingly, CBN could not provide foreign exchange to facilitate the transfer of the money to overseas creditors before the introduction of the Second Tier Foreign Exchange Market (SFEM) in 1986. The hike in exchange rates put the importers who had already settled their bills in difficult position as they were being asked by their bankers to pay the new rates.

The importers, however, insisted that it was not proper for the banks to ask them to pay the prevalent exchange rates. According to most importers then, they paid in the N2.6673 billion into banks when the exchange rate was about N1.00 to $1.00.

But with the devaluation of the naira, the Central Bank issued a guideline in which the settlement rate was fixed at the rate ruling as at September 26, 1986 of about N1 to $1.5, and importers were asked to pay the difference which, according to financial experts, amounted to N1.332 billion.

Nigerian banks’ quest for foreign bonds over

In the present circumstance, Nigerian banks’ that have in recent time been rushing to the international capital market to raise funds will have to think twice before doing so.

The overseas borrowing fiesta looks to be over in the wake of dramatic currency devaluation last week, but while risks are rising, repaying existing debt could be a problem for most.

Nigerian companies have rushed in recent years to take advantage of rock-bottom global borrowing costs and investors’ hunger for yield, selling some $5 billion in hard currency bonds since 2007, according to Thomson Reuters data. Of this, more than $2 billion was raised this year by financial institutions shoring up their balance sheets, Standard Chartered estimates.

Oil producers’currencies in trouble

The oil price collapse has prompted currencies of oil economies from Nigeria to Malaysia to hit multi-year or all-time lows. In Russia, where energy accounts for two-thirds of exports, the rouble slumped 1.2 per cent and headed for its biggest monthly loss since 2009.

Moscow’s dollar-denominated stocks fell 2.6 per cent, set for their fifth month in the red. Russian bonds were also sold off; with dollar debt spreads over U.S. Treasuries at three-year highs and local 10-year yields surging to levels last seen in December 2011.

“The market reaction is very conventional. We see divergence between the winning countries over the decline of oil prices and the losing countries,” HSBC strategist Murat Toprak said. The rouble has overshot – but if the oil price keeps going lower like that, this momentum may continue.” Three-month forwards meanwhile imply a 10 per cent depreciation in oil-rich Kazakhstan’s Tenge.

In Nigeria, the Naira lost 1.3 percent and dollar bonds fell, just like in Angola. Earlier, Malaysia’s Ringgit hit five-year lows, forcing the central bank to step in. Societe Generale advised buying Turkish lira versus rouble as a proxy for oil. “For a vast majority of emerging market countries, the sharp decline in oil prices may help reduce macro vulnerabilities,” SG wrote. “This means local rates are going to perform strongly in high-yielding markets where inflation is set to decelerate.”

Indian and Turkish local 10-year yields plunged to 16- and 17-month lows on expectations that cheaper oil will lead to policy easing. Non-oil currencies were kept in check by a firmer dollar, though Indian stocks touched new record highs, Chinese equity markets rose two per cent while Istanbul hit six-month peaks.

The currency’s woes have raised some fears about the impact on the balance sheets of companies and banks and have been reflected in some of Nigeria’s top banks’ Eurobonds. First Bank Holdings 7-year Eurobond issued in June traded at 97.27 after hitting a record low of 96.85 on Monday. Meanwhile Access Bank’s 7-year Eurobond issued the same month traded at a record low of 97.89.

Effects on banks

Commenting on the  possible impacts on banks, Bismarck Rewane, Managing Director/Chief Executive, Financial Derivative Company said, “Banks capital adequacy ratio now is much higher than in the past.

But there would be a gap, and that gap has to be covered. But they have enough of buffers, capital buffers to cover the gap, so there is no question about that.  Definitely it would affect their profitability in the short run, but it won’t affect their liquidity confidence.

In the same vein, Mr. Opeyemi Agbaje, Senior Consultant/CEO, RTC Advisory Services Limited said, “Anybody that has a dollar exposure obviously, his debt would have increased. But I am sure the banks have covered that risk because everybody knew the devaluation is imminent. Everybody knew that there is no way this exchange rate can survive beyond March.

So everybody that has a dollar exposure especially a bank, knowing that devaluation was inevitable, would have covered that exposure. I want to imagine, they would have tried their best to cover that exposure by putting dollars in their portfolio, especially because CBN was still providing them with cheap dollars.

“So they would have covered that exposure. But yes it is a real issue, whether they cover it or not, it is still a real issue. That cost has gone up by about 10 percent; the cost of servicing those debts has gone up by about 10 percent. But it goes beyond the banks.

It affects anybody that has dollar exposure, even if it is payment of school fees. But for banks, it is significant, I am only speculating, that I am sure, because they are professionals with their jobs, and it was clear that it was inevitable, they would have tried to cover that risk.

Yes in the short term, next year, two years’ time, yes you can expect that the banks will have challenges with their profitability”.

Ratings agency Fitch also pointed to the naira devaluation potentially spelling trouble for firms’ ability to service the foreign currency debt they owed Nigerian lenders, with a knock-on effect on banks’ asset quality.

“Inflationary pressures from the devaluation could also affect consumer disposable income and banks’ retail loans,” Fitch said in a note published last week.

Richard Segal, emerging markets analyst at Jefferies, noted that Nigerian banks’ debt had performed far worse than the sovereign as the naira weakened but he added:

“Neither the ability to pay of the banks, nor the capacity of the government to support them, has declined significantly.” One reason is that many Nigerian banks lend in foreign currency, predominantly U.S. dollars, to major companies active in the dominant oil, gas and power sectors. This has boosted banks’ assets and loans denominated in currencies other than the naira.

