Out of Options Amid Economic Slump, Nigeria Abandons Naira Pegby
Central bank says it will allow currency to float freely
Announcement ends year of resistance while economy shrinks
Nigeria has finally bowed to the inevitable.
Battered by the oil plunge, starved of foreign currency and with the economy headed into recession, Africa’s second-biggest crude producer said Wednesday it will allow the naira to float, setting the stage for the currency to weaken. Free trade in the naira, set for Monday, will mark the end of more than a year of resistance by President Muhammadu Buhari, who reiterated his opposition to devaluation as recently as two weeks ago.
Markets reacted with glee. Stocks surged, with bank shares leading gains, while yields on Nigeria’s dollar bonds fell the most in two years. The decision surpassed many analysts’ expectations of a managed float or two-tier foreign-exchange system, and may draw back foreign investors who sold Nigerian assets, concerned that a devaluation would erode their returns.
A free float was “one option we didn’t see coming,” said Nema Ramkhelawan-Bhana, an analyst at Rand Merchant Bank in Johannesburg. “It’s definitely a step in the right direction. It’s long overdue and it will go a long way toward an economic re-balancing. But it’s just the first step.”
A free-floating and weaker naira won’t be just good news. It may also fuel inflation, already at a six-year high, and force the central bank to raise borrowing costs, hurting those who can least afford it: the poor.
“The economy is going to struggle for the rest of the year partly owing to the delay” in implementing a floating exchange rate, said Adewale Okunrinboye, an analyst at Lagos-based Asset & Resource Management Co. “The nation has suffered from the delay. Prices are going to come under pressure.”
The Central Bank of Nigeria will select a group of around 10 primary dealers through which the naira will be traded. There will only be one official exchange rate and the bank will intervene in the market to buy or sell foreign exchange “as the need arises,” Governor Godwin Emefiele told reporters in Abuja, the capital, Wednesday.
“We’re talking about an open, transparent two-way system,” Emefiele, 54, a former chief executive of Zenith Bank Plc who has headed the central bank since June 2014, said. “The exchange rate would be purely market-driven. I don’t expect that any other exchange rate will be recognized.”
Nigeria has held the naira at 197-199 per dollar since March last year, spending about $2.7 billion -- 9.3 percent of its foreign reserves -- to defend the peg this year alone, even as other oil exporters from Russia to Kazakhstan and Angola devalued their currencies as crude prices more than halved since 2014 to around $50 a barrel.
Investment into Nigeria has shriveled as foreigners are put off by capital controls, while local businesses have struggled to import raw materials and equipment. International carriers including United Airlines and Iberia have halted operations in the West African country, saying they couldn’t move revenue out.
Three-month non-deliverable naira forwards surged 1.9 percent to a record 310 per dollar on Wednesday, suggesting traders expect the Nigerian currency to trade around that level in the market. The contracts rose further to 311.5 as of 2:03 p.m. in London. Stocks climbed 2.6 percent on Thursday, the best performance worldwide, after jumping 3.2 percent yesterday. Nigeria’s 2023 dollar bonds slipped, sending the yield up 15 basis points to 7.21 percent, following the biggest gain since 2014 the previous day.
“It’s probably the best that the markets could have hoped for,” Ridle Markus, a Johannesburg-based analyst at Barclays’ Africa unit, said by phone. “It certainly seems like it will be a normal, free-floating currency. That would be positive.”
The turnabout came after gross domestic product contracted in the three months through March for the first time since 2004 and inflation accelerated to 15.6 percent in May. MSCI Inc. said Wednesday -- before the central bank’s announcement -- it may drop Nigerian stocks from its Frontier Markets Index because of capital-mobility issues.
To help reduce currency volatility, the central bank will introduce over-the-counter naira futures trading, which would move non-urgent foreign-exchange demand from the spot to the derivatives market, Emefiele said. There will be no pre-determined spread on spot transactions, he said.
Investors may remain wary of buying naira assets given that Nigeria’s oil production, which accounts for the vast bulk of export earnings, has plummeted since February to an almost 30-year low amid an upsurge of militant attacks on crude and gas pipelines, according to Gaimin Nonyane, an economist at Ecobank Transnational Inc. in London. The naira will probably trade in a range of 280 to 350 against the dollar from next week, she said.
“The speed of economic contraction probably surprised” the central bank, said Ayodele Salami, who manages about $500 million of African equities as chief investment officer at Duet Asset Management Ltd. in London. His company has reduced the proportion of its assets invested in Nigeria to 20 percent from 40 percent in the past 18 months. “If it turns out that the new system does what it says -- a free float with occasional central-bank intervention -- then it would it encourage us to come back into the market.”