The Central Bank of Nigeria (CBN) closed the Retail Dutch Auction (rDAS), thus directing all foreign exchange demand to the interbank market. This measure was taken due partly to increasing spread between the official (rDAS) and interbank market; a phenomenon that has encouraged round-tripping, speculation and related undesired practices – all at the expense of the external reserve, which has fallen 6 percent YTD to $32.55 billion or barely six months import cover.
Even so, the CBN will continue to intervene in the interbank market when it sees the need for such measure, such intervention will be done at prevailing market rate, which will be at notable premium to the official rDAS band of N168 ± 5 percent.
Thus, we consider this measure as a technical devaluation of the local currency, especially as it technically removes the “subsidy” on FX rate for “legitimate/genuine” demand. While this measure may help the CBN to accrue some savings in the external reserve account, it will further weaken supply of foreign currency, thus justifying the speculative pressure on the naira and our call for further devaluation, particularly as it reinforces our concern over the ability of the CBN to sustainably defend the local currency at current valuation.
While crude oil price has firmed at $51/barrel and January production level rose by 44,000 barrels to 1.94mbpd, we believe oil receipts will be inadequate to meet rising FX demand, particularly as foreign portfolio inflow, FDI, remittances and other autonomous FX sources remain weak.
Impact on the yield curve – Negative: In our view, foreign investors will consider this measure as signal of probable capital control policy in the near future, especially as the closure of rDAS may undermine the liberalisation of the FX market over the near to medium term.
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Even so, the closure of rDAS window will release naira to the interbank market, with attendant moderation in money market rates, the net impact of the rDAS closure may be negative for the yield curve. Notably, we expect foreign investors to turn bearish on Naira-denominated assets, with attendant rise in the yield curve. More so, the monetary policy committee (MPC) may further increase the benchmark rate (MPR) at its upcoming March meeting, thus justifying our expectation of a rise in yield.
Notably, as outlook of an upward shift in the yield curve suggests relative pressure on the short-end of the yield curve, as we think the treasury bill market will be more vulnerable to probable sell-off in the days ahead. Beyond foreign investors’ concern on the liquidity of the naira at the FX market (particularly as upcoming dividend repatriation season in March/April will further pressure the naira), uncertainties over election risk will further douse foreign investors’ appetite for Nigerian treasuries and sovereign notes. We see yields rising an average of 100bps through the election cycle.
Equities – Here is another clog in the wheel: While the equity market recovered 5.8 percent week-to-date to moderate the year-to-date loss at 15.8 percent, the closure of rDAS will reinforce the sell-off by foreign investors. While the market is oversold, with compelling investment for local investors (which has nil exposure to foreign currency risk), we think the bearish sentiment of foreign investors may have a contagious impact on local pension fund managers and HNIs who seek bargain opportunities on undervalued stocks.
Valued at 9x P/E and 5.7 percent dividend yield, Nigerian equity market is attractive; albeit macroeconomic volatilities and political uncertainties will prolong the bearish pricing in the market. More so, we reiterate our conservative outlook on the earnings season, as reflected in the scorecards of large-cap consumer goods companies which recently published results. Thus, we reinforce our bearish sentiment on equities in the short term, even so we look forward to a strong rally in the second half of the year, when the risk factors ease and crude oil price firms.
