It has been six weeks since the Central Bank of Nigeria (CBN) commenced its FX injections. This has resulted in convergence of the interbank and parallel rates, which we think is a precursor to a devaluation to NGN350-390/$1. The CBN’s fixation with a stable FX rate implies it will need to sustain its FX injections to contain the parallel market premium. We estimate FX reserves begin to fall when the CBN’s quarterly injections exceed $3.7bn.
Convergence optics
On 20 February, the CBN announced it will make FX available for retail transactions, including travel allowances, school fees and medical trips. This policy followed a $6bn build-up of FX reserves, since November, to c. $30bn today. Since February, the naira has appreciated in the parallel FX market, and the parallel and interbank FX rates have converged (Figure 1). We consider this ‘convergence optics’ a signal that a naira devaluation is in the offing. In reducing the parallel market premium (with the parallel rate at NGN380/$1, vs NGN520/$1 at its low), we believe the CBN is hoping the market is now less inclined to think the naira should be at NGN500/$1.
CBN can inject $3.7bn/quarter while keeping FX reserves flat
Nigeria’s oil receipts – the country’s biggest source of FX, by far – will be a key determinant of how much the CBN can inject into the market while keeping FX reserves flat. In our balance of payments (BoP) scenario analysis, we make a few assumptions, the most material being that of crude oil production. We assume that Vice President Yemi Osinbajo’s overtures to Niger Delta stakeholders, in recent months, have helped stabilise oil production at c.1.9mbd. Based on that assumption and our commodities team’s oil price projection of $55/bl for 2017, we estimate the CBN can inject $3.7bn per quarter (from 2Q17 to 4Q17), on average, and concurrently keep FX reserves stable at $30bn. An injection greater than $3.7bn, would result in reserves falling. The CBN has injected c.$2bn in the market since this policy was introduced.
Fixation on a stable FX rate
The FX rates for retail transactions and bureaux des change (BDCs), have converged at c. NGN360/$1, in recent days. This indicates where the interbank FX rate may be adjusted, in our view. As the market is unlikely to believe this is the clearing rate for the naira, we think the CBN’s fixation on a stable FX rate will compel it to sustain FX injections, to hold off an increase in the parallel market premium. An FX injection of $3.7bn would result in imports increasing by 17%, vs 2% in our base case, by our estimates. This would be negative for GDP growth, as the trade balance would turn negative. The risk is that Nigeria’s fixation on a stable FX rate will see the naira become increasingly overvalued, and FX reserves’ decline likely to resume.
At what point do FX reserves fall?
At what point do the FX injections for imports result in FX reserves falling? The oil price retreat in recent weeks implies there is a risk the oil price could end up lower than our average $55/bl projection. If we assume production is fixed at 1.9mbd, we find that FX injections would trigger a fall in FX reserves when the oil price drops below $45/bl. When we do the converse, and assume that the oil price averages $55/bl, FX reserves begin to fall when production drops below 1.6mbd.
