Nigeria: Cbn’s New Exchange Rate Guidelines Puts Economy on Path to Recovery but Uncertainty to Prevail

• Yesterday, after months of defending its policy not to devalue the NGN, Governor of the Central Bank of Nigeria (CBN), Godwin Emefiele, released guidelines on the operations of its flexible exchange rate system that will come into effect on 20 June 2016.

• CBN indicated plans to allow the NGN to float through a single market structure in the inter-bank FX market and the secondary market and to intervene in the market only when necessary. Effectively, this suggests that the exchange policy will be a ‘managed float’.

• The CBN also highlighted that it will select around 10 FX primary dealers who will be registered authorised dealers designed to deal with the CBN on large trade deals; FX primary dealers will also deal with other authorised dealers in the inter-bank market, improving price competiveness and transparency.

• However, the ban on importers of 41 goods and services from accessing interbank will remain inadmissible in FX interbank market. While this move may help to conserve FX reserves, we believe that this policy measure is counterproductive and will continue to damage the economy via higher inflation, slower growth and FX market uncertainty given the concerns already existing about weaker oil production in the economy.

• Ongoing imposition of FX trading restrictions has supported the artificial stability seen since early 2015, but these barriers will prevent the market from effectively clearing, sustaining pressure on the NGN and reserves.

• The CBN will also retain the ban on the sale of interbank FX to Bureaux de Change markets in an effort to curb currency speculation.

• These guidelines come after recent evidence of further deterioration of the economy (acute FX liquidity challenges, rising inflation despite a hike in interest rates in March (see Chart 1), contraction in Q1 GDP and ongoing depletion of FX reserves) stemming from the oil price slump since mid-2014 and the non-optimal mix of policy response.
• Such imbalances are in addition to rising spread between the official and parallel exchange rates (Chart 2).

• Although the NGN is broadly stable, it has become increasingly overvalued, with the parallel rate trading around 60% above the official rate owing to speculative demand, strong import demand and inadequate production inputs against a background of weak exports and investment inflows.

• The artificial stability of the NGN on the interbank exchange rate market since March has come at the expense of a depletion in FX reserves (down 10.7% to USD26.5bn from a year ago).

• The CBN’s move to adopt exchange rate flexibility is welcome news; although it did not overtly say that it will devalue the NGN, the currency will officially be devalued and it is likely to trade in the range of NGN280-350.

• This will help to alleviate pressure on the NGN, albeit limited, given still weak oil receipts, which account for the country’s main source of FX.

• While the new exchange rate policy will put Nigeria on the right path to recovery, uncertainty will prevail given other pressures in the economy including rising inflation.

• The new exchange rate system will also stoke inflationary pressures in the short term, in addition to a potential rise in fiscal spending, reducing the scope for any policy easing in the foreseeable future. As a result, we expect the CBN to raise the MPR by around 100bp at the next MPC meeting scheduled for July.

• Meanwhile, with the financing requirement remaining high in the months ahead given a weak outlook for oil prices, T-bill and bond issuance will continue apace.

Chart 1: Monetary Policy & Inflation Rates (%)

Source: CBN

Chart 2: NGN: Official vs Parallel Exchange Rate

Sources: Bloomberg; Ecobank Research

DISCLAIMER

• This document was prepared under the supervision from the Research Division of EBI SA (a member of Ecobank Group), and is not necessarily definitive, current or authoritative. Data used in this document was gathered from reliable sources, but the analyst(s) and the publishers of this document do not hold themselves responsible for the accuracy or completeness of data used. The document provides the opinions, analyses and conclusions of the Research division only and is provided without any warranties of any kind. EBI SA and any member of Ecobank Group and its affiliates do not in any way endorse the findings, views and conclusions in this document. EBI SA, Ecobank Group and its affiliates’ Directors, Employees or Agents do not accept any liability for any direct or remote loss or damage arising out of the use of all or any part of the information contained in this document.

