One Month On, Traders Ponder the Naira Free Float That Wasn’t

  • The naira may breach 300 per dollar by next week, RMB says
  • Bond yields too low to lure foreign investors, FBNQuest says

It’s been one month since Nigeria ended its currency peg, pledging to let the naira float freely in the interbank market. It did, for a day.

Since the naira fell 30 percent against the dollar on June 20, the central bank has kept a grip on the exchange rate. Foreign-exchange inflows have barely picked up, according to FirstRand Ltd.’s investment banking unit, as policy makers maintain measures to curb dollar demand. The naira weakened 0.3 percent to 294.25 per dollar on Wednesday.

Forward contracts, which are bought and sold offshore and seen as a gauge of foreign investors’ views on the currency, are at record highs, suggesting traders expect the naira to drop further. The question is when. Non-deliverable forwards maturing in three months rose 2 percent to 335 per dollar on Tuesday, while the black market rate of 368 is about 20 percent weaker than the official rate.

“We’re still plagued by the same problem we had prior to June,” said Nema Ramkhelawan-Bhana, an analyst at FirstRand’s Rand Merchant Bank in Johannesburg. “There’s growing import and investment demand that isn’t necessarily being settled. Market participants have been quite skeptical of this new framework. They’re not yet allowed to determine the rate themselves.”

Central bank Governor Godwin Emefiele and one of his deputies, Sarah Alade, met investors in the U.S. and U.K. last week to encourage them to buy naira stocks and bonds. Emefiele dismissed suggestions that there was too little foreign-exchange liquidity and said the black market was too small for investors to use as a gauge of the naira’s true value, according to two people who attended the private talks and asked not to be identified.

Forwards jumped and volatility surged following those meetings and after the central bank removed a rule capping the difference, or spread, between bids and offers in the foreign-exchange interbank market at 50 kobo on July 15. One-week historical volatility in the naira’s spot price increased to 21 percent this week, compared to an average of 6.7 percent over the past five years.

Curbing Demand

Still, little trading is taking place. Turnover in the interbank market averages around $40 million a day, according to analysts at Johannesburg-based Standard Bank Group Ltd. Three years ago, weekly volumes were as high as $1 billion.

The Central Bank of Nigeria is curbing demand for foreign currency by preventing importers of “non-essential” items ranging from glass to textiles from using the interbank market, forcing them on to the black market. Plus, to prevent speculation, all purchases of dollars in the interbank market have to be backed by customer orders, meaning primary dealers and other banks can’t trade for a profit on their own behalf.

After the central bank cut the spread limit, “market players appear to be more willing to bid for dollars at higher rates as demand remains strong,” Samantha Singh and Ayomide Mejabi, analysts at Standard Bank, said in a July 19 note. “It remains to be seen if this willingness of the central bank to see a truly free floating regime will be regarded as credible.”

‘Speculative Projections’

The CBN said nothing had changed since Emefiele’s meeting with investors last week.

“Investors should allow the market some time to work itself out,” said spokesman Isaac Okorafor. “No one is fixing any prices. The market is not bound to pander to unrealistic and speculative projections.”

Naira yields will have to rise by around 200 basis points before bond investors are keen to re-enter the country, according to RMB’s Ramkhelawan-Bhana. While average yields on local-currency government bonds of 15.1 percent are the highest after Egypt among 31 emerging markets tracked by Bloomberg, they’re negative in real terms, with Nigeria’s inflation accelerating to 16.5 percent in June.

Yet, the government seems reluctant to let yields increase much, according to FBNQuest, the investment banking unit of First Bank of Nigeria Ltd. Rates were kept below 15 percent at a 120 billion naira ($420 million) bond auction on July 14 and “offshore buyers were again notable for their absence,” Gregory Kronsten, an analyst at FBNQuest in London, said in a note.

Tricky Sell

Nigeria faces a tricky sell even if it frees the naira, with inflation rising, the economy weakening and production of oil, which provides the bulk of export earnings, down since February as militants attack pipelines. Economic output will probably shrink 1.8 percent this year, the first contraction in more than two decades, the International Monetary Fund said Tuesday.

That will heap more pressure on the naira, says Ramkhelawan-Bhana.

“A breach of 300 is very likely, if not this week then next week,” she said. “The rhetoric is quite strong. The market is pushing for more flexibility.”

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