World’s worst currency slump gleaning rewards for Nigeria

Biggest losers*Currency has declined more than peers since oil price crash
*Nigerian T-Bills offering market-beating returns, Exotix says

24 August 2016, Lagos — More than two months after Nigeria allowed its currency to devalue, the country is starting to reap some dividends.

In the past two weeks, Exotix Partners LLP and Standard Bank Group Ltd. have told clients, most of whom fled after the country started imposing capital controls from late 2014, that they should start buying naira assets again. The worst-performing currency this year among more than 150 globally has depreciated 37 percent against the dollar since the central bank abandoned its peg on June 20, while bond yields have jumped to more than 20 percent. The naira strengthened 4.6 percent to 315 per dollar on Tuesday after falling to a record 350.25 on Aug. 19.
“The cheap naira is attracting foreign investors,” said Lutz Roehmeyer, a money manager at Landesbank Berlin Investment, which oversees about $12 billion of assets. “At 325 per dollar, the naira is too weak” and Landesbank anticipates a rebound, he said.

Doubled Holdings
Roehmeyer’s funds have doubled their holdings of naira debt, albeit in the form of bonds issued by the World Bank’s International Finance Corp. rather than the Nigerian government, to the equivalent of around $9.2 million this month, he said.
Nigeria’s central bank Governor Godwin Emefiele fixed the currency in February 2015 at 197-199 per dollar to stop it plunging amid the decline in the price of oil, on which Nigeria depends for 90 percent of exports and the bulk of government revenue. He relented after 16 months as the country stumbled toward a recession and foreign reserves fell to their lowest level in 11 years.

The naira has now weakened more than any other major oil currency since mid-2014, when crude prices started retreating. It’s lost almost half its value against the dollar in that period, compared with 46 percent for Kazakhstan’s tenge and 35 percent for the Colombian peso.

That makes it a good time to buy Nigerian one-year Treasury bills with yields of about 22 percent, Stuart Culverhouse, chief economist at Exotix in London, wrote in an Aug. 9 note. The potential return is more than 33 percent if the naira strengthens to its fair value of 290 against the greenback, he said. In April, one-year T-bills yielded just 10 percent.

Oil Production
The trade is not for everyone, given Nigeria’s outlook. The economy will shrink 1.8 percent this year, its first contraction since at least 1991, the International Monetary Fund forecasts. Oil production has sunk to a near three-decade low of about 1.5 million barrels a day as militants attack pipelines and export terminals in the south of the country.
While Landesbank Berlin and Exotix say the currency has fallen enough, others aren’t convinced. The naira will weaken to 396 by year-end and 515 by the second quarter of 2017, according to Access Bank Plc, Nigeria’s fourth-biggest lender.
Forward prices also predict worse to come. Three-month non-deliverable forwards trade at 357 to the dollar, and one-year contracts at 394. The median forecast of economists in a Bloomberg survey is for the currency to stabilize at 344 this year.

Sidelines Preferred
“The combination of a cheaper naira and higher yields on naira paper are tempting, but we remain comfortable on the sidelines,” Brett Rowley, a managing director at Los Angeles-based TCW Group Inc., which oversees $195 billion of assets, said in an e-mailed response to questions on Aug. 16. “Restoring oil output would help assuage our concerns.”

Investors are also yet to be convinced that the naira truly floats. The central bank sold dollars at 309 last week and may be trying to keep the rate stronger than 320, according to Craig Thompson of Continental Capital Markets SA, based in Nyon, Switzerland. The naira trades at 395 on the black market, 20 percent weaker than the official rate.

“The exchange rate is closer to fair value in the eyes of most investors,” said Andrew Howell, a New York-based frontier-markets analyst at Citigroup Inc., the world’s biggest foreign-exchange trader. “But there still aren’t many inflows. You can’t really call it a normally-functioning exchange rate yet.”

Mitigating Risk
Still, bond investors are closer to pulling the trigger than they have been in more than a year. They’d be even more confident if they were able to mitigate the risk of further depreciation by buying the naira-settled futures that Nigeria introduced in June, according to Stephen Bailey-Smith, senior economist at Copenhagen-based Denmark’s Global Evolution Fonds A/S, which manages $3.2 billion of assets.

Nigerian local-currency bonds have lost 17 percent in dollar terms this quarter, through yesterday, compared with the 3 percent average return for 31 developing nations monitored by Bloomberg indexes. The yield on benchmark government naira notes due January 2026 has climbed 226 basis points since June to 15.08 percent.
“We haven’t come back in to the local market yet, but we’re looking at it closely,” Bailey-Smith said. “If you can get a yield above 20 percent and hedge the FX risk, it’s not a bad trade at all. The futures market is intended to help you do that, but it’s difficult to buy them.”

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