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Nigeria’s devaluation won’t fix managed-float woes

By David Whitehouse
Posted on Monday, 7 June 2021 16:20, updated on Tuesday, 17 August 2021 11:57

NAIRA
REUTERS/Afolabi Sotunde

Nigeria’s naira devaluation in May is unlikely to be the last and won’t fix the chronic dollar shortage which hampers the economy.

In May, the central bank merged the official fixed rate of N379 ($0.92) to a dollar with the investors and exporters (I&E) exchange rate, effectively devaluing the currency by 7.6% against the US dollar. Central Bank Governor Godwin Emefiele says the new unified rate will still work as a managed float.

The naira has continually lost value over the last decade through a myriad of currency regimes. The official rate dropped from 157 to the dollar in 2011, to 412 in May this year; which means the currency has lost more value in the last decade than South Africa’s, Egypt’s, Indonesia’s and Malaysia’s, according to research from FSDH Merchant Bank in Lagos.

Analysts say the new rate is unlikely to halt the naira’s long-term depreciation or end parallel market dollar trading. “The foreign currency shortages and overall policy uncertainty can only lead to more speculative activity in the parallel market which unfortunately leads to more losers than winners,” says Barbara Barungi, an economist in Abuja.

“The harsh reality is that there are likely to be more adjustments needed,” says Ibrahim Shelleng, managing director at Credent Investment Managers in Abuja. “The continued pressure on scarce forex will more than likely lead to further adjustment.”

Overall, equities are losers from the protracted uncertainty. According to Chapel Hill Denham in Lagos, foreign investors are still “apprehensive” towards equities because of their fears over the naira, despite attractive valuations and dividend yields. Exporters in theory should benefit from a devaluation. Yet Shelling sees those benefits as being limited by a high cost of finance for Nigerian companies, which in turn limits their international competitiveness.

The manufacturing sector which relies heavily on machinery and raw material imports will be hardest hit by the devaluation, Shelling says. “The construction and real estate industry will also take a big hit.”

Forex backlogs

The central bank is likely to devalue the naira again later in the year as depreciation pressures continue to build and foreign reserves remain under pressure, says William Attwell, senior sub-Saharan Africa analyst at Fitch Solutions in London.

  • Despite oil prices rising by 36% in the first five months of the year, Nigeria’s foreign reserves fell to $34.3bn in May – the lowest in over a year and less than pre-Covid levels.
  • Attwell doesn’t expect to see any significant improvement in dollar availability in the short to medium term.
  • He predicts that the naira will end the year at 438 to the dollar and says any move to a free float is “highly unlikely.”

FSDH sees some grounds for optimism. Previous central bank exchange-rate adjustments were not aligned with prevailing market rates, and the official rate was still below the rate used in the I&E window. But this time, the I&E level is being used as the official rate.

This is “a first and major step towards gaining back investor’s confidence in the economy, which in turn could improve forex inflows into the economy,” FSDH says. Plans to sell eurobonds will lift external reserves in the short term, it adds.

Still, FSDH says, demand from imports and other payments will continue to put pressure on the rate, and exchange-rate unification in itself won’t be enough to attract new capital to the country. Nigeria needs “consistent forex policies that seek to improve market liquidity and prevent every form of forex arbitrage and unnecessary forex subsidies.”

The central bank will also need to clear forex backlogs to build market confidence, FSDH says. The IMF estimated the backlogs to be $2bn in February and FSDH says this will only be cleared gradually. “The supply shortage of forex is still a major problem.”

  • FSDH sees the naira at around 430 to the dollar in the second half of the year.

The arbitrage opportunities that exist between the official and the parallel market rates have given speculators an incentive to hoard forex, drive up demand and create volatility, says Shelleng at Credent. This, he argues, discourages potential foreign investors from bringing in much needed liquidity.  The solution is to reduce the incentive for speculators to hoard the forex.

This would require “a very brave government” to implement, Shelleng says. “the potential impact on the economy may be devastating in the short term. Still, that political courage will need to be found at some point. Maintaining a fixed rate is simply delaying the inevitable,” Shelleng says.

Bottom line

The free float, which would take away incentives to hoard dollars, remains the least likely political scenario.

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