• EBI SA is a credit institution authorized by the Autorité de contrôle prudentiel.

USE OF THIS PUBLICATION FOR THE PURPOSE OF MAKING INVESTMENT DECISION EXPOSES YOU TO SIGNIFICANT RISK OF LOSS.

• Reception of this publication does not make you a client or provide you with the protections afforded to clients of EBI SA (A member of Ecobank Group).When distributing this document, EBI SA or any member of Ecobank Group is not acting on behalf of the recipient of thi s document and will not be liable for providing investment advice to any recipient in relation to this document. Accordingly, EBI SA (A member of the Ecobank Group) will not be held accountable to any recipient for providing the protections afforded to its clients.

• This document is published for information purposes only and is not an offer to solicit, buy or sell any security of any kind. This document does not provide customised investment advice. It has been prepared without regard to the individual financial circumstances and risk and return objectives of individuals who receive it. The appropriateness of a particular investment will depend on an investor’s individual circumstances, risk tolerance and return objectives. The investments and shares referred to in this document may not be suitable for all or certain categories of investors.

• The Research Division and EBI SA have implemented Chinese walls procedures to prevent any conflict of interest. Additional information may be available to EBI SA or the Ecobank Group which is not discussed in this report. Further disclosure regarding Ecobank policy regarding potential conflicts of interest in the context of investment research and Ecobank policy on disclosure and conflicts in general are available on request.

• The opinions presented in this note may be changed without prior notice or cannot be depended upon if used in the place of the investor’s independent judgment.

• The historical performance of a security is not representative of the security’s future returns. Investment in securities can be highly risky as security prices may go down in value as well as up and you may not get back the full amount invested. Where an investment is denominated in a currency other than the local currency of the recipient of the research report, changes in the exchange rates may adversely affect the value, price or income of that investment. In case of illiquid investments for which there is no organized market it may be difficult for investors to exit investment positions or to obtain reliable information about its value or the extent of the risk to which it is exposed.

• The information contained in this document is confidential and is solely for use of those persons to whom it is addressed and may not be reproduced, further distributed to any other person or published, in whole or in part, for any purpose.

• © EBI SA Groupe Ecobank 2016. All Rights Reserved. This note has been prepared by Edward George and the Ecobank Research Division. For any question, please contact: Edward George, Head, Group Research, EBISA, 20 Old Broad Street, London, EC2N 1DP, United Kingdom.

DISCLOSURES

Research analyst certification: The research analyst(s) primarily responsible for the preparation and content of all or any identified portion of this research report hereby certifies that all of the views expressed herein accurately reflect their personal views. Each research analyst(s) also certify that no part of their compensation was, is, or will be, directly or indirectly, related to the view(s) expressed by that research analyst in this research report.

Important disclosures

1. The analyst(s) responsible for the preparation and content of this report (as shown on the disclaimer page of this report) holds personal positions in a class of common equity securities of the company.
2. The company beneficially owns more than 5% in EBI SA or Ecobank Group (“the Group”).

III. EBI SA or the Group is a market maker in the publicly traded equity securities of the company.

1. EBI SA or the Group beneficially owns 5% or more of the equity securities of the company.
2. EBI SA or the Group beneficially holds a significant interest of the debt of the company.
3. EBI SA or the Group has been lead manager or co-lead manager over the previous 12 months of any publicly disclosed offer of securities of the company.

VII.         The company is a client of EBI SA or the Group.

VIII. EBI SA or the Group has lead managed or co-lead managed a public offering of the securities of the company within the last 12 months. IX. EBI SA or the Group has received compensation for investment banking services from the company within the last 12 months.

1. EBI SA or the Group expects to receive, or intends to seek, compensation for investment banking services from the company during the next 3 months
2. EBI SA or the Group has any liquidity contract between EBI or related entity and the issuer

XII. EBI SA and the issuer have agreed that EBI will produce and disseminate investment recommendations on the said issuer as a service to the issuer.

