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We were surprised by the boldness of the liberalisation of the exchange-rate announced on Wednesday by the CBN governor, Godwin Emefiele. We also suspect that the vast majority of analysts who follow Nigeria closely felt similarly. All the indications from the CBN, the monetary policy committee and the political leadership pointed to a devaluation, whether so termed or not, as being a last resort. The fact that a preferential rate for “critical transactions” has also been dropped tells us that decision makers suddenly embraced Tina (there is no alternative).
Fx inflows, both to the CBN and in aggregate, slumped under the collapse of oil revenues and, to lesser extent, the stance of the central bank. In Q1 2016 the CBN’s amounted to just US$3.99bn, compared with US$12.68bn in Q1 2014. (We draw parallels in this column with the quarter two-years earlier because it predates the slide in the oil price). In aggregate they fell over the same period to US$15.43bn from US$35.98bn. This second decline was driven by a fall in autonomous flows to US$11.44bn in Q1 2016 from US$25.89bn.
Non-oil exports are a small part of these autonomous inflows, amounting to US$1.02bn in Q1 2016. Remittances are running at about US$5bn per quarter. The greater part consists of investment flows: direct, portfolio and other in balance-of-payments terminology. Nigeria’s removal from the JP Morgan emerging market indices for local currency government debt and the delays since end-2015 in repatriations for offshore investors clearly contributed on the portfolio side to the slump in autonomous inflows. As for the other investment inflows, we know that international banks and other providers of liquidity have stepped back from the market in response to the CBN stance and slowdown in the economy now that Nigeria’s Achilles heel has been painfully exposed.
Fx outflows totaled US$6.47bn in Q1 2016. The main player was the CBN, which sold US$4.67bn to authorized dealers in the quarter. Once we exclude transactions with bureaux de change, since abandoned due to perceived market abuse, and swaps, we are left with sales of US$3.43bn. This last figure is broadly consistent with the CBN’s sales to banks, published in the local media, of about US$200 per week. It rejected the majority of bids from banks so as to contain the depletion of official reserves. In consequence, a backlog of unmet demand has developed, estimated at a minimum of US$6bn.
We cite this CBN data at length to form a view as to whether the liberalisation will plug the sizeable gap in fx supply and demand. Our method, as ever, is to look at the market by segment and to make allowances for investor sentiment. It is not mathematical. The examples of Russia, Kazakhstan and Angola tell us that devaluation is not an instant remedy for poorly-diversified oil economies.
On the supply side, we do not expect a marked recovery in oil revenues before 2018. Over time, we see a brighter picture for non-oil exports on the back of the weaker naira and import substitution. The governor said on Wednesday that the CBN circular of June 2015 ruling that 41 items were ineligible for fx from official sources was unaffected by the liberalisation. While these policies are designed to increase domestic production for the domestic market, they will boost certain non-oil exports.
For a third segment of fx supply, remittances, we see a modest lift on the adjustment to a weaker naira. The governor specifically highlighted one element of these flows (international money transfers) as a source of additional supply for the new market. There is no data to show the fx value of these transactions, compared with, say, remittances by bank transfer.
Finally we come to investment inflows. In time and not less than 12 months, the liberalisation, as outlined in the governor’s speech and the two sets of operational guidelines on the CBN website, should lead to the re-entry of Nigeria into the JP Morgan indices. The new system is unlikely to tackle the backlog in full in a hurry but should prevent its deepening. The other investment inflows are critical for the resumption of standard trade flows, and should start to pick up once the main players are comfortable with the new system in operation.
The new regime should therefore unlock some additional fx supply. In this context we highlight remittances, and those portfolio investors and non-bank providers of liquidity with above-average risk appetite. Demand has been weakened by the squeeze on consumers’ purchasing power.
The opening level of the new market is anybody’s guess. The likely direction would be an overshoot, followed by a correction. We stress that the CBN will be the largest single player, given the inflows it still sees. It can intervene for its own needs and to smooth out excessive volatility, which is the textbook role of central banks. It has warned against speculation, and has sanctions in place for both primary and authorised dealers. The authorities have not performed this huge about-turn out of choice and have not undergone an ideological conversion. They have been lured by Tina into uncharted territory, through which they must skillfully navigate.
Gregory Kronsten
