Is the CBN Finally Bowing to Pressure?
Analyst View

Sometimes last year at an investor meeting in London, the CBN Governor, Godwin Emefiele stated that, the bank would only consider devaluing the Naira in a situation where oil is trading below US$45/bbl and external reserves drop below US$30billion.

As fate would have it, the outbreak of COVID-19 in China at the end of 2019 has sent oil price southwards, touching its lowest level in 18 years. While the average oil price for the month of March 2020 is US$36.42/bbl, significantly lower than the CBN’s “devaluation-benchmark” of US$45/bbl, FX reserves is currently US$6billion above the CBN’s trigger level. Nonetheless, the latter was rightly not enough to stop investors and analysts from forecasting the possible devaluation of the Naira in coming months due to the heightened FPI outflows as well as weaker outlook for FX inflows on the back of declining oil price.

The panic from the rapid spread of the virus, dampened global growth sentiments and weakened oil price set the tone for the pressures experienced in the Nigeria FX markets as Naira touched N400 to a dollar at the parallel market and N374/USDat the IEFX window. 

To allay the fears of a devaluation, the CBN released a circular on 12th March 2020 stating confidently that, “market fundamentals do not support naira devaluation at this time”. 

However, on the 20th March 2020, the CBN technically devalued the Naira to N380/USD at the IEFX window. Furthermore, the bank devalued the official exchange rate to N360/USD (from N306/USD) and directed oil companies (Local and International) to stop the sales of FX to the Nigerian National Petroleum Corporation (NNPC).

While the move was not surprising, as it has been widely expected, the CBN has come out to term its move on 20th of March 2020 as a readjustment aimed at reflecting the present market conditions, rather than a devaluation. Nonetheless, we aim to discuss the possible effects of this policy move on the Nigerian economy:



Unification of FX rates

Following the 2016 recession, the CBN has been able to ward off pressures from the International Monetary Fund (IMF) to adopt a single exchange rate system. One of the positives of the devaluation in Naira is the unification of rates at different FX markets. We think this should, to some extent, lessen the fears of portfolio investors and reduce incidence of speculation and arbitrage between these markets. 

We also expect a decline in other illegal practices (such as those listed above) that have starved the industrial and manufacturing sector of forex for raw materials, machinery and spare parts, which has inhibited potential for economy growth and development.

This will also help the apex bank harmonise Nigeria’s FX earnings and meet local and international obligation.



Possible Improvement in Trade Balance

Theoretically, a devaluation makes import more expensive and exports cheaper thereby bringing about a decline in trade deficit and improvements in trade balance. While we expect to see a similar trend in Nigeria’s trade balance, we posit that the current low levels of oil sales and price, trading at US$28/bbl (crude oil accounted for c.77% of total export in 2019) may delay the fruition of an improved trade balance. This position is further supported by the oil price war between Saudi Arabia and Russia, which has led to supply glut; the possibility that Nigeria finds it difficult to sell its oil in the international market remains.




Trouble for Manufacturers and Pressure on Inflation 

For manufacturers who use imported input items in their production processes, the devaluation in naira may lead to increased production costs as a result of increased cost of imports. This could further result into hike in prices of their finished products, putting upward pressures on inflation. For importers of finished products, we also expect increase in the prices of their products as they will look to pass increase importation costs to final consumers – whose spending ability remain weak. This should however discourage consumers demand for imported products as demand may shift to cheaper local products. 

While this may lead to decline in the purchasing power of consumer, it may also lead to a slowdown in economic activities as increase in costs may cause shutdown in some manufacturing operations.




Positive for FPI inflows, But not in the near term

We normally would expect inflows from foreign investors in a case of devaluation but not in this case. The growth forecast for the world economy is currently being strangled in the throat by COVID-19 and investors are seeking to invest in riskless assets; Nigeria, on the other hand faces an impeding decline in revenue and FX inflows. Given these factors, among others, we do not expect FPIs inflows to increase in the near term. 

Furthermore, we believe the devaluation in the currency to N380/USD may not be enough to instill full confidence in FPI’s as the possibility of further deterioration remains. We believe this may lead to investors taking to the sideline in the near term. 



More Control of FX supply?

Following the announcement of devaluation in naira, the CBN further directed all oil companies in the country to stop the sale of FX to the NNPC; the apex bank directed oil companies to sell their FX to the CBN. We point out that the NNPC remains the sole importer of fuel into the economy and will surely need FX to execute its trades. Although this policy directive is a little surprising, it appears the CBN is seeking to have a holistic control of FX supply in the economy. We believe this should bode well for FX management and could also aid redistribution of FX supply to the most productive economic activities.


Oil Subsidy 

We opine that the devaluation in official rate may have a counter reaction to the FG’s reduction in fuel pump price. We recall that the Federal Government reduced fuel pump price to N125/liter from N145/liter, reflecting the current plunge in crude oil price in the global market. While the new pricing template is yet to be released we posit that the official rate used in its computation is likely the previous official rate of N306/USD, as this announcement was made 2 days before the CBN devalued the Naira. 

At the official rate of N306/USD and oil price at sub US$30/bbl, we estimate that the FG’s subsidy payment declines completely however, with the devaluation in official rate to N360/USD, it appears the FG will have to pay an estimate of N19.13/liter as fuel subsidy to maintain a fuel pump price of N125/liter. Given the expectation of a decline in revenue and increasing fiscal responsibilities, it is likely that the FG increases fuel pump price in the coming months; we point out that the Petroleum Product Pricing Regulatory Agency (PPPRA) has committed to announcing a monthly guiding/expected open market price at the beginning of every month, effective 1st April 2020.


Unfavourable for FG’s Debt Servicing 

With official rate at N360/USD, we can only imagine the FG settling its debt servicing responsibilities (especially foreign debt) through its nose. This view is hinged on the low revenue forecast that has necessitated the slashing of the 2020 budget. The total debt stock of the country as at September 2019 sits at N26.21 trillion (US$85.39 billion), with foreign debt accounting for c.32% of total debt. By our estimate the depreciation in official rate will lead to an increase of about N1.43trillion in the naira value of foreign debt stock. 

According to the 2020 budget appropriation, the Nigeria government has budgeted to spend N719billion on foreign debt servicing in 2020 (including debt servicing on proposed new borrowing); we estimate that the devaluation in official rate will result into an estimated increase of N129billion in foreign debt service during the year. Furthermore, due to the downgrade of the economy by global rating agencies, raising debt in the Eurobond market may become more expensive as investors are likely to price in higher risk. Nonetheless, we do not expect the government to raise foreign debt in the near term as global economy uncertainty remains at high levels.



Our Verdict

The CBN termed this policy directive as a readjustment and it is unclear what this means, how long this readjustment will remain or when/if it will be reversed. Nonetheless, market fundamentals suggests that FX rates will remain at N380/USD levels with a possibility of further depreciation. Our view is hinged on current happenings in the global space. We believe an uncontained spread in the virus will lead to continued outflow and slowdown of funds from the FPIs resulting into a further decline in the CBN’s ability to defend the Naira.