KPMG Nigeria, a professional service company has projected that the FX rate in Nigeria will range between N650/$ to N750/$ following the floating of the currency Wednesday.
“We estimate that the FX rate will range within N650 to 750/$ in the near term,” KPMG said, adding that relative equilibrium will depend on how quickly supporting policies are introduced that encourage and guarantee FX supply.
KPMG Nigeria said in its flash notes published on June 15, 2023, that this will require amongst other things, proper decentralisation of the FX supply environment where the CBN still act as the primary supplier of FX.
“By taking this bold yet risky decision, the gap in the official and parallel markets will likely narrow over time, thereby eroding the FX gap and the opportunities for round-tripping as the arbitrage opportunity reduces,” it said.
“Furthermore, this will overtime encourage capital inflows from FPI, and FDI and deepen the forward’s market,” it added.
The CBN issued a communique on June 14, 2023, indicating it had collapsed all its multiple FX windows into its I & E window.
By this decision, the CBN has granted commercial banks and dealers in the forex market the authority to sell forex freely at any rate.
KPMG stated that this move has inspired domestic and international confidence in the Nigerian economic environment and together with the earlier removal of PMS subsidies, will likely support an imminent sovereign ratings upgrade.
“By collapsing all its official; multiple FX windows into its I & E window and granting commercial banks and dealers in the forex market the authority to sell forex freely, the government has initiated the first of several steps it needs to take to unify the FX rates,” it said.
KPMG Nigeria said the immediate reaction was a jump in the official I & E window which closed at N664/$ on the day of announcement compared to N473/$, the day before.
“Net export proceeds from exporting companies which earn FX as well as home remittances will likely now be incentivised to bring in FX through the official channels,” it said.
KPMG Nigeria said this will thereby boost FX supply given the anticipated smaller gap between the official and parallel FX rates.
“The eventual anticipated convergence of the FX rates will also immediately improve much-needed government FX-related revenue which helps to slow the pace of debt accretion and improve expenditure on physical and social infrastructure.”
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It noted that this may however bare unintended consequences, such as a reduction in value-added tax and companies income tax if consumption expenditure shrink.
KPMG Nigeria said this could result in a reduction in corporate earnings as demand for corporate goods and services decline.
“There might also be a possibility of increased costs to businesses from FX losses from having to deal with a higher FX rate in between the financial year they may not have anticipated and not planned for.”
“Furthermore, total government debt in naira terms and accordingly debt to GDP and debt service ratios may worsen compared to immediate post-PMS subsidy levels unless measures are urgently taken to boost revenue and further rationalise government expenditure,” KPMG Nigeria said.
It said the price of PMS may also have to be adjusted upwards in the short term to consider the adjustment in the market FX rate, putting further pressure on inflation which may ultimately inch closer to 30 percent before the end of 2023, holding all other things constant.
This may consequently lead to an increase in interest rates, KPMG said, adding that arguably less important is the fact that Nigeria will move from the largest economy in Africa to the third behind Egypt and South Africa with its GDP dropping from $504 billion to about $304 billion.
KPMG believes that the net effect of these two key decisions targeting monetary and fiscal policy is potentially positive especially in the long term despite the anticipated short-term difficulties.
“Nevertheless, the immediate consequence of a combination of the subsidy removal and the removal of the peg on FX in June 2023 will however, result in a short-term increase in the rate of inflation for June and July 2023,” it said.
KPMG Nigeria estimates these developments to lead to an increase in the monthly rate of inflation by between 3.4 percent to 4.4 percent in June from 1.94 percent in May 2023.
It said this will translate into an increase in headline inflation to between 24.4 percent to 25.6 percent for June and July 2023.
“To avoid any reversals to gains experienced in the last few weeks, sustain the positive momentum and atmosphere of cautious optimism currently being witnessed, it is important that clarity especially relating to the remaining FX and monetary policy supporting structures are worked out,” it said.
KPMG Nigeria stated that this includes the role of the CBN as the primary FX supplier and for FX supply to be properly decentralised.
“It is important government communicates and introduces erstwhile promised inflation support post-PMS subsidy removal to minimise disruptions in consumer demand and business earnings,” KPMG Nigeria said.
It said to do this, short to medium-term income tax, value-added tax and corporate tax reliefs and other non-cash-based incentives will tend to be less inflationary.
KPMG Nigeria said, “The government should lead by example also by reviewing and cutting out wasteful expenditure just as it advocates for the public to bear the short terms pains from needed restructuring and reform.”
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