CEM REPORT, ECONOMY| Nigeria’s foreign exchange (FX) reserves have been a source of concern for some time, and a recent report by Fitch Ratings sheds light on a key factor contributing to this uncertainty: foreign exchange bank swaps.
In its latest credit outlook for Nigeria, Fitch Ratings highlighted the lack of transparency surrounding the composition of the country’s FX reserves. The credit agency estimates that a staggering 30% of these reserves are comprised of foreign exchange bank swaps, a figure that raises questions about the true net FX reserves available to Nigeria.
This concern stems from the Central Bank of Nigeria’s (CBN) 2022 consolidated financial statement, which lists nearly $32 billion in “FX forwards, OTC futures, and currency swaps” as off-balance sheet commitments. The opacity surrounding these off-balance sheet items makes it difficult to determine the precise size and readily available portion of Nigeria’s FX reserves.
Fitch Comments:
“Uncertainty continues over the net FX reserve position, with a particular lack of clarity on near USD32 billion of ‘FX forwards, OTC futures, and currency swaps’ recorded as an off-balance sheet ‘commitment’ in CBN’s last consolidated financial statement for 2022,” stated Fitch in its report.
“Fitch estimates around 30% of Nigeria’s reserves are made up of FX bank swaps, although we expect most of these to continue to be rolled over,” the report added.
Temporary FX Stability But Volatility Remains:
Despite the uncertainties, there have been some recent positive developments on the FX front. A recent upswing in non-resident inflows, likely due to increased formalization of FX activities and tighter monetary policies, has led to a notable appreciation of the Naira at the official FX window. This follows a period of sharp depreciation, with the Naira losing a staggering 71% of its value between June 2023 and mid-March 2024.
While Fitch anticipates that most of the FX bank swaps will likely be rolled over, providing some temporary stability, the lack of transparency remains a significant constraint on Nigeria’s sovereign credit rating.
The exchange rate volatility further complicates the picture. Despite a recent appreciation of the Naira at the official FX window, following a significant depreciation earlier this year, Fitch warns that the exchange rate remains volatile and poses risks to economic stability.
Declining Reserves and Future Projections:
The report also highlights a recent decline in Nigeria’s gross FX reserves, falling from $34.4 billion in mid-March 2024 to $32.2 billion by the end of April. This decrease is attributed partly to debt repayments and FX sales aimed at bolstering the Naira.
Fitch projects a modest current account surplus for Nigeria, averaging 0.5% of GDP for 2024-2025. However, this is accompanied by a concerning forecast: FX reserves are expected to diminish and cover only 4.2 months of current external payments by the end of 2024. This aligns with the median for countries with a ‘B’ credit rating from Fitch.
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Fitch’s Projections:
“Gross FX reserves fell to USD32.2 billion at end-April, from a peak of USD34.4 billion in mid-March, partly reflecting repayment of existing debt obligations, and FX sales to BDCs to support the currency,” the report states.
“Fitch projects a broadly flat current account surplus, averaging 0.5% of GDP in 2024-2025, supported by a modest rise in oil production and remittances. We forecast FX reserves to fall to 4.2 months of current external payments at end-2024 (‘B’ median 4.2), from 4.4 months at end-2023.”
If You Ask Me
The lack of transparency surrounding Nigeria’s FX reserves, particularly the significant portion tied up in foreign exchange bank swaps, creates uncertainty for investors and international creditors. While Fitch expects some temporary stability through rollover of these swaps, a more permanent solution is needed to build confidence in Nigeria’s FX reserves management and improve the country’s creditworthiness.
Addressing the opacity surrounding off-balance sheet commitments and implementing clear policies for managing FX reserves will be crucial for Nigeria to navigate this complex situation and ensure long-term economic stability.
