Currency Conundrum: Catching a Falling Knife

Currency Conundrum: Catching a Falling Knife

A little over two months after the Central Bank of Nigeria (CBN) consolidated the various segments of its multiple exchange rate structure into a unified floating exchange regime, foreign exchange (FX) shortages have worsened, with the naira plunging to new lows in both the official (Investors and Exporters (IEFX) window) and the parallel market – seemingly on a daily basis.

The initial wave of optimism, triggered by the raft and accelerated pace of reforms enacted by the new administration, has now given way to uncertainty as the FX supply question continues to puzzle market participants and policymakers. Foreign investors, many of whom have been badly burnt in the past, are largely in “wait and see” mode, watching with keen interest the level of transparency, efficiency and credibility of the new FX regime. This is in addition to keeping one eye on the strategic sequencing of the next set of reforms, and how they are expected to dismantle long-standing structural bottlenecks that have constrained Nigeria’s business climate for decades.

Reverse Convergence

The ensuing volatility and the steep slump in the value of the naira at the Investors and Exporters window in the immediate aftermath of the policy announcement was largely expected given the significant backlog of unmet FX demand, estimated at circa $12 billion. As at 21 June, a week after the effective liberalisation of the FX market, the naira had lost 38.7% to trade at ₦763/$ at the IEFX window – at par with the parallel market rate. However, in the seven weeks that have followed, banks have largely been unable to come up with the dollars to meet FX demand, and buyers have increasingly turned to the parallel market, widening the gap between the official exchange rate and the alternative markets. As at 15 August, the naira closed trading at the IEFX at ₦774/$ while the parallel market rate traded at ₦940/$, pushing the premium to ₦166/$ (21.4%) and creating the incentive for round-tripping, which was pervasive under the previous multiple exchange rate system.

Figure 1: Exchange Rate (₦/$)

Source: The CBN

The gross external reserves level had lost 8.6% year-to-date as at 13 August 2023 to $33.8 billion. While the CBN has categorically stated that it would conduct periodic interventions in the FX market, a review of its recently released audited accounts reveal a $13.8bn exposure to JP Morgan, Goldman Sachs and FX Forwards, leaving the Apex bank with significantly less ammunition (40% less) than initially thought to embark on its planned FX interventions. The net reserves are now estimated at $18.6 billion, which is sufficient to cover an estimated 3.5 months of imports of goods and services compared to the 6.46 months that was previously brandished as at April 2023.

Figure 2: Gross External Reserves ($’ Billion)

Source: The CBN

At the same time, FX turnover on the Spot market fell substantially (by 39.71%) in July to $4.66 billion after a 22.48% increase in June to $7.73 billion as the initial market euphoria faded and the supply question became increasingly louder.

Figure 3: FX Turn Over ($’ Billion)

Source: FMDQ

In addition, Nigeria has what many might call an excess liquidity problem. Money supply (M3) has surged to an all-time high of ₦64.9 trillion while the real return on 364-day Treasury Bills remains firmly in negative territory (averaging -13.6% so far in 2023), which is fueling the demand for FX as well as equites.

A Silver Lining?

Nigerian companies with significant dollar debts have suffered significant currency-related losses, and many more, reeling from the double whammy of heightened FX costs and inflationary pressures, are now seeking to import goods ahead of Christmas season sales and, as a result, we expect currency pressures to intensify in the coming weeks. This is in addition to the impact of increased FX demand stemming from overseas school fees payments. Nonetheless, the silver lining is that many companies, unable to access FX to import raw materials, are now substituting imported raw materials with locally produced items and also expanding exports to boost FX earnings, in a bid to curb dependence on external sources for foreign currency.

Who needs a Parallel Market?

The CBN is putting the blame for the downward spiral in the parallel market partly on the diversion of diaspora remittance inflows to unofficial channels, which is starving the official FX market of inflows. The CBN has stated the ‘what’ and the ‘where’ without crucially addressing the ‘why’. Remittances from the diaspora, estimated at $20.13 billion in 2022, have risen substantially in the past decade, playing an increasingly essential role in Nigeria’s economy, serving as an important source of FX earnings and a catalyst for economic growth and development. While the slow economic recovery and cost of living crises that confronted many developed economies in 2022 constrained remittance flows into Nigeria, the implementation of capital controls and other unpopular policies by the CBN also restricted inflows through official channels. As the parallel market premium widens, we expect diaspora inflows through the unofficial channels to increase further.

The liberalisation of the FX market was supposed to allow the naira trade freely, so why does the parallel market still exist? On one hand, businesses and individuals are looking for any means to access FX in the face of worsening scarcity. On the other hand, the restrictions on access to FX via the official market for the import of 43 items remain in place as part of the CBN’s import substitution objective within its development strategy. This, in itself, is a form of capital control and implies that importers of these ‘restricted’ items will simply access FX via alternative channels. We believe that these restrictions continue to send a negative signal, particularly to foreign investors, and that the CBN should now adjust its approach to achieving its import substitution goal by abandoning these restrictions in favor of fiscal tools (tariffs), which reflect the Common External Tariff of the Economic Community of West African States (ECOWAS), and are aimed at making domestic production relatively more competitive than imports. This will be critical in minimising the current distortion in the FX market.

