BusinessDay

Explainer: Why Nigeria’s foreign reserves remain under pressure?

Nigeria’s foreign reserves have been declining on the back of low oil production and tough financial market conditions due to monetary policy tightening by global central banks.

The country’s gross official reserves declined to $37.20 billion on November 11 from $40.52 billion at the end of last year, data obtained from the Central Bank of Nigeria (CBN) show.

According to the CBN, foreign reserves, also known as foreign exchange reserves or external reserves, are assets held on reserve by a monetary authority in foreign currencies.

Foreign reserves are used to back liabilities and influence monetary policy. They include foreign banknotes, deposits, bonds, Treasury bills, and other foreign government securities.

They serve many purposes but are most significantly held to ensure that a government or its agency has backup funds if their national currency rapidly devalues.

Here are the reasons for Nigeria’s foreign reserves decline

According to FBNQuest, the sharp drop in the FX reserves is mostly due to the CBN’s increased interventions on the various FX windows, such as the Investors and Exporters (I&E), and the Secondary Market Intervention Sales windows, following the difficulties with FX supply.

Read also: Nigeria’s foreign reserves to shrink further as debt servicing, imports mount pressure on FX

CBN’s increased intervention in the foreign exchange market, notwithstanding the nation’s external reserves, depreciated to $37.39 billion at the end of October 2022 from the $38.255 billion at the start of the month.

FX inflow, through the CBN, increased by 15 percent quarter-on-quarter (q/q), driven mainly by 70 percent and 117 percent q/q increase in FX inflow from oil and the CBN’s swap positions to $2.5 billion and $2.3 billion respectively.

“Despite the high level of crude oil prices, the external reserves have seen very little accretion from oil sales this year, due to the sector’s low productivity because of large-scale crude oil theft,” analysts at FBNQuest said in a note.

Nigeria’s oil output fell below 1 million barrels per day in August and September this year due to oil theft, and vandalism, which resulted in production shut-ins. The decline in oil production threatens foreign exchange revenue from crude oil exports.

Also, the divestment by international oil companies (IOCs) threatens our oil production and the inflow of foreign exchange into the country.

According to the National Bureau of Statistics, the total value of foreign capital attracted by the petroleum industry in the second quarter of this year fell by 83 percent to $1.93 million from $11.3 million in Q2 2021.

“Nigeria has crude oil production concerns. Our crude oil exports are below the expected, as it affects the inflow of foreign exchange,” said Olaolu Boboye, economist analyst at CardinalStone.

Another reason why Nigeria’s foreign reserves have been under pressure in recent months is that Foreign Direct Investment (FDI) and Foreign Portfolio Investment (FPI) inflows have been very limited on account of tough financial market conditions due to monetary policy tightening by global central banks.

NBS report showed that the largest amount of capital received was through portfolio investment which accounted for 49.33 percent ($757.32 million), followed by other investments with 41.09 percent ($630.87 million) and foreign direct investment (FDI) accounting for 9.58 percent ($147.16 million) of total capital imported in Q2 2022.

FDI is a category of cross-border investment in which an investor, company, or government resident in one economy establishes a lasting interest in another economy, while FPI is the purchase of securities and other financial assets by investors from another country like stocks, bonds, mutual funds, and exchange-traded funds.

“Another significant factor responsible for the dwindling capital inflow is the relative over-valuation of the naira on the official Nigerian Autonomous Foreign Exchange Fixing window relative to the dollar and other major currencies,” FBNQuest said.

The latest quarterly statistical bulletin of the CBN shows that total FX inflow into the Nigerian economy increased to $19.5 billion in Q2 2022 from $18.4 billion in Q1.

However, the naira continued to depreciate at the official and parallel markets despite the increase in foreign exchange inflows in the economy in the second quarter of 2022.

“Nigeria’s foreign reserve is under pressure because of the demand for foreign exchange and low supply, which leads to the depreciation of the naira,” Muda Yusuf, chief executive officer of the Centre for the Promotion of Private Enterprise, said.

The strain on Nigeria’s foreign reserves has caused the naira to depreciate for years, analysts say.

Naira depreciation has been attributed to the dollar shortage as Nigeria continues to struggle with diversifying and improving foreign exchange inflows.

Other factors that cause the depreciation include market structure, restrictive policies, low oil sales and revenue, rationing of FX supply, and capital flight.

“Nigeria’s foreign reserve is pressured because of the global risk-off sentiment and rising yields globally; foreign investors are leaving the margin and frontier markets like Nigeria to the US because of risk and volatility,” Boboye added.

Risk-off sentiment is where traders and investors in the financial market reduce their exposure to risk and focus on protecting their capital.

According to Boboye, the foreign reserve pressure has been on for about two years. He said the pressure might ease via FX reforms by CBN, like the FX policy in 2017 when they created the I&E window, which influenced a magnitude of foreign inflows.

He said FX reforms, coupled with an increase of carry trade opportunities for foreign investors, will promote the country’s foreign reserves.

Carry trade is a strategy that involves borrowing at a low-interest rate and investing the amount in an asset offering higher returns.

“If the present attrition rate continues, Nigeria’s foreign exchange reserves will probably fall to a little under $36 billion by the end of December,” FBNQuest said.

Get real time updates directly on you device, subscribe now.