• Yesterday, after months of defending its policy not to devalue the NGN, Governor of the Central Bank of Nigeria (CBN), Godwin Emefiele, released guidelines on the operations of its flexible exchange rate system that will come into effect on 20 June 2016.

• CBN indicated plans to allow the NGN to float through a single market structure in the inter-bank FX market and the secondary market and to intervene in the market only when necessary. Effectively, this suggests that the exchange policy will be a ‘managed float’.

• The CBN also highlighted that it will select around 10 FX primary dealers who will be registered authorised dealers designed to deal with the CBN on large trade deals; FX primary dealers will also deal with other authorised dealers in the inter-bank market, improving price competiveness and transparency.

• However, the ban on importers of 41 goods and services from accessing interbank will remain inadmissible in FX interbank market. While this move may help to conserve FX reserves, we believe that this policy measure is counterproductive and will continue to damage the economy via higher inflation, slower growth and FX market uncertainty given the concerns already existing about weaker oil production in the economy.

• Ongoing imposition of FX trading restrictions has supported the artificial stability seen since early 2015, but these barriers will prevent the market from effectively clearing, sustaining pressure on the NGN and reserves.

• The CBN will also retain the ban on the sale of interbank FX to Bureaux de Change markets in an effort to curb currency speculation.

• These guidelines come after recent evidence of further deterioration of the economy (acute FX liquidity challenges, rising inflation despite a hike in interest rates in March (see Chart 1), contraction in Q1 GDP and ongoing depletion of FX reserves) stemming from the oil price slump since mid-2014 and the non-optimal mix of policy response.
• Such imbalances are in addition to rising spread between the official and parallel exchange rates (Chart 2).

• Although the NGN is broadly stable, it has become increasingly overvalued, with the parallel rate trading around 60% above the official rate owing to speculative demand, strong import demand and inadequate production inputs against a background of weak exports and investment inflows.

• The artificial stability of the NGN on the interbank exchange rate market since March has come at the expense of a depletion in FX reserves (down 10.7% to USD26.5bn from a year ago).

• The CBN’s move to adopt exchange rate flexibility is welcome news; although it did not overtly say that it will devalue the NGN, the currency will officially be devalued and it is likely to trade in the range of NGN280-350.

• This will help to alleviate pressure on the NGN, albeit limited, given still weak oil receipts, which account for the country’s main source of FX.

• While the new exchange rate policy will put Nigeria on the right path to recovery, uncertainty will prevail given other pressures in the economy including rising inflation.

• The new exchange rate system will also stoke inflationary pressures in the short term, in addition to a potential rise in fiscal spending, reducing the scope for any policy easing in the foreseeable future. As a result, we expect the CBN to raise the MPR by around 100bp at the next MPC meeting scheduled for July.

• Meanwhile, with the financing requirement remaining high in the months ahead given a weak outlook for oil prices, T-bill and bond issuance will continue apace.

Chart 1: Monetary Policy & Inflation Rates (%)

Source: CBN

Chart 2: NGN: Official vs Parallel Exchange Rate

Sources: Bloomberg; Ecobank Research

DISCLAIMER

• This document was prepared under the supervision from the Research Division of EBI SA (a member of Ecobank Group), and is not necessarily definitive, current or authoritative. Data used in this document was gathered from reliable sources, but the analyst(s) and the publishers of this document do not hold themselves responsible for the accuracy or completeness of data used. The document provides the opinions, analyses and conclusions of the Research division only and is provided without any warranties of any kind. EBI SA and any member of Ecobank Group and its affiliates do not in any way endorse the findings, views and conclusions in this document. EBI SA, Ecobank Group and its affiliates’ Directors, Employees or Agents do not accept any liability for any direct or remote loss or damage arising out of the use of all or any part of the information contained in this document.

• EBI SA is a credit institution authorized by the Autorité de contrôle prudentiel.

USE OF THIS PUBLICATION FOR THE PURPOSE OF MAKING INVESTMENT DECISION EXPOSES YOU TO SIGNIFICANT RISK OF LOSS.

• Reception of this publication does not make you a client or provide you with the protections afforded to clients of EBI SA (A member of Ecobank Group).When distributing this document, EBI SA or any member of Ecobank Group is not acting on behalf of the recipient of thi s document and will not be liable for providing investment advice to any recipient in relation to this document. Accordingly, EBI SA (A member of the Ecobank Group) will not be held accountable to any recipient for providing the protections afforded to its clients.

• This document is published for information purposes only and is not an offer to solicit, buy or sell any security of any kind. This document does not provide customised investment advice. It has been prepared without regard to the individual financial circumstances and risk and return objectives of individuals who receive it. The appropriateness of a particular investment will depend on an investor’s individual circumstances, risk tolerance and return objectives. The investments and shares referred to in this document may not be suitable for all or certain categories of investors.

• The Research Division and EBI SA have implemented Chinese walls procedures to prevent any conflict of interest. Additional information may be available to EBI SA or the Ecobank Group which is not discussed in this report. Further disclosure regarding Ecobank policy regarding potential conflicts of interest in the context of investment research and Ecobank policy on disclosure and conflicts in general are available on request.

• The opinions presented in this note may be changed without prior notice or cannot be depended upon if used in the place of the investor’s independent judgment.

• The historical performance of a security is not representative of the security’s future returns. Investment in securities can be highly risky as security prices may go down in value as well as up and you may not get back the full amount invested. Where an investment is denominated in a currency other than the local currency of the recipient of the research report, changes in the exchange rates may adversely affect the value, price or income of that investment. In case of illiquid investments for which there is no organized market it may be difficult for investors to exit investment positions or to obtain reliable information about its value or the extent of the risk to which it is exposed.

• The information contained in this document is confidential and is solely for use of those persons to whom it is addressed and may not be reproduced, further distributed to any other person or published, in whole or in part, for any purpose.

• © EBI SA Groupe Ecobank 2016. All Rights Reserved. This note has been prepared by Edward George and the Ecobank Research Division. For any question, please contact: Edward George, Head, Group Research, EBISA, 20 Old Broad Street, London, EC2N 1DP, United Kingdom.

DISCLOSURES

Research analyst certification: The research analyst(s) primarily responsible for the preparation and content of all or any identified portion of this research report hereby certifies that all of the views expressed herein accurately reflect their personal views. Each research analyst(s) also certify that no part of their compensation was, is, or will be, directly or indirectly, related to the view(s) expressed by that research analyst in this research report.

Important disclosures

1. The analyst(s) responsible for the preparation and content of this report (as shown on the disclaimer page of this report) holds personal positions in a class of common equity securities of the company.
2. The company beneficially owns more than 5% in EBI SA or Ecobank Group (“the Group”).

III. EBI SA or the Group is a market maker in the publicly traded equity securities of the company.

1. EBI SA or the Group beneficially owns 5% or more of the equity securities of the company.
2. EBI SA or the Group beneficially holds a significant interest of the debt of the company.
3. EBI SA or the Group has been lead manager or co-lead manager over the previous 12 months of any publicly disclosed offer of securities of the company.

VII.         The company is a client of EBI SA or the Group.

VIII. EBI SA or the Group has lead managed or co-lead managed a public offering of the securities of the company within the last 12 months. IX. EBI SA or the Group has received compensation for investment banking services from the company within the last 12 months.

1. EBI SA or the Group expects to receive, or intends to seek, compensation for investment banking services from the company during the next 3 months
2. EBI SA or the Group has any liquidity contract between EBI or related entity and the issuer

XII. EBI SA and the issuer have agreed that EBI will produce and disseminate investment recommendations on the said issuer as a service to the issuer.