The absence of red tape in the parallel market and the growing adoption of digital channels, particularly by FinTech Money Transfer Operators (MTO) and blockchain-based digital currencies due to their speed, convenience, seamlessness and cost-effectiveness continue to make the alternative FX market more preferred. Banks, bogged down by regulatory bottlenecks and institutional requirements, are struggling to play catch up in this regard.  For instance, a recently instituted regulation requires customers to present their tax clearance certificates (TCC) before they can access FX from banks, pushing even more buyers to the alternative FX markets. This is a particularly worrisome constraint in a country where the informal sector is estimated to account for as high as 80% of GDP with many not having the tax certificates.

Low Hanging Fruit

At the crux of the matter remains Nigeria’s external imbalance problem and the CBN still obsessively seeking to manage FX demand. In the medium- to long-term, we expect greater fiscal and monetary policy coordination as well as the elimination of structural rigidities to build investor confidence and invisible flows. However, a short-term solution to FX scarcity requires the ‘de-bottlenecking’ the official FX market to incentivise supply, in addition to enacting reforms targeted at squarely addressing insecurity in the Niger Delta region to restore oil production to at least OPEC-sanctioned levels of 1.38 million barrels per day and benefit from relatively higher oil prices (average of $80 in 2023).

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Finance & Leasing

COMPANY RATING EXPIRY OUTLOOK COUNTRY
FundQuest Financial Services Limited Bbb- Jun 30 , 2024 Stable Nigeria
C&I Leasing Plc's Series II ₦10 Billion Bond Bbb+ Jun 30 , 2024 Stable Nigeria
Fewchore Finance Company Limited Bbb- Jun 30 , 2024 Stable Nigeria
C&I Leasing Plc Bbb- Jun 30 , 2024 Stable Nigeria
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Corporates

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Tempo Paper Pulp and Packaging Plc Bbb- Jun 30 , 2024 Stable Nigeria
Lagos Free Zone Company Bbb Jun 30 , 2025 Stable Nigeria
Dangote Sugar Refinery PLC A+ Jun 30 , 2024 Stable Nigeria
African Non-Ferrous Industries Limited A- Jun 30 , 2024 Stable Nigeria
Paras Energy and Natural Resources Development Limited Bbb+ Jun 30 , 2024 Stable Nigeria
Nigerian Breweries PLC A+ Jun 30 , 2024 Stable Nigeria
Paras Energy and Natural Resources Development Limited Bbb+ Jun 30 , 2024 Stable Nigeria
North South Power Company Limited A Jun 30 , 2024 Stable Nigeria
African Foundries Limited Bbb+ Jun 30 , 2024 Stable Nigeria
Food Concepts Plc A Jun 30 , 2024 Stable Nigeria
Industrial and Medical Gases Nigeria Plc A+ Jun 30 , 2024 Stable Nigeria
African Steel Mills (Nigeria) Limited Bbb+ Jun 30 , 2024 Stable Nigeria
Odu'a Investment Company Limited A Jun 30 , 2024 Stable Nigeria
Lionseal Industries Limited Bbb- Jun 30 , 2024 Stable Nigeria
Saro Lifecare Limited Bbb+ Jun 30 , 2024 Stable Nigeria
Julius Berger Nigeria Plc A- Jun 30 , 2024 Stable Nigeria
African Steel Mills Bbb Jun 30 , 2024 Stable Nigeria
GEL Utility Limited Bbb+ Jun 30 , 2024 Stable Nigeria
Saro Agrosciences Limited Bbb Jun 30 , 2024 Stable Nigeria
Lafarge Africa Plc Aa- Jun 30 , 2024 Stable Nigeria
UAC of Nigeria PLC A- Jun 30 , 2024 Stable Nigeria
Sundry Foods Limited A- Jun 30 , 2024 Stable Nigeria
CapitalSage Technology Limited Bbb+ Jun 30 , 2024 Stable Nigeria
Romco Recycling Company Limited Bbb- Jun 30 , 2024 Stable Nigeria
Nisa Medical Group Limited Bbb Jun 30 , 2024 Stable Nigeria
BUA Cement PLC A+ Jul 31 , 2024 Stable Nigeria
Johnvents Industries Limited Bbb Jun 30 , 2024 Stable Nigeria
MTN Nigeria Communications PLC Aa+ Jun 30 , 2024 Stable Nigeria
Wemabod Limited A- Jun 30 , 2024 Stable Nigeria
TotalEnergies Marketing Nigeria Plc A- Jun 30 , 2024 Stable Nigeria
BB Landmark Realty Limited Bbb+ Jun 30 , 2024 Stable Nigeria
Flour Mills of Nigeria Plc A- Sep 30 , 2024 Stable Nigeria
GZ Industries Limited A Jun 30 , 2024 Stable Nigeria
Ibom Airlines Limited Bbb- Jun 30 , 2024 Stable Nigeria
Coleman Technical Industries Limited Bbb Jun 30 , 2024 Stable Nigeria
Geregu Power Plc Bbb+ Jun 30 , 2024 Stable Nigeria
Global Accelerex Limited Bbb Jun 30 , 2024 Stable Nigeria
Axxela Limited A- Jun 30 , 2024 Stable Nigeria

Corporate Bonds

COMPANY RATING EXPIRY OUTLOOK COUNTRY
LFZC Funding SPV Plc’s ₦25 Billion Bond  Aaa Mar 16 , 2025 Stable Nigeria
LFZC Funding SPV Plc’s ₦10.5 Billion Bond Aaa Sep 16 , 2025 Stable Nigeria
LFZC Funding SPV Plc’s ₦17.5 Billion Bond  Aaa Mar 16 , 2025 Stable Nigeria
River Jamieson SPV Limited’s ₦15.306 billion Series 1 and ₦2.25 billion Series 2 Bonds A Mar 14 , 2025 Stable Nigeria
River Jamieson SPV Limited’s ₦24.5 Billion Bond Bbb Dec 31 , 2024 Stable Nigeria
GPC-SPV Company PLC’s ₦20 Billion Bond Aaa Nov 23 , 2024 Stable Nigeria
MTN Nigeria Communications Plc's ₦89.99 Billion 10-Year Series II Bond Due 2031 Aa+ Sep 30 , 2024 Stable Nigeria
MTN Nigeria Communications Plc's ₦10 Billion Series 1 Bonds Due 2026 and ₦104.9 Billion Series 1 Bonds Aa+ Sep 30 , 2024 Stable Nigeria
Presco PLC's ₦34.5 billion Seven-Year Senior Unsecured Fixed Rate Bonds Due 2029 Aa- Jun 30 , 2024 Stable Nigeria
Sundry Foods Funding SPV PLC’s up to ₦5.5 Billion Five-Year Fixed Rate Senior Unsecured Bond Due 2028 A- Jun 30 , 2024 Stable Nigeria
Sundry Foods Funding SPV PLC’s ₦2.5 bil+B47lion 5-Year 13.5% Fixed Rate Bond Due 2026 A- Dec 15 , 2024 Stable Nigeria
BUA Cement PLC’s ₦115 billion 7.5% Seven-Year Senior Unsecured Fixed Rate Bond Due 2027 A+ Dec 31 , 2024 Stable Nigeria
GEL Utility Funding SPV PLC's ₦13 Billion Infrastructure Bond Due 2034 Aaa Aug 31 , 2024 Stable Nigeria
NECIT Nigeria Limited's Up to ₦10 billion Commercial Papers under the ₦20 billion Programme A Jun 30 , 2024 Stable Nigeria
MTN Nigeria Communications PLC's ₦110 Billion Seven-Year 13% Senior Unsecured Fixed Rate Series 1 Bond Aa+ Jun 30 , 2024 Stable Nigeria
ABC Transport Plc's ₦900 Billion Five-Year 16.5% Fixed Rate Senior Secured Bond Bbb- Jun 30 , 2024 Negative Nigeria
Flour Mills of Nigeria PLC’s ₦4.89 billion 5-Year 5.5% Fixed Rate Senior Unsecured Bond and ₦25 billion 7-Year 6.25% Fixed Rate Senior Unsecured Bond A- Dec 15 , 2024 Stable Nigeria
Aradel Plc's (formerly NDEP) ₦10.318 billion Five-Year 17% Fixed Rate Senior Unsecured Bond A+ Jun 30 , 2024 Stable Nigeria
Geregu Power Plc’s ₦40.085 Billion 7-Year 14.5% Senior Unsecured Fixed Rate Bond Bbb+ Jul 28 , 2024 Stable Nigeria
Axxela Funding 1 Plc’s ₦11.5 Billion Series 1 Seven-Year 14.3% Fixed Rate Bond Due 2027 Bbb+ May 31 , 2024 Stable Nigeria
AFEX Fair Trade Limited ₦150 Billion Asset-Backed Commercial Paper S3 sf Nov 30 , 2024 Stable Nigeria
Accelerex Funding SPV Plc’s ₦2.275 billion 14% Series 1 Senior Bond Bbb- Jun 30 , 2024 Stable Nigeria
Axxela Funding 1 Plc's up to ₦15 Billion Ten-Year Series 1 Bond A- Nov 30 , 2024 Stable Nigeria
NSP-SPV PowerCorp Plc’s ₦10 Billion 15-year Series 1 Aaa Dec 31 , 2033 Stable Nigeria