CEM REPORT, MARKET | The Nigerian Naira is facing turbulence times which has impacted inversely on the cost of living and business. Despite this downing situation, a recent report foresees the Naira strengthening towards ₦850/$1 at the close of the year.
A recent report by JP Morgan Chase & Co report states that achieving ₦850/$1 will require a combination of tighter policy, more attractive rates, and FX levels that discourage additional dollarization while also attracting some foreign capital.
“We expect USD/NGN to eventually move lower towards 850 by year-end as the combination of tighter policy, as well as more attractive rates and FX levels deter incremental dollarization and perhaps attract some foreign capital.”
The report titled Nigeria Local Markets Strategy: Getting Set for Re-Opening notes that the Central Bank of Nigeria (CBN), must sustain its efforts of flexibility of the exchange rate but cautioned that it must be accompanied by tighter monetary policies.
“The Central Bank of Nigeria (CBN) appears willing to once again allow a flexible exchange rate without the use of moral suasion to limit the upside. This was initially the case during the first attempt at re-calibrating the FX market, however, those efforts lost steam due to inflation concerns.
“We believe recent efforts to restore a flexible FX regime may be sustained given the willingness to accompany it with tighter monetary conditions.”
While noting that unifying the various FX windows and eliminating the longstanding list of ineligible transactions helps simplify the FX policy framework, the report added that due to still limited FX liquidity in the official market, and the fact that the naira isn’t a fully convertible currency, “some FX demand will inevitably find its way to the parallel market.”
JP Morgan noted that the large backlog of unmet FX demand should be cleared but worries that the nation’s low net FX reserves might make it difficult to achieve.
“In our opinion, when authorities refer to the FX backlog, they are actually referring to $6.8billion in FX forward commitments which the central bank has not honored – the majority of which has been covered by commercial banks.
“However, we estimate there is up to a further $$3-4billion (probably less given the FX adjustment) in unmet FX demand needed for goods and services imports. CBN will need to clear both backlogs, a difficult task given the low levels of net FX reserves.
“We previously estimated that Nigeria’s net FX reserves could be as low as $ 3.7 billion at the end of 2022. We do not have new information about the central bank’s short-term contingent liabilities, however, gross FX reserves have further declined by $ 4.1 billion through this year and now amount to around $ 33.3 billion, suggesting the net position could be lower.”
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Additionally, JP Morgan believes the current -300 basis points (bp) / +100bp corridor around the 18.75 per cent policy rate needs to be narrower in order to increase the market (and real economy) relevance of the policy rate. However, the report noted that it expects the CBN to keep the policy rate unchanged.
It further stated that in a situation where open market operations (OMO) auctions are held on a more regular basis, it will result in tighter liquidity conditions, which will in turn help slow dollar demand
“While optically and for signalling purposes, this may appear odd, especially if the OMO rate is set above 21percent for an extended period, it may be a necessary compromise given the political sensitivity and preference for lower interest rates (recall the President’s inauguration speech signaling the need for lower interest rates, see here) particularly as the MPR should typically serve as the base rate for bank loans. Similarly, the CBN might also remain cost-conscious by not wanting to pay significantly higher rates on both OMOs and SDFs.”
The report expresses fear that if short-term rates move nearer 25 per cent in order to narrow the current negative real rates “the policy rate won’t matter”. Although it stated that continuous OMO auctions and CRR debits can help to further tighten liquidity conditions, ease FX and inflationary pressures.
Recall that the CBN earlier this week mopped up around ₦400 billion of liquidity via open market operations (OMO) at a significantly higher yield of 21.2 per cent for the 1-year bill, compared to 17 per cent at the previous OMO auction in August.
JP Morgan said that the willing buyer-willing-seller nature of the foreign exchange market is contributing to the extreme volatility in the FX market.
It noted the willing buyer-willing-seller model impedes price discovery, calling on the CBN to reconsider the strategy.