The Nigerian currency, the naira (NGN) should ordinarily not be under much pressure given the nation’s economic fundamentals.
Nigeria ran a current account surplus – a broad measure of trade – equivalent to 5.2 percent of gross domestic product (GDP), last year, while its economy may expand by 7 percent in 2014.
Even as oil production under-performs the budgeted output at just below 2 million barrels per day, prices for bonny light (Nigeria’s benchmark crude) have remained firm, averaging $110 per barrel year to date.
The country’s external debt (Federal and State) is manageable at $8.2 billion, while foreign exchange (FX) reserves of $40.5 billion (Feb. 25), is able to finance about 7 months worth of imports.
However the slight currency weakness seen in recent months due to foreign capital outflows on the US Federal Reserve’s tapering policy have been exacerbated with the suspension of Nigeria’s Central Bank governor, Sanusi Lamido Sanusi as naira denominated assets witnessed a broad sell-off last week.The naira posted its biggest five-day drop versus the dollar (USD) in eight months after Sanusi’s removal on Feb. 20, trading as low as N167/ dollar before recovering.
The currency has lost 2.3 percent this year, compared with a 0.6 percent drop in the JPMorgan Chase & Co. Index of African sovereign debt. It traded at N164.70 per dollar at the interbank market on Friday, and N172 at the parallel market.
The biggest driver of the weakness in the currency is the erosion of investor confidence and uncertainty that the action to suspend Sanusi has brought about.
“Governor Sanusi’s suspension came as a shock to the market. The suspension is a disruptive move which indicates that the CBN has de facto lost much of its independence,” wrote Samir Gadio, an emerging markets strategist, at Standard Bank, in London, in a note released on Feb. 20.
“The risk is that this development will compound upside risks to USD/NGN by precipitating the ongoing foreign exit and reinforcing the negative domestic positioning against the naira. The pace of FX reserves will probably accelerate, and in the absence of sharp monetary tightening, it is questionable how long current USD/NGN levels can be sustained.”
The CBN has aggressively intervened in the FX market since Sanusi’s suspension by selling dollars to banks, in a bid to contain some of the sell pressures on the naira.
The regulator sold $1.10 billion in one week to banks (Feb. 19 – 26), in a bid to keep the naira within the nominal peg of N155 plus or minus 3 percent per dollar.
Acting CBN Governor Sarah Alade also stressed in a statement that the CBN was committed to macroeconomic stability and would like to minimise FX volatility.
Why the fuss about the naira level?
The level of the naira affects the proverbial ‘man on the street’ more than most realise. Two seemingly unrelated statistics (to the naira) will help to bring that out clearly.
The first is that interest expense on the total public debt (domestic and foreign) will rise to N712 billion in 2014, according to the budget proposals, a 20 percent increase from the N591.7 billion spent on debt service in 2013.
The second data set is that consumer inflation for January 2014 is currently at 8 percent – its 13th consecutive month in single digits – according to data from the National Bureau of Statistics (NBS).
Both sets of data are linked to the naira because the CBN has chosen to raise interest rates, (since 2010) in a bid to contain inflation as well as make the yields on naira assets attractive to foreign investors.
The CBN hiked its benchmark monetary policy rate (MPR) to 12 percent and removed the restrictions that limited foreign buyers of Nigerian bonds to a minimum one year holding period.
Nigeria’s bond yields in turn adjusted to higher interest rates as the yield on the benchmark 10 year bond rose from a record low of 5.92 percent in March 2010, to currently trade at 13.82 percent.
The higher yields on Nigerian bonds has meant that interest expense on debt accumulated has spiked, which has led to fewer resources being available for spending on health, education and social welfare, that might have benefited the common man.
On the other hand, inflation has also moderated as a result of higher yields and portfolio inflows to the tune of $20 billion, which has reduced naira volatility and certainly led to more willingness by companies to invest and grow their businesses, which again provides jobs to the average Nigerian.
A pointer to this fact is that Nigerian companies signed more than $13 billion of syndicated debt last year, four times the amount raised in 2012, according to data compiled by Bloomberg.
Michael Larbie the Chief Executive Officer (CEO) of Rand Merchant Bank (RMB), takes on the conundrum of lower interest rates versus naira stability, in a recent interview with BusinessDay.
“When one looks at Nigeria’s financial markets, what impacts the consumer more? Is it a lower interest environment or a stable exchange rate regime? It is no secret that the economy continues to be import independent… So a stable exchange rate is very important, because that indeed has an immediate impact on inflation than the direction of interest rates,” Larbie said, on Feb.13, at RMBs Lagos headquarters.
“Real rates of returns – if you look at where MPR is (12 percent) and where inflation is (8 percent) – are actually very decent. Now somebody will ask the question ‘is that for the benefit’ of a consumer, corporate or banks? I do believe that the spread works for a consumer, who invests their money in Government treasury bills against the back drop of a very stable exchange rate regime and declining inflation. If interest rates were to fall, incrementally, how does that drive the Nigerian economy or how does that support growth? There is a need for further analysis on that,” he said.
Prospects of naira devaluation and economic impact
The naira is 5 – 10 percent overvalued in comparison to its ten- year trend, according to a November 25 note by macro-economic research firm Capital Economics.
Critics of the approach of defending a nominal naira peg at all costs have argued that a less hawkish monetary policy committee would help boost growth, exports and lending.
Nigeria’s $283 billion economy grew by 6.8 percent in 2013 while oil and gas exports accounted for 95 percent of dollar revenue.
There however remains a slack or output gap with potential GDP growth as high as 11 percent, according to a 2013 review by Financial Derivatives Company (FDC), a research firm.
This raises the question of the appropriate value of the naira and its role if any in boosting economic growth and output.
The International Monetary Fund (IMF) in a November 2013 paper entitled ‘Drivers of Growth: Evidence from Sub-Saharan African (SSA) Countries’ authored by Manuk Ghazanchyan and Janet G. Stotsky, looked at SSA countries (including Nigeria) from 1999 to 2011, and found a significant positive correlation between GDP per capita growth and having a flexible exchange rate.
“If a currency peg is not credible or leads to overvaluation and black market premiums, then it may lead to lower investment, productivity, and trade, and hence weaken growth and competitiveness,” the IMF said in the paper.
The naira has appreciated in real terms versus the dollar over the past few years, however the widening spread between the official and black market rates, seem to suggest that it may need to adjust lower to be more in equilibrium.
The CBN external reserves at $40.56 billion (Feb.25) are currently 16 percent lower than the 2013 peak of $48.86 billion, and 6.67 percent less than December’s level of $43.6 billion.
It is certain that the CBN cannot defend the naira indefinitely, if weakness and pressure due to a lack of confidence in the currency remains.
It is therefore imperative that the regulators and policy makers engage in a frank discussion about the economic arguments underpinning Nigeria’s current naira policy and the adjustments needed if necessary to underpin growth.
By: PATRICK ATUANYA