“A lot of the balance sheets of these Nigerian banks are already dollarised,” said Kato Mukuru, head of equities research at brokerage Exotix. One thing is for sure: abundant Nigerian Eurobond issuance is unlikely to continue in the same volume as before.

The central bank this week also imposed tighter restrictions on banks’ foreign currency borrowing. “It is not the same environment…the whole issuance of the eurobond is likely to recede,” Standard Chartered’s Gadio said.

Naira devaluation: No effect on capital market, economy

Some stakeholders in the financial sector have continued to react on the recent devaluation of the Naira, saying it would not have fundamental effects on the financial markets, especially the capital market but may create artificial inflation in the country.

They commended the devaluation of the Naira (Nigeria’s legal tender) by the Central Bank of Nigeria (CBN) to a new official exchange rate at N168 to the United States (US) dollar from its previous rate of N155.

The move was stemmed from the recent free-fall of the Naira resulting from global oil price decline and high dollar demand. Also, benchmark interest rate was increased to 13 per cent from 12 per cent; indicating an appreciation of 100 basis points.


Right step

Commenting on the devaluation, Mr. Michael Oyebola, Managing Director/ Chief Investment Officer FBN Capital Asset Management commended the action and said it was a step in the right direction.

According to him “We are having a naira which is over-valued. CBN has to do something because of devaluation and oil price falling and for CBN to stem the ability for banks to keep running the foreign exchange, CBN has to be very bold and that is exactly what they did.

“For the economy, we are an import dependent nation and if oil prices keep going down. There may be economic slow down so it is good to tighten our belt.

Another operator in the nation’s capital market who pleaded anonymity said, “ It was imperative going by what is happening to the key produce, which is the oil that informs the devaluation.  So it was also appropriate and long expected since the naira has not been defendent on the dollar.

The Chief Executive Officer, Financial Derivatives Company Limited, Mr. Bismarck Rewane, said the devaluation of the Naira was the right move because the country’s revenue was down, explaining that before the devaluation, foreign investors had been selling their shares to take their money out, “but now that the value has been established that will stop.

According to him “Devaluation would help stop investors that were trying to pull out of the country from doing so. The decisions taken by members of the committee were “a very frank assessment of the economy. Monetary Policy Committee, MPC decisions established the independence of the central bank.

“They moved in the right direction and anytime you move prices to equilibrium, the economy moves in that direction. The exchange rate was priced in a distorted manner and with the MPC decision, it is gradually getting to equilibrium and so the amount of imbalance would be reduced.”

On his part, the Managing Director/Chief Executive Officer, Cowry Asset Management Limited, Mr. Johnson Chukwu argued that the devaluation of the nation’s currency would lead to high cost of goods and services, saying that manufacturers would pass the high cost of forex to consumers. Furthermore, Chukwu noted that it would lead to an uptick in inflation rate.

However, the Director General of the Lagos Chamber of Commerce and Industry (LCCI), Mr. Muda Yusuf who welcomed the decision to officially devalue the Naira, maintained that raising the Monetary Policy Rate, MPR and Cash Reserve Ratio, CRR would affect profit margins of manufacturers in the country and thus may attract inflation.

“The devaluation is almost inevitable given the situation we have found ourselves as regards the falling oil prices and given that the value of the naira has depreciated significantly at the inter-bank market.

“But raising the MPR and private sector CRR was unnecessary and can be said to be an over kill. If you look at the list of items that were recently removed from the RDAS for importers, you will know that importers now get dollars at a very high cost.

“So, what the central bank has done will affect the cost of production, profit margins of organisations will drop and the cost of goods and services will increase,” he said.

To the Sub-Saharan Africa Economist at Renaissance Capital, Yvonne Mhango, the central bank’s decision would lead to greater flexibility of the exchange rate.

According to her, the adjustment of the exchange rate band implies that the new target (official) exchange rate band is N160-176/$1.

“This is typical of the central bank – they adjust to where the market is trading. Fall in oil price has undermined reserves position, and weakened central bank’s ability to defend the naira. Forex reserves currently stand at seven months of import cover.

“Low oil prices are here to stay. MPC believes we are in an episode of low oil prices, where fall in oil prices is permanent,” she explained.

The Head, Africa Macro Research, Standard Chartered Bank, Razia Khan who described the central bank’s decision as a big surprise also noted that the moves showed that the central bank has absolute commitment to dealing with current challenges.

“They have not shied away from the tightening needed to sustain current forex reserves. The official devaluation of the naira allows the RDAS to move within the range that straddles the interbank forex rate.

“While the market reaction to the RDAS move in the near-term will be important, we think that these measures deal as comprehensively as possible with the challenges facing Nigeria.

“While Nigeria cannot do much to influence the oil price, the combination of measures today sends a powerful signal to all stakeholders on the CBN’s intent to do what it can to preserve macroeconomic stability,” she stated.

The Chief Executive Officer, Enterprise Stockbrokers, Mr. Rotimi Fakayejo, expressed the view that the devaluation would be positive for the capital market.

This, he explained, was because it would attract foreign funds into the market as the equities were currently cheap and the dollar would give more naira.

He added that the move might also ease the impact of the political uncertainty in the country.

According to him The way it has been, there is likelihood that this (naira devaluation) would override the political uncertainty,” he said stressing that many foreign investors knew that Nigeria would overcome the current situation.

“We have been in situations that are more difficult than this. Also, by the time the party primaries have taken place, there is going to be more stability in the market.”

Fakayejo also said the gains of the last two day of equity trading could be linked to the move.

“When you look at the kind of volume it is easy to infer that. It had been speculated that the naira was going to be devalued and the immediate impact of that is the attraction of funds into the market and that has already started happening,” he said.

– Vanguard

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