Analysis – Much ado about FX

In December 2016, SBM Intelligence was commissioned to do a study on the FX market. The report was delivered, and the client granted permission for an updated and redacted version to be released to the public six weeks after the presentation of the original report.

Being a largely import dependent consuming economy, Nigeria needs foreign exchange in order to function. This has been the story for half a century at least.

The Nigerian FX market has evolved over the years, influenced by a number of factors such as the changing pattern of international trade, institutional changes in the economy, structural shifts in production and government policies.

Major oil producers suffered huge financial challenges in 2016 as oil prices hovered between $30 and $50, down from the $100+ enjoyed just two years previously. In addition to low oil prices, the nation faced declining oil production due to militant attacks on oil production installation in the Niger Delta region. Facing downward pressure on Naira as a result of falling foreign reserves, the CBN started measured devaluation of the naira in November 2014 and this continued through 2015 and 2016. This was in addition to other measures like exclusion of certain transactions from eligibility to access FX in the Nigerian foreign exchange market. However, demand for FX continued to grow even as supply dwindled, leading to huge divergence in the official FX market rates and the parallel market.

In a move largely applauded across the Nigerian and international financial markets, the CBN in June 2016 released revised guidelines for the operation of the Nigerian inter-bank foreign FX market towards the liberalisation of the market. Within a few weeks of the launch there were signs that the federal government was not as committed to the float. The naira behaved differently from what many market analysts expected. The naira-Settled OTC FX Futures which was designed to help in smoothing the FX demand, thereby reducing frontloading of FX requirements suffered liquidity issues and devaluation risks which limited its success in attracting FX inflows. As at December 2016 the CBN had paid a total amount of about ₦31.1 billion on the naira Settled OTC transactions.

In comments delivered during the 2017 World Economic Forum at Davos, Switzerland, Nigeria’s Vice President, Yemi Osinbajo said that the government cannot simply allow the naira to float while admitting that the CBN has confidence in floating the local currency. It is clear now that the federal government was never a believer in a floating naira but were forced to consider the option as foreign reserves dwindled. Following the late 2016 rise in foreign reserves buoyed by improved dollar earnings from rising oil prices and production, the federal government has been reconsidering its stance as the CBN’s ability to defend the naira around a chosen benchmark improves.

Possible scenarios for the Nigerian FX market in 2017

FX is currently a hot button issue in Nigeria and many are eager to make a name for themselves without fully understanding the market. The biggest unknown is which way the regulation may swing. We have projected stable oil prices/production in Q1, 2016. However, things could change quickly by Q2 if political gains made are not consolidated. The real fallout may be a redesign of the supervisory landscape and consolidation of powers in the hands of CBN in order to control the price and volumes of foreign currency held by individual and corporate entities.

Scenario 1 – Oil price stabilises >$50 and oil production rises >2.0mbpd

• Prognosis: Very likely in Q1, 2017

Scenario 2 – Oil production drop (<1.5mbpd) magnifies severe oil price drop (<$45)

• Prognosis: Not likely in the short term

Scenario 3 – FX liberalisation is fully activated

• Prognosis: Not likely in the short to medium term

Scenario 4 – FG reverses FX liberalisation

• Prognosis: Not likely in the short term. However, if the naira continues to weaken public sentiment may change in favour of tougher regulations by Q3, 2017

Download the complete report (11 pages)