NGN: Manageable Pressure With Downside Risks

BMI View: The naira will remain volatile over the next six months as downside pressure will emanate from the approach of elections and shifting global financial market sentiment. However central bank support will prevent the unit from depreciating significantly. Pressure should subside after the election but uncertainty over the trajectory of monetary policy poses risks to this view.

Short-Term Outlook (three-six months)

The naira has experienced volatile trade during the first half of 2014, continuing its form from the second half of 2013. We believe that volatility will continue to be the dominant theme for the remainder of the year as fundamental downside pressure stemming from the approach of elections persists. The authorities have sufficient reserves to prevent meaningful depreciation on the interbank market and to keep that rate within sight of their NGN155.00/USD +/- 3% target rate. With Nigeria's macroeconomic and political stability in sharp focus as the early-2015 vote approaches, the central bank will want to use these resources to prevent the naira from succumbing to depreciatory pressure over the coming months as significant depreciation would be a clear signal of distress politically and economically. With this in mind, although trade is likely to be volatile, we do not expect the currency to fall too far below NGN165.00/USD during the remaining months of 2014.

Volatile 12 Months For Naira
Nigeria - Exchange Rate, NGN/USD
BMI Nigeria Currency Forecast
Spot Short Term 2014 2015
NGN/USD, ave 162.70 165.00 162.65 167.50
NGN/EUR, ave 221.35 - 217.95 209.38
Policy Rate, % eop 12.00 12.00 12.00 10.00
Source: BMI/Bloomberg. Last updated June 25 2014

BMI View: The naira will remain volatile over the next six months as downside pressure will emanate from the approach of elections and shifting global financial market sentiment. However central bank support will prevent the unit from depreciating significantly. Pressure should subside after the election but uncertainty over the trajectory of monetary policy poses risks to this view.

Short-Term Outlook (three-six months)

The naira has experienced volatile trade during the first half of 2014, continuing its form from the second half of 2013. We believe that volatility will continue to be the dominant theme for the remainder of the year as fundamental downside pressure stemming from the approach of elections persists. The authorities have sufficient reserves to prevent meaningful depreciation on the interbank market and to keep that rate within sight of their NGN155.00/USD +/- 3% target rate. With Nigeria's macroeconomic and political stability in sharp focus as the early-2015 vote approaches, the central bank will want to use these resources to prevent the naira from succumbing to depreciatory pressure over the coming months as significant depreciation would be a clear signal of distress politically and economically. With this in mind, although trade is likely to be volatile, we do not expect the currency to fall too far below NGN165.00/USD during the remaining months of 2014.

Volatile 12 Months For Naira
Nigeria - Exchange Rate, NGN/USD

Long-Term Outlook (six-24 months)

While the authorities have the resources to defend the currency in the months leading up to the election, this is obviously not a sustainable situation over a longer time horizon. Indeed, reserves have already declined by more than USD10bn in the past 12 months to reach USD37.1bn on June 20 2014 from a peak of USD49.0bn in May 2013.

Reserves On The Decline
Nigeria - Gross Official Foreign Exchange Reserves, USDbn

There are several sources of pressure on the currency. A change in global financial market sentiment as investors price in higher interest rates in the developed world as well as investor concern about domestic Nigerian risk factors such as elections and the economy in general have seen portfolio inflows slow as indicated in the chart below.

Portfolio Flows Lower But Still Positive
Nigeria - Portfolio Flows, USDmn

However, we do not believe that this slowdown in portfolio flows is the only - or even the main - explanatory factor behind the decline in reserves and the concomitant pressure on the currency. As the two charts below illustrate, the external accounts have also been buffeted by large negative balances for the 'other investment' component of the financial account and for net errors and omissions.

Other Investment & Net Errors & Omissions Outflows
Nigeria - Net Errors & Omissions (LHS) & Components Of Financial Account Other Investment Outflows (RHS), USDmn

Looking at the spread between the interbank and the bureau de change exchange rates - with the latter being weaker - we believe that this demand has come more from retail buyers of foreign currency - ie ordinary Nigerians looking to externalise assets - rather than foreign or domestic institutional investors. The demand is also most likely made up of increased spending by politicians ahead of the election and by unrecorded imports.

Spread Indicative Of Retail Demand For Forex
Nigeria - Interbank & BDC Exchange Rates, NGN/US$ & Spread Between The Two

In so far as demand is related to the elections, the pressure should ease on the currency once they have taken place. However, there is a level of uncertainty about the naira owing to mixed policy signals from the central bank. New Central Bank Governor Godwin Emefiele made a speech in early June in which he outlined seemingly contradictory goals of lowering interest rates and ensuring currency stability. This suggests that he is likely to be more dovish than his predecessor, Sanusi Lamido Sanusi, who prioritised price and currency stability above all else when formulating policy. Because of some of the pressures outlined above, we do not believe that the CBN will loosen policy until after the election. From then however, the outlook for the naira will depend on whether the CBN priorities lower interest rates or currency and price stability.

Risks To Outlook

At this stage our long-term forecasts see a gradual depreciation for the naira over a 12-24 month time horizon based on the assumption that monetary policy will remain relatively tight. In the event that policy is loosened aggressively under the new central bank regime, the naira would come under far greater pressure than our current forecasts suggest. Additionally, with reserves on the decline, the naira is also susceptible to shocks such as a major domestic political event or a fall in oil prices.

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Related sectors of this article: Economy, Finance, Forex, Political Risk, Business Environment, Investment Climate, Monetary Policy
Geography: Nigeria, Nigeria
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