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Strong dollar worsens naira pressure, US enters recession

Strong dollar worsens naira pressure, US enters recession

The naira has come under increased pressure as the United States dollar has risen to a record high against other global currencies following interest-rate hikes meant to tame inflation.

The Federal Reserve officials, on Wednesday, unanimously agreed to raise their benchmark federal-funds rate to a range between 2.25 percent and 2.5 percent.

On Thursday, the US economy shrank 0.2 per cent in the June quarter, or 0.9 per cent on an annualised basis. The US economy fell into a technical recession in the second quarter, with data published by the commerce department on Thursday showing a contraction in the second three months of the year, Financial Times reports.

According to the Wall Street Journal, a stronger US dollar draws investors away from emerging markets, and governments that issue debt in foreign currencies face greater risks.

“A strong dollar nearly always puts pressure on emerging and frontier economies – and usually forces their currencies to become weaker, which often adds to inflation. External debt in dollars becomes more expensive to repay, and this can weaken sovereign risk ratings,” said Charlie Robertson, global chief economist at Renaissance Capital.

The naira has been on a free fall in recent weeks, depreciating to N430 per dollar at the official market, known as Investors and Exporters forex window, and N710/$ at the parallel market, popularly called black market.

According to StatiSense, a data consulting firm, in 1981, N1 million was $1,570,105, showing that the naira was stronger than the dollar. But 10 years after, precisely in 1991, the hand of the clock was turned as N1 million was $102,517. Twenty years later, in 2001, N1 million was $8,814. In 2011, N1 million was $6,382 and 40 years after, precisely in 2021, N1 million became weaker and stood at $2,421.

“Indeed the USD has appreciated relative to other global currencies especially in the past one year as a result of the interest rate normalisation by the Federal Reserve to curb rising inflation,” Taiwo Oyedele, head of tax and corporate advisory services at PwC, said.

This, according to him, makes investment in US government treasury instruments more attractive to investors who then pull out their funds from other markets, especially those considered risky and invest them in the US.

He said: “So what has really happened is not that the USD has appreciated in value, it is that other currencies have depreciated in value against the USD.

“Interestingly, while other major economies such as the EU have responded by raising rates and thereby halt the depreciation of their currencies, this has not been the case for Nigeria, essentially because the country is considered risky for investment, so much so that the yield on Nigeria’s Eurobond is now more than 1,000 basis points above the yield on US treasury bonds, hence the classification as distressed investment.”

Commenting on the implications of a stronger US dollar for the naira, Uche Uwaleke, a professor of Capital Market at the Nasarawa State University Keffi, said, “It means higher exchange rate for the naira, imported inflation and higher cost of servicing external debt.”

On his part, Ayodeji Ebo, managing director/chief business officer, Optimus by Afrinvest, said: “This signifies that it’s more expensive to import from the US given the stronger currency relative to other countries. This will impact negatively on the Naira given that we are not earning enough FX relative to the demand.”

Gafar Bashiru, senior associate at Parthian Partners, said a stronger dollar would lead to a weaker naira in terms of import cost, capital outflow and speculation.

“As an import-dependent nation, we will have to spend more naira to buy the same volume of imported goods, thus worsening the naira-dollar exchange rate, ” he said.

On capital outflow, he said as investors seek safety in the greenback and US treasuries, foreign investors’ exit will deplete Nigeria’s external reserves, and its ability to defend the naira.

“As Nigerians anticipate devaluation from these factors, we would see increased speculative demand for dollars in an attempt to hedge against devaluation. An expectation of devaluation will thus lead to further devaluation,” Bashiru said.

Read also: Naira records lowest fall to N710 as demand rises astronomically

Meanwhile, the US economy contracted for the second consecutive quarter in 2022, data released Thursday by the Bureau of Economic Analysis, US Commerce Department, have shown. According to the estimate, the economy shrank by 0.9 percent, following a 1.6 percent contraction in GDP at the end of the first quarter of 2022.

However, it appears the US government may not admit the country is in a recession now because the official confirmation is yet to come from the National Bureau of Economic Research, which is the body that has the prerogative right to declare that the US economy is in a recession. This is as CNN quoted the US government officials as saying that the US economy might not be in a recession simply because of the two contractions in gross domestic product (GDP).

“The administration even took the unusual step of publishing an explainer of sorts, maintaining that two consecutive quarters of economic contraction does not, in and of itself, constitute a recession. The White House posted a blog entry last week saying that in addition to GDP, data pertaining to the labour market, corporate and personal spending, production and incomes all go into the official determination of a recession,” the CNN said.

Consumer spending slowed at an annual rate of one percent in the US as American households spent more on healthcare, accommodation and dining out while there was reduction in spending on goods and groceries.

The announcement of a second consecutive contraction in GDP came a day after the US Federal Reserve raised the benchmark interest rate by additional 75 basis points, which was in line with many expectations, to a target range of 2.25 percent to 2.5 percent.