Why rising oil price fails to boost Nigeria’s foreign reserves

The recent spat between Saudi Arabia and UAE which pushed oil prices to historic heights is having little or no effects on Nigeria’s external reserves, a development that questions the various Central Bank of Nigeria (CBN) interventions to stabilise the exchange rate.

Intrinsically, one might think that the recent rally in crude oil prices of $76 would signal a boon for Nigeria’s external reserve, considering the country’s budget benchmark of $45.

However, that’s not the case as Nigeria’s foreign exchange reserve fell 5.8 percent to $33.32 in the first half of the year compared to $35.37 billion recorded as of 31st December 2020, according to the Central Bank of Nigeria (CBN).

“The increase in oil price is yet to reflect in the foreign reserves is because the CBN intervention across the official channels is still towards addressing the latent demand that has accumulated over the last one year,” Gbolahan Ologunro, an economist at Lagos-based Cordros said.

Ologunro also explained that the CBN has also been comfortable with draining the oil reserves because of the N3 billion they are expecting from the sales of Eurobond which will push foreign reserves to $36 billion.

Read also: Oil prices extend gains after OPEC+ talks called off

“We should begin to see the impact of its interventions before the end of the third quarter,” he said.

Analysts at Financial Derivatives Company Limited also noted that the downward trend in foreign reserves is due to increased dollar sales to banks by the CBN in its bid to clear the backlog of dollar demand by Foreign Portfolio Investors (FPIs).

The widening gap

The CBN has been dipping into the foreign reserves in an attempt to defend the Naira and close the gap between the Investors and Exporters Window (I&E Window) and the parallel market.

According to analysts at Coronation Research, the disparity between the I&E Window and the parallel market has widened by 22.31 over the past week. The exchange rate at the Investors and Exporters Window (I&E Window) appreciated by 0.10 percent to close at N411.25/US$1 last week. However, in the parallel (or street) market, the Naira weakened by 0.60 percent to close at N503.00/US$1.

“We expect the parallel rate and the I&E Window rate to remain under pressure over the months to come,” the analysts say.

The I&E window is the market trading segment for investors, exporters, and end-users that allows for FX trades to be made at exchange rates determined based on prevailing market circumstances.

A parallel market arises when exchanges for foreign currency take place at an unofficial exchange rate. Nigerians go to the parallel market because of the difficulty in obtaining foreign exchange from the official Market.

How CBN intervenes in the foreign exchange market

If a central bank does not intervene regularly in the foreign exchange market, it will lose control of the exchange rate. The CBN intervenes in the foreign exchange market to control demand and supply of dollars in order to stabilize the Naira.

Whenever demand for the dollar exceeds its supply in Nigeria, the exchange rate would inevitably go up. Conversely, when the supply of dollars outstrips demand, it would be expected that rates would go down.

Nigeria has experienced a drop in dollar inflow over the past year due to a decline in crude oil earnings caused by a cut in production quota by OPEC+ to stabilize the oil market as economics recover from the covid-19 pandemic. There has also been an increase in imports and more reliance on foreign goods and services, even for items that are available locally.

Nigeria imported goods worth N6.85 trillion in Q1 2021, the highest in over 12 years while export declined to N2.9 trillion.

While there have been various interventions by the CBN, the World Bank in its bi-annual Nigerian Development Update said the way the exchange rate was managed has limited access to foreign exchange and thus adversely affected investor confidence and investment appetite.

The CBN has excluded about 44 items from the official market to boost local production of these items. This means importers of those items cannot get dollars from the official market which is often cheaper which means they have to go to the parallel market.

When manufacturers go through the parallel market where it is more costly to get dollars, they pass on the cost to the consumers in the form of high prices pushing up inflation. Inflation hit 17.89 percent in May 2021.

However, the CBN recently took concrete steps towards rate unification between the official and IEFX rates but the World Bank has said the IEFX rate continues to be managed and is not fully reflective of market forces. Furthermore, there remains a 20 percent premium between this unified rate and the parallel market rate.

The Apex bank also recently extended the Cash4Dollar scheme introduced back in March hoping this will drive more diaspora inflows into the banking system. However, the World Bank noted that while this may indeed encourage the use of formal channels, it is not clear that incentive payments will increase remittances to the country.