Naira ‘Shock and Awe’ Rally: Dead Cat Bounce or Fundamental Change in Sentiment?

Volatility has been a recurring theme in the Nigerian foreign exchange market, particularly at the parallel segment, since the oil market downturn which began in H2:2014 and subsequent constraints from the capital account due to underwhelming policy responses. The Naira consequently shed 46.5% and 66.3% in the interbank and parallel markets respectively between June 2014 and January 2017, while the spread between the two rates reached an all-time high of N215.00 last week as monetary authorities remain reluctant to implement “short term painful, yet necessary” reforms.

The political and economic implications of the FX shortages motivated the directive issued by the National Economic Council to the CBN last week for a more flexible FX market structure and closure of the gap between interbank and parallel market rates. In light of this, the CBN issued a new policy action on the 21st February, 2017 which is expected to increase FX allocations to retail end users while reducing the demand pressures in the parallel market. The main highlights of the guideline include:

  • Direct additional funding to banks in order to shore up forex liquidity to address customer needs with regards to Personal and Business Travel Allowances, Medical needs as well as school fees. A weekly sale (every Tuesday) by the CBN to commercial and merchant banks for PTAs and school fees shall commence, while the rate at which these transactions will be settled was capped by CBN at a spread of 20.0% over the prevailing interbank rate. The CBN also advised banks to setup FX retail outlets at major airports.
  • Reduction of the maximum tenor on forwards sales from the current 180-days to 60-days on all transactions. Further to this, the CBN plans to take steps to improve market efficiency and liquidity via intervention programs to clear all the unfulfilled orders in the interbank market and removal of the FX allocation/utilisation rule on commercial banks. This latter implies that banks will have the liberty to provide FX to customers at their discretion, as opposed to the earlier 60/40 rule which gave precedence to manufacturers over other sectors.

In a “shock and awe” move, the CBN held two successive 60-Day FX forwards sales totaling US$600.0m since the release of the circular on Monday, this drove interbank lending rate above 200.0% as Banks scrambled for Naira liquidity to position at the auctions. DMBs have also started to call for bids from retail end-users in preparation for the first PTA/School Fees auction. The success of the CBN’s aggressive intervention and moderation in demand in the unofficial market led the Naira to post its biggest one-week rally in more than 3 years (+13.0%) in the parallel market, appreciating from a trough of N520.00/US$1.00 (pre announcement) to a 3-month high of N460.00/US$1.00 (post announcement) as speculators with short Naira positions sold off.

The Naira rally in the parallel market in addition to increasing external reserves, stable crude oil prices and rebound in oil production to 2.2mb/d (according to Finance Minister Kemi Adeosun) have prompted three questions from market participants:

  • Is the Naira rally in the parallel market a dead cat bounce or a signal for sustainable fundamental change in sentiment?
  • Does the Central Bank have enough Dollar liquidity to sustain pace of interventions for commercial transactions in the interbank and retail end users?
  • Will the fundamental change in current account dynamics (a major determinant of long run exchange rate) encourage the CBN to relax its currency peg – a decision which could buoy capital account activities and autonomous supply of FX liquidity?

In our view, whilst the implementation of the revised FX market guideline has been greeted with much optimism, we do not believe this move can sustainably address the lingering FX liquidity challenges in the economy without relaxing FX rate peg and review of list of items ineligible for FX transactions in the parallel market. Personal and Business travel allowances, school fees and medical fees have been estimated to account for less than 20.0% of total FX demand in the country hence there is still a large volume of demand (particularly the 41 ineligible items) that could pressure rate at the parallel market.

It is hard to make an exact call on direction of rate, but it is unlikely the parallel rate will breach the N500.0/US$1.00 mark again in the shorter term as a more dollar liquid CBN will not shy from further interventions. Yet, our medium term conviction remains that maintaining the interbank rate at current peg (without implementing deeper reforms required) will lead to deterioration in current account as more demand surfaces. Hence, there is still a need to address the FX liquidity challenge appropriately and we reaffirm our view that increased flexibility will be needed in order to allow restore investor confidence and boost autonomous FX supply.