Investors see growing risks in naira devaluation delay

03 July 2015, Lagos – International investors, dismayed by Nigeria’s decision to delay a naira devaluation they see as long overdue, will hold back from its stock and bond markets, raising risks of a deeper crisis in Africa’s biggest economy.

Bundles of N1000 Naira notes.

Bundles of N1000 Naira notes.

The afterglow from March, when an incumbent president handed over power after what was seen as Nigeria’s freest ever election, is dissipating as President Muhammadu Buhari shows little sign of following up on promises of economic reform, Reuters reported.

Markets have moved sharply in the past week in particular after the Central Bank of Nigeria (CBN) announced curbs on dollar funding for investors, as well as for importers of goods ranging from toothpicks to private jets.

The move, meant to conserve foreign exchange, has dashed widely-held expectations of a naira devaluation – the central reform that investors had been banking on.

Since then 10-year bond yields have jumped 1 percentage point to almost 15 per cent, stocks have fallen and the naira’s value is plunging in the parallel market, down about 7 percent from early-June levels.

A devaluation to restore the economy to competitiveness is a matter of time, fund managers still believe. In the meantime, they are unlikely to bring back cash they pulled out before the election.

“It will take a combination of weaker currency and higher interest rates to get us back to Nigeria,” Reuters quoted a bond fund manager at Standard Life Investments, Kieran Curtis, to have said.

“When we compare Nigeria to other oil exporters it hasn’t had enough of a currency adjustment.”

With oil exports providing 70 per cent of budget revenues, Nigeria can certainly use a cheaper currency. Most had reckoned on a 10-15 percent devaluation at least and some such as Curtis estimate a 20-25 percent move is probably needed.

The naira fell 20 percent in the year to February. In real terms, currencies of oil-exporting peers Russia and Colombia are five and 17 per cent respectively below long-term averages. African oil producer Angola also recently devalued its kwanza, which is down 15 per cent to the dollar this year.

And the price for supporting the naira is high – the central bank has spent at least $3.4 billion since fixing the exchange rate in February and reserves have fallen below $30 billion for the first time since 2005.

Devaluation expectations continue to mount. Non-deliverable forwards (NDF), derivatives used to hedge against future exchange rate moves, reflect expectations of currency weakening: six-month NDFs price the naira at N225 per dollar, while a week ago the forward price was around N215.
“To me, (central bank measures) are doing more harm than good: you are putting off the inevitable and the reaction you are seeing on rates markets and the NDF shows that,” a fund manager at Aberdeen Asset Management, Kevin Daly said.

“Effectively the bond market is starting to price in a much wider move on the currency.”

Curbing access to dollars may briefly stabilise reserves and constrict imports but pent-up demand for hard currency will eventually weaken the exchange rate and drains central bank coffers.

It may also stoke inflation if importers are forced to pay more for dollars. The naira trades at  N230 per dollar in the black market, some 14 percent below the official rate.

With oil revenues down and borrowing costs rising, the 2015 budget is already 3.2 per cent smaller than last year’s. By early May, the government had already exhausted half its borrowing allowance for the year.
Ten-year yields at almost 15 percent, N250 basis points above post-election lows, will raise borrowing costs for the government and the private sector.

“Ultimately (devaluation) will become more of a fiscal necessity than an external necessity. The longer they will take to do the adjustment, the bigger the adjustment would have to be,” portfolio manager at Investec’s African Fixed Income Fund, Antoon de Klerk said.

And crucially for investment flows, Nigeria’s place in the GBI-EM local currency debt index looks increasingly precarious.

JPMorgan warned in June it could eject Nigeria from its benchmark index by year-end unless it restores liquidity to currency markets in a way that allowed foreign investors to transact with minimal hurdles.
Nigeria has a 1.8 percent share in the $220 billion index, suggesting $4 billion in inflows, Morgan Stanley estimates, a major offset to its current account deficit.

“Were Nigeria to be removed from the index as a result of the dry-up in liquidity as forewarned by the index provider, upside risks to our naira forecast of 200-205 (per dollar) over the next 12 months could crystallise immediately, especially if one considers that its (annual) current account deficit could be up to … $10 billion,” Morgan Stanley said.

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