A Potteresque Alternative Emerges in Nigeria’s Currency Markets

There are no wizards or muggles in the currency-forwards markets. Yet in Nigeria, a parallel universe is taking shape.

The African country’s traditional currency-forwards market is facing competition from an upstart system based on the new exchange-rate window policy makers opened six weeks ago. Bond investors and speculators are switching away from non-deliverable forwards that are based on the main interbank exchange rate, which is tightly controlled by the central bank, and embracing the more liberal pricing mechanism.

As Nigeria takes tentative steps toward currency liberalization amid economic turmoil caused by lower oil prices, the emergence of a separate NDF market underlines investors’ growing confidence in the new so-called Nafex window. Traders expect the forwards to give them greater control in predicting future exchange rates and raise the appeal of carry trades in naira assets.

“It’s created a situation in which you have two NDF markets,” Samir Gadio, head of Africa strategy at Standard Chartered Plc, said by phone from London. “The Nafex NDF market is just emerging. So far there have been tentative trades, but we are getting to the point where market stakeholders are starting to quote consistently. The expectation is that the Nafex market will become more and more relevant.

The emergence of the new forwards market comes as the Nafex window helps to alleviate the dollar squeeze and boost Nigerian assets. The main stock index has risen 31 percent since it was opened, the second-best performance globally. While some investors continue to shun Nigeria as they dislike its system of multiple exchange rates, Cape Town-based Allan Gray Ltd. is among those that have increased their exposure, tempted by cheap stocks and bond yields of around 20 percent.

Africa’s biggest oil producer has suffered from dollar shortages since crude prices crashed in 2014, a problem the central bank exacerbated by tightening capital controls. Governor Godwin Emefiele opted to keep a tight grip on the interbank exchange rate, while opening the Nafex window on April 24, allowing the naira to drop to around the same level as the black-market rate.

The naira trades at 324.5 per dollar on the interbank market and 376.7 on the Nafex market. Nifex NDFs linked to the interbank rate, of which around $20 million to $50 million-worth trade each day, fell 0.4 percent to 357.5 for six-month contracts as of 4:10 p.m. in Lagos. Similar-maturity Nafex contracts were bid 390 and offered at 405, according to Gadio.

Forward contracts are sometimes used by investors who own naira bonds to hedge against movements in the currency. Others use them purely to bet on how much the naira will weaken.