Last week, the Central Bank of Nigeria (CBN) devalued the naira and tightened policy. In addition, OPEC opted not to cut output, confirming low prices are here to stay. Leading financial solutions provider, Renaissance Capital, thinks the naira remains at significant risk, implying that the probability of further tightening is high.

CBN governor: “downturn in oil prices…appears to be permanent”

Three months ago, the probability of the oil price falling below $80/bl was low. Today, we are adapting to the fact that this may be the new normal, following OPEC’s – which represents 40 percent of the world’s production – decision to maintain current production levels in response to lower oil prices. Renaissance thinks there is scope for the crude oil price to drop below $70/bl in the near term. Lower oil prices may result in a further slowdown in FX inflows, challenging the central bank’s ability to defend the naira. This confirms the assumption that the 2015 oil price is likely to settle around the current forward price of $80/bl.

Goodbye to trade (current account) surplus

At an oil price of $80/bl, Nigeria’s current account (C/A) would become negative for the first time in 12 years, from our revised 2014 estimate of 2.2 percent of GDP 2014E (vs 4.3 percent previously). While a weaker naira would possibly slow demand for imports and the lower oil price reduce the cost of importing refined oil (20 percent of imports), this would be sufficient to keep the C/A positive, implying that FX reserves may have to be drawn down to finance Nigeria’s balance of payments (BOP). This is negative for the naira, which we see at NGN197/$1 at YE15 vs NGN182/$1 at YE14E.

Expect a weaker currency….

Because a fall in import demand should lower trade credits (and by implication, financial outflows), a capital and financial account surplus may result. This may, however, be undermined by portfolio investment outflows. If the central bank therefore finds itself in the position where it is drawing on FX reserves to cover the BOP’s financing gap (as it did in 2009 and 2010 (Figure 3)), and needs to defend the naira in a low oil price environment, there is a risk that it may be forced to loosen its hold on the naira, implying further currency weakness (an interbank rate of NGN185-195/$1 in the short term is plausible, in our view).

…..tempered by further monetary policy tightening

The MPC last week hiked the policy rate by 1 ppt to 13 percent, the highest it has been since the global financial crisis. The short-term risks to the naira outlined above suggest to us that further tightening may be necessary. We think another rate of hike of 2-5 ppts is possible over the short term (our YE15 policy rate forecast is 15 percent), as is a further increase in the cash reserves requirement.

Fiscal austerity is a must

Given the downside risk to revenue and the near-depletion of the excess crude account, the government may have little option but to remove the fuel subsidy. This means savings of $2.5bn, or 4 percent of FY14 consolidated government budget. We think the current low public debt levels of 11-12 percent of GDP and revenue growth challenges imply government borrowing may increase in FY15, leading to an increase in yields in 2015, after being depressed in 2014.

By Yvonne Mhango, SSA Economist at Renaissance Capital.

Elsewhere on Ventures

Triangle arrow