Exploring How a Government-Sponsored Hedging Fund Can Address Currency Risk and Attract Long-Term Investments in Nigeria
Currency risk remains one of the most significant barriers to attracting foreign investments in Nigeria. Recent initiatives such as the Bank of Industry (BOI) €1 billion syndication debt facility to provide naira loans, backed by a CBN-guaranteed currency swap agreement, and the CBN’s collaboration with the International Finance Corporation (IFC) to scale up local currency financing solutions worth over $1 billion, also with an agreement to address currency risks, demonstrate progress. These efforts show the government’s willingness to tackle currency risks in innovative ways. But let’s face it, while these efforts are commendable, they don’t address the broader, systemic challenges posed by currency risk — challenges that continue to deter much-needed foreign capital, especially for critical investments.
The Currency Risk Problem
Over the past decade, when excluding foreign portfolio investments, Nigeria has experienced a worrying decline in equity capital flows and stagnant growth in debt capital. Looking at the capital importation data between 2013 and 2023:
• Equity Capital: Recorded an average annual decline of 10%.
• Debt Capital: Achieved only a 1% compound annual growth rate (CAGR), with an average of $2.6bn over the period.
In Q2 2024, debt capital stood at $1.15bn, recording a year-on-year growth of 49% from $771.3m while equity capital plummeted by 65%, dropping to a historic low of $29.3m.
Why does currency risk stand out as such a significant deterrent?
The answer lies in the fundamental mismatch between obligations and revenues. Foreign capital is typically raised in USD, but returns are often generated in naira. As the naira depreciates — which it frequently does — profits shrink, leading to significant foreign exchange losses. Over the past 12 months alone, several corporates operating in the country faced substantial losses, further underscoring the need for effective hedging solutions.
Why Market-based solutions Are Currently Insufficient
To manage these risks, these companies and investors in general traditionally rely on hedging instruments like swaps and forwards. However, these solutions come with limitations:
• Limited availability for longer-term investments.
• Hedging costs are prohibitively high. This is driven by not only the currency risk but also the counterparty credit risk, which makes a fully hedged foreign loan as expensive as naira commercial loans and not attractive, especially to development focused financiers
• Market constraints from ongoing reforms. The absence of a deep derivatives market limits the options and shows a lack of depth to meet their needs.
In 2016, FMDQ introduced the Cleared Naira-settled Non-Deliverable Forwards (NDF), which helped to reduce counterparty risk via a Central Clearing Counterparty (CCP) and offered tenors of up to five years with CBN as the pioneer seller. Despite its promise, the product faced significant challenges and was temporarily halted over a year ago. Fast forward to today, and the situation is even more dire. The currency crisis has further strained the system, making hedging solutions even more costly. While market-based solutions have their place, they currently can not address the systemic nature of Nigeria’s currency risk in the short to medium term. A dedicated government-sponsored hedging mechanism could provide the stability investors need to commit to long-term projects.
The Case for a Government-Sponsored Hedging Fund A standalone, well-structured fund could offer a sustainable approach to managing currency risks. Rather than relying on ad hoc CBN swap agreements — such as the one currently with the BOI — this fund could serve as a transitional mechanism.
Eyitope is a Regional Lead within the Institutional Client Group at RMB & Head of GM Structured Sales for Nigeria
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