Tide turns for naira but foreign investors want more

The Central Bank of Nigeria (CBN) is making all the right moves to attract foreign portfolio investors (FPIs) into a market that burnt fingers in the last eight years, but there’s still some way to go if the country must get ahead in a stiff competition for investment flows with other emerging markets.

The foreign exchange forwards backlog – money owed by the CBN to banks in forward contracts – has been cleared, interest rates are trending upwards and the damaging gap between the official and black market rates has vanished, with the naira strengthening to a more than one-month high.

As momentum builds in favour of the naira, there are however still some knotty issues holding back the full weight of the gains from the CBN’s reforms. These bottlenecks are seeing investors flock to other markets like Egypt that have also delivered a devaluation and jumbo hike in interest rates.

Convertibility risk spooks foreigners from local auctions

One of these bottlenecks is the currency convertibility risk in Nigeria which is not helped by current rules restricting banks from borrowing naira on behalf of foreign investors who want to participate in local bond and open market operations (OMO) auctions.

Foreign investors are currently mandated to fund their accounts with the banks before they can participate in Treasury Bill and OMO auctions. They would however rather be sure they are successful at auctions before sending dollars to Nigeria.

If they have to prefund their auction bids, the banks will exchange their dollars for naira and then hold the naira uninvested if the bids are not successful.

This has been discouraging FPIs who would like to participate in the auctions but balk at the idea of the banks converting their funds to naira whether their bids are successful or not.

“The CBN will need to address the operational bottlenecks of FPI getting involved in Nigeria,” said Razia Khan, managing director and chief economist, Africa and Middle East at Standard Chartered Bank.

“Current rules do not allow banks to borrow naira to participate in auctions, even if on behalf of foreign investors,” Khan said in an emailed response to questions.

A source familiar with the matter said FPIs will need to be allowed not to pre-fund their auction bids such that they only send their dollars to Nigeria when they are sure their bids are successful.

“The CBN can get the banks to guarantee the FPIs’ bids, i.e. if they are successful, the naira will be provided in 24/48 hours,” the source said. “This will accelerate inflows and help push the rate down faster as the dollars may have to be sold to the CBN for quick naira.”

BusinessDay understands that the central bank is working to address this, in recognition of the gains it holds in terms of attracting more FPIs.

A substantial amount of FPIs’ capital has gone to Egypt and Kenya in recent months because the convertibility risk in both countries is low compared to Nigeria’s.

“While Nigeria has a lot of interests, convertibility risk is still considered high as the level of unencumbered external reserves and pent-up demand, not unsettled forwards, are unknown,” one investor said.

Nigeria’s external reserves, which stood at $34.98 billion as of March 14, have surged this year, thanks to higher crude oil prices and the impact of the reforms by CBN Governor Olayemi Cardoso.

The Abuja-based apex bank on Thursday projected the reserves to hit $35.01 billion by the end of March.

The problem however is that investors now take data on the Nigeria’s external reserves with a pinch of salt after JP Morgan’s big expose last year that the net reserves were closer to $3.7 billion as at the end of 2022.

“There needs to be more clarity around the external reserves to give confidence to investors,” an investor who did not want to be named said.

Foreign investor sentiments towards Nigeria have significantly turned the corner, especially after the jumbo rate hike at the last Monetary Policy Committee (MPC) meeting which helped narrow the negative real rates on naira assets.

Minutes from the MPC meeting revealed that Cardoso wanted an even bigger rate hike than the 400 basis points that was delivered in his bid to achieve real positive interest rates on naira assets from Treasury Bills to bonds.

Inflation has however spiked to 31.7 percent since the last meeting, setting the stage for another possible rate hike for a central bank desperate to ensure market rates are higher than the inflation rate, which it hopes to moderate to 21 percent by year-end.

“We think the CBN will hike again at its March MPC meeting by 150 basis points,” Khan of Standard Chartered Bank said.

The CBN raised its policy rate to 22.75 percent in February.

Market reaction has been largely positive since the last meeting, despite an unchanged floor to market rates, with the lowering of the corridor around the policy rate keeping the rate on the CBN’s Standing Deposit Facility at 15.75 percent.

“Nonetheless, February inflation accelerated to 31.7 percent year-on-year, with food inflation reaching 37.92 percent. While FX stabilisation should moderate the pace of inflation in time – once the issues impeding offshore investor participation in local currency auctions are resolved – we think that further rate hikes remain likely,” Khan said.

Khan however said there are risks to Standard Chartered’s view that all 150 basis points of further tightening will be delivered at a single meeting, not least because of the Federal Government’s need to keep debt-service costs contained.

For Charles Roberston, head of macro-strategy at FIM Partners, the recent reforms of the CBN means “an inflow of dollars is looking likely and some big gains for dollar based investors holding Nigeria assets.”