Fresh pressure mounts on CBN to devalue Naira

The exchange rate went from N156 to N165 and finally N198 to the dollar after unifying the different forex markets.

Beside the fall in oil since June 2014, the country has also been confronted by power and energy challenges this year following payment dispute between government and oil marketers which resulted fuel scarcity and shut down in gas supply to the power plants. Further more public sector employees across the country have faced nonpayment of salaries by state governments some for over six months. About 27 of them owe salaries.

However, Mr. Phillips Ikeazor, Managing Director/Chief Executive Officer, Keystone Bank, said that overall harmonisation of CRR will make for level playing field and improve liquidity which will encourage increased lending to the real sector by banks.

Based on these factors experts believe that the economic outlook at least for the first half year will be negative which may compound further the woes of the local currency. Mr. Bismarck Rewane, Chief executive officer of Financial Derivatives had argued recently that mere oil export adds four percent growth to the economy implying that the projected 4.6 growth in 2015 may actually be negative in real terms.

Afrinvest, a leading research and investment banking firm, has noted in its investment report that weak macroeconomic fundamentals make currency devaluation plausible. According to the firm, the downward spiral of crude oil prices which commenced in the second half of 2014 and increased political risk profile prior to the 2015 general elections led to instability in the financial markets.

Against the backdrop of the fiscal strain and