Nigerian businesses and emergent risks for 2015

These are interesting times for most economies around the world and Nigeria in particular. With interest rate normalisation imminent in the US and UK in 2015, some market jitters have now reappeared. The financing patterns of the last seven years have succeeded in creating distortions in the markets, and quantities and prices, long dissociated from their fundamentals, will now need to readjust. We have already witnessed some adjustments to oil prices, and expectation of higher funding costs next year may engender further corrections across the different asset classes. This is further compounded by the uncertain global macroeconomic outlook, with 2014 and 2015 global output growth numbers further revised downward.

The unfolding events have implications for Nigeria and businesses operating in the country. There is a threat to government revenue from a fiscus that is heavily reliant on oil, a revenue stream that is now under threat from declining oil prices (now below $90 per barrel), and an outlook suggesting even softer prices in 2015. The fiscal buffers are also currently low, with the 30-day moving average of the reserves at $39bn, and the actual liquid reserves at about $36bn (our in-house estimate by stripping the reserves numbers since November 2011 when the CBN introduced reporting of the 30-day moving average rather than the actual). If we take account of the ‘rented’ funds portion of the reserves, then the figure is even lower.

The Bank of International Settlements (BIS) estimates that about $1.4 trillion of the liquidity created during the highly accommodative monetary policy in major advanced economies are invested in emerging and frontier markets’ assets. There are, however, indications that global liquidity will be tighter in 2015, which suggests possible reallocation of resources by asset managers and likely repatriation of some of the foreign funds. The decision of foreign asset managers to buy or sell has an impact on small and illiquid markets like Nigeria, a country that has become dependent on the foreign capital flows as a major source of FX in recent years. All these suggest tough decisions will need to be made by both the fiscal and monetary authorities in the coming year in order to maintain a stable macroeconomic environment.

Domestic businesses will face a number of risks triggered by the fallout from both the global and domestic environments, and there will be many dimensions to these risks, depending on the nature and level of each organisation’s exposure. One of the key emerging risks is the foreign exchange risk. With the outlook for 2015 suggesting a much weaker naira, corporates need to devise foreign exchange management strategies that mitigate their exposure. In recognition of the risk posed by foreign exchange fluctuations, and increasing FX exposure by Nigerian banks, the CBN just released a circular limiting banks’ foreign currency borrowings and deployment of such borrowings.

Although I think this is a move in the right direction by the CBN, it is a bit late. The banking sector will be one of the hardest-hit if the exchange rate risk crystalises. Many of them have already deployed tier-2 capital into foreign currency-denominated projects based on limited knowledge of the dynamics of the projects and assumptions that are no longer realistic. Their balance sheets will also be negatively impacted by their subsidiaries across Africa operating in countries with weak currencies; to consolidate their accounts in Nigeria, all their subsidiaries across the world will need to translate their accounts into naira. Imagine the impact of a subsidiary in Ghana with a currency that has depreciated by 27 percent this year against the naira. Now is the time to re-evaluate and adjust in line with changing market conditions.

Other corporate entities should also be concerned about the risk that foreign exchange fluctuations pose to their businesses. Volatile exchange rates can often undermine the profitability of any project or business if appropriate measures are not adopted to insulate a firm from such risks. In the world of foreign exchange, there are a multitude of alternatives that are available and strategies to fit almost every level of risk. The key is to devise a strategy that best aligns organisational goals with the day’s market realities.

Some of the solutions can be actively deployed using internal hedge strategies built into the company’s overall risk management strategy. There are also external hedge strategies that can be designed to adequately mitigate FX exposure. The conversation around identifying and implementing a foreign currency hedge or risk management strategy should, in our view, begin with a review of the process itself. The time for that review is now.

Olugbenga A. Olufeagba