Nigeria’s central bank last Friday weakened the local currency and adopted a uniform exchange rate amid depleting foreign exchange reserves. And if market trends since Friday are anything to go by, the Naira’s devaluation was too small and could be reduced further.
The local unit on Wednesday depreciated against the United States dollar to stand at $1 per ₦390, while the black-market rate has weakened from ₦380 to ₦403 this week. In addition, one-year non-deliverable forward contracts rose to ₦515 on Monday, its biggest drop in more than a decade.
Forward markets are over-the-counter places that set the price of a financial instrument or asset for future delivery. The rise in the Naira’s one-year forward price, an indication of where the currency could trade in a year’s time, means traders see another 11.3 percent devaluation in that period.
On the back of the plunge in Brent crude prices this month, the devaluation of the Naira by about 4 percent to ₦380 per dollar pales in comparison to the depreciation seen in other major oil currencies, some of which have fallen much more by 14 to 15 percent. That means CBN’s ‘adjustment’ is most likely overvalued and falls short of fair market value as the coronavirus outbreak continues to wreak havoc to the global economy.
Nigeria has for over two years tightly controlled the exchange rate, depending on oil earnings, which account for about 90 percent of foreign exchange, to defend the local currency. But with the crash in prices, triggered by the virus outbreak and a pricing war between top oil exporters Saudi Arabia and Russia, Africa’s biggest economy finds itself in a tight situation.
Brent crude is currently below $30 a barrel and analysts see prices falling to $10 a barrel in the coming months as an OPEC agreement with its allies to hold back on production expires from April 1 while the world runs out of storage for oil products due to dented demand.
Despite the impact of the ongoing pandemic on economic activity and oil earnings, the apex bank’s monetary policy committee, split between stimulating growth and maintaining exchange rate stability, kept the monetary policy rate and other parameters unchanged after a meeting on Tuesday.
The decision to maintain its benchmark rate was meant to protect the Naira after the devaluation. Adopting policy loosening (cutting interest rates) in line with global trends would have worsened the already rising inflation, which could result in massive pressure on reserves and the exchange rate, CBN Governor Godwin Emefiele explained. There is a need to “check capital outflows, support external reserves and ensure foreign-exchange market stability,” he said.
Typically, a weaker Naira would free up some of the scarce foreign reserves that would have otherwise been used to defend the local currency at the fixed rate while at the same time improve government revenues by allowing dollar earnings from oil to be converted at a higher rate. But the downside of that would be an increase in Nigeria’s foreign debts in local-currency terms.
During the oil price crash of 2014-16, similar to the current crisis, the Central Bank of Nigeria refused to let the naira drop, a decision that caused severe shortages of foreign currency and hurt the economy. But in this time of the coronavirus pandemic and historically low oil prices, Nigeria will most likely be forced to weaken the naira further following last week’s devaluation, which the apex bank had denied for several months.
