CBN’s naira defence masks true value of currency

Nigeria’s apex bank, the Central Bank spent as much as $3.1 billion in the month of September alone, propping up the country’s local currency, the naira.

But it has now emerged that this and other efforts by the bank in the last one year may have been giving the lie to the true value of the domestic currency.

The currency has been stable at the official market, resulting in exchange rate of between N155:73 and N155:77/$ for the past one year following massive defence by the CBN. At the parallel market it depreciated, evidence analysts said shows that the nation’s currency is being mispriced.

The massive spending of $3.1 billion last month in defence of the currency, even against dwindling oil revenues following falling oil prices, was believed to have been undertaken to avoid devaluation. But this is now being interpreted to mean further monetary policy tightening ahead.

Analysts said at the weekend that the development portends an uphill task for the apex bank as devaluation may be the last option, given the potential rise in political and security spending.

They said at the current official exchange rate of N155:76/$, and at the parallel market exchange rate of N168, N169 and N174.60/$, respectively, for August, September and October, the naira had been mispriced by 1.8, 2.2 and 2.9 percent for the respective periods.

Consequently, some of the analysts said the wider gap between the official and parallel market rates created opportunity for round-tripping, more so as the naira remains more susceptible and vulnerable to government oil revenue and external reserve levels than to inflation and interest rate differentials.

Mispricing denotes that at the current official rate against parallel market rates, the naira is not trading at its fair value. The implication is that as a result of the fixed exchange rate regime by CBN, the exchange rate is not determined by the forces of demand and supply, since a shortage in the green back at the forex market will be offset by the CBN using the external reserves and sales from oil majors.

With expectations of further depreciation occasioned by increased political spending and injection of N866 billion into the economy through redemption of matured bonds by the Asset Management Corporation of Nigeria (AMCON), the naira will be mispriced by 3.4 percent at N175.43/$ and 3.9 percent when it depreciates to N176.26/$ in November and December, respectively.

The unexpected 22 percent fall of crude oil price from $116 per barrel in June to $88/b in October has once again reminded Nigerians of their country’s economic vulnerability to exogenous shocks, according to analysts.

Oil prices have taken a hit in recent months, falling steadily from $116/b in June to below $90/b, its lowest level in over two years, due to global demand growth recording its weakest level in three years and buoyant non-OPEC supply (led by the US shale boom) recording its highest level in three decades.

“CBN has consciously continued to intervene at the foreign exchange market to ensure the macroeconomic conditions remain stable, considering the import-dependent structure of the Nigerian economy,” said Ayodeji Ebo of Afrinvest.

“To this end, the CBN spent approximately $3.1 billion in defending the naira at the official market in September, the highest in five months. This was in addition to an undisclosed amount used to intervene at the interbank market. However, the capacity to intervene at the foreign exchange market, spurred by weaker macroeconomic concerns represented by declining oil prices, may be highlighted as the momentum of capital reversals increases,” Ebo added.

He further said a sustained level of pressure on the reserve might underscore the unlikely option of a devaluation preventing the probable situation of exhausting the foreign exchange reserves.

“In the medium term, we anticipate the apex bank will continue to defend the naira, preventing a panic in the capital market,” he said.

Bismarck Rewane, chief executive officer, Financial Derivatives Company, in his September publication, said the fall in oil prices could spell major economic problems for Nigeria.

“The analysis shows that at current prices of approximately $90/b, government revenue for October will drop by 7 percent to $7.03 billion. The fiscal deficit will rise to $1.39 billion (3.3 percent of GDP) and the external reserves will deplete to $36.83 billion. At current official exchange rate and RDAS forex sales, the naira will be mispriced by approximately 2.9 percent in October,” Rewane said.

He added that a further decline of oil prices to $80/b (just $2.5 above the Federal Government’s budget benchmark oil price of $77.5/b for 2014) would cut government revenue to $6.25 billion, push the deficit to 3.7 percent and deplete external reserves further to $33.36 billion.

“At this point, the naira will be mispriced by 3.9 percent if the CBN continues to defend it at the expense of the external reserves. FAAC disbursements will nosedive and more money will be needed to fund the deficit. Erosion in reserves will put the currency under immense pressure, and the CBN is likely to further tighten monetary conditions and bring the issue of currency adjustment to the front burner. Nigeria’s import dependency makes any decision on the value of the currency rather intricate given that general elections are barely four months away and the attendant consequences of any downward adjustment will not just be economic, but political,” he further said.

Bolade Agbola, executive director, Cashcraft Asset Management, called on the Federal Government to use the present opportunity to deregulate the oil pricing as the cheaper prices of oil at the international market might have eroded the subsidy.

He also called for the scrapping of the Petroleum Equalisation Fund, which, he said, had contributed to the imperfections in the oil market.

“If I were President Jonathan I would use the opportunity of declining crude oil price to deregulate petroleum product pricing as subsidy element is wiped off by cheaper crude oil global price, create an independent road tax element in the price of petroleum and scrap Petroleum Equalisation Fund,” Agbola said.

“A 33MT trailer load of fuel from Lagos to Sokoto costs about N400,000, which means it costs about N12 to transport a litre of fuel to Sokoto. In a deregulated market and with scrapping of the Equalisation Fund, fuel that is sold at N100 in Lagos will be sold at no more than N150 in Sokoto, which is a fair price and would not give room for local arbitrage,” he said.

John Omachonu