Further tightening, weaker currency loom as cheap oil becomes new normal

As the price of oil settles at c.$71/b, a fundamental shift in Nigeria’s fiscal dynamics is seen occurring. This shift would imply a further devaluation of the naira and an increase in interest rates.

Africa’s largest economy, Nigeria, depends on crude for 95 percent of its forex earnings. FX revenues are expected to take a significant dent as prices settle within its new range.

Public funding from the Excess Crude Account (ECA) has dropped from $20b to $2b. External reserves have fallen to a six-month low of $36.7 billion December 2, down 4.5 percent from its November levels.

The “lower oil prices may result in a further slowdown in forex inflows,” said Yvonne Mhango, Economist at RenCap, in an emailed note to BusinessDay. This will “challenge the Central Bank’s ability to defend the naira”, it said.

The shortfall in forex inflows will lead to a further and more fundamental weakening of the naira against the US dollar.

According to Mhango, “at an oil price of $80/b, Nigeria’s current account (C/A) would become negative for the first time in 12 years”.

Nigeria has been able to maintain a positive current account for the 12 years despite its undiversified economy, as a result of above $100/b oil prices.

Mhango forecasts the 2015 oil price is likely to settle around the current forward price of $80/bl.

Mhango also points out that the prospects of wage increases for civil servants in the short term have dimmed, as a result of the contractionary fiscal policy the government would have to undertake.

Lower wages, devaluation and the threat of inflation would greatly reduce disposable income of consumers.

Bismarck Rewane, MD, FDC, said at the 2014 LBS Alumni Day, “merchants would have to become very innovative in distributing to consumers as consumers now have lower disposable incomes.”

Rolake Akinkugbe, VP & Head, Energy and Natural Resources, FBN Capital, forecasts oil prices will settle at $70-80/bl.

Futures markets show oil trading at $65, while the Fibonacci pivot point is at $71/b.

OPEC for its part, decided not to cut output, confirming low prices are here to stay. OPEC accounts for 40 percent of world oil production.

In its first response to the oil price slide, the CBN devalued the naira and simultaneously tightened the monetary environment.

More regulatory responses are expected to kick in next year after the elections, as the CBN moves to stem highly probable slides in the currency, as trade terms further deteriorate.

However, the lack of FX savings will greatly challenge the Central Bank’s ability to defend the naira, and keep inflation in check.

At the same time, Nigeria’s Balance of Payment would need to be financed from the FX reserves.

“While a weaker naira would possibly slow demand for imports and the lower oil price reduce the cost of importing refined oil (20% of imports), we do not think this would be sufficient to keep the C/A positive, implying that FX reserves may have to be drawn down to finance Nigeria’s balance of payments (BOP)”, Mhango explains.

This could lead to a further devaluation of the naira to NGN197/$1 at YE15 vs NGN182/$1 at YE14E.

“There is a risk that [the CBN] may be forced to loosen its hold on the naira, implying further currency weakness; an interbank rate of NGN185-195/$1 in the short term is plausible”, according to Mhango.

Given the downside risk to revenue and the near-depletion of the excess crude account, the government may have little option but to remove the fuel subsidy – creating savings of $2.5bn, or 4% of FY14 consolidated government budget.

Revenue growth challenges will also lead to increased government borrowings in FY15, leading to an increase in yields in 2015, after being depressed in 2014.

  

Edozie Ifebi & Yinka Abraham