Rare Voice Calls Bottom for Nigeria

A currency trader in Nigeria, which has bowed to market pressure to devalue the naira, counts notes

Good news about Nigeria, Africa’s largest economy, has been rarer than hens’ teeth in recent years.

A first recession in 20 years, inflation at a decade high of 17.6 per cent, collapsing oil production, a slumping currency and a severe shortage of dollars have grabbed the financial headlines. The government’s struggles against Boko Haram jihadis in the north and insurgencies by secular militants in the south have fed talk of a “perfect storm”.

With the naira having slumped from 435 to the dollar on the black market to 460 in less than a week, according to website AbokiFX, which monitors rates at Lagos’ bureaux de change, taking it still further away from the official, heavily controlled, rate of 315/$, most analysts are still resolutely downbeat.

However one, Alan Cameron, economist at Exotix Partners, an investment bank focused on smaller markets, has stuck his neck out to call a “watershed moment”.

“There are more things that can go right than wrong at this point, but people are locked in to only thinking things can go wrong,” he says.

Although there is a widespread view that the official naira rate, pegged at 198/$ until June, as the first chart shows, is still unsustainable and is destined to fall further towards the parallel, black market rate, Mr Cameron disagrees.

According to his calculations, at 315/$ the naira is now modestly undervalued on a real effective exchange rate basis. On this basis, investors should be far more worried about the wildly overvalued currencies of Laos, Uruguay and Vietnam, his analysis, depicted in the second chart, suggests.

“Having long been one the most overvalued currencies in this universe, often by 40 per cent or more, Nigeria is now trading below its ‘fair value’,” Mr Cameron says. “While such measures are admittedly not all that helpful in determining short-term market direction, we think they act as an important benchmark for investors looking to make inwards investments — both portfolio and direct.”

Chart: Naira

On a more anecdotal level, he says luxury hotel rooms in Lagos, the business capital, have fallen to $200 a night, a “remarkable adjustment” from the $500-$800 charged until recently.

“The dollar cost of living in Lagos has already fallen by 40 per cent in the last decade. Are we really saying that it needs to fall another 40 per cent in order for people to feel like they’re getting their money’s worth?” he asks.

As to why the black market rate has fallen to 460/$ if 315/$ is around fair value, Mr Cameron points to a lack of liquidity. Bureaux de change, which Nigeria’s large informal economy is forced to rely on, are not being given the dollars they need thanks to rationing by the central bank, which saw its foreign exchange reserves fall to a 10-year low of $25.4bn in August, only enough to cover four months of imports.

If all restrictions were removed, the currency would settle somewhere around the current interbank rate of 345/$, rather than 460/$, Mr Cameron believes.

For the disparate exchange rates to converge, Nigeria needs a readier supply of dollars. One source, Mr Cameron believes, will be a return of foreign portfolio investors to the country.

This may be hard to envisage, given the widespread expectations that the naira’s slide is far from over: 12-month non-deliverable forwards are trading at 407/$, according to Win Thin, head of emerging market currency strategy at Brown Brothers Harriman. Investor fears that any money they send to Nigeria may become trapped there, due to the FX restrictions, are also likely to act as a deterrent.

Chart: Real effective exchange rate valuations

Nevertheless Mr Cameron believes that yield-hunting western investors may be drawn to Nigeria’s local currency government debt, particularly its Treasury bills, which yield between 17 and 23 per cent, up from just 1-8 per cent in January.

Sovereign debt would become more attractive if Nigeria’s inflation rate, which has surged to 17.6 per cent a year off the back of the weakening currency, was to fall. Again Mr Cameron is confident this will be the case, noting that the month-on-month inflation rate fell to 1 per cent in August, from a high of 2.75 per cent in May.

Even if the more closely watched annual inflation figure was to start to ease, this would not guarantee foreign investor interest, given that Nigerian local currency debt was ejected from the influential JPMorgan index in 2014 because of the restrictions on forex transactions. But “if people are looking for an off-index bet to generate a little bit of outperformance, then it becomes one of the most attractive ones”, Mr Cameron argues.

An improvement in Nigeria’s trade balance would also improve dollar liquidity. At first glance, this appears unlikely. Mounting attacks by militant groups on oil installations in the oil-rich Niger Delta have caused production to plunge to a 33-year low of 1.4m barrels a day, as the final chart shows.

Given the importance of oil to Nigeria’s economy, and the softness in global oil prices, this has pushed the country into a current account deficit, while the “other investment assets” line of its balance of payments data is also strongly negative.

Yet Mr Cameron points to an “unseen external adjustment” that has pulled its external accounts almost into balance.

The “net errors and omissions” component of the balance of payments data has been positive to the tune of $26bn over the past year. He attributes this to four factors: the rise of informal non-oil exports, boosted by the devaluation; the repatriation of savings from abroad via the black market; an increase in unrecorded remittances; and a rise in informal (ie stolen) oil exports.

Moreover, Mr Cameron is confident a deal will be done with the militants in the Niger Delta to reinstate the stipends they were paid for agreeing to an amnesty after a previous wave of attacks on oil facilities in 2009. Funding for the programme was cut by 70 per cent this year, triggering the renewed attacks.

John Ashbourne, Africa economist at Capital Economics, says Exotix’s argument is “not unreasonable”, but that it may be premature, with Nigeria unlikely to begin its turnround until the end of this year or early 2017. Indeed, he sees a likelihood of third quarter economic growth data being worse than the 2.1 per cent contraction recorded in the year to the second quarter.

Mr Ashbourne believes the modest increase in forex flexibility generated by the ending of the rigidly fixed dollar peg will help ameliorate the shortage of dollars, helping steady the black-market exchange rate and bring inflation down. “If inflation hasn’t peaked, it’s very close to peaking,” he says.

That should help the economy “bounce back a bit,” as would any stabilisation in oil production.

“Oil production has fallen a lot. The chance of that happening again by as much is unlikely,” says Mr Ashbourne. “We are probably near the bottom of oil production. If it stabilises or even starts to rise, that will help the oil component [of GDP].”

He is sceptical about any pick-up in portfolio inflows, however, noting that the bulk of the capital inflows seen of late has simply been due to Nigerian companies borrowing abroad, rather than inbound foreign direct or portfolio investment.

BBH’s Mr Thin is more sceptical. He regards the allegedly “floating” forex regime introduced by the central bank in June as mere “window dressing”, arguing that importers and foreign investors are still not getting access to the dollars they need.

Mr Thin is one of those expecting the official naira rate to plunge towards the black market rate, even though that would represent an “overshoot”, arguing that “the longer the adjustment is put off, the bigger the move that eventually happens”.

If such a devaluation was to occur, this would push inflation higher still and necessitate “aggressive” rate rises, he suggests. This in turn could prolong Nigeria’s recession.

And although Mr Ashbourne is somewhat more upbeat, even he does not conjure up a happy picture of Nigeria’s immediate fate.

“Even if things turn around, next year is probably still a pretty bad result. Growth of 2 per cent for a country that is as poor as Nigeria and with the level of population growth it has [2.4 per cent] is really not very good,” he argues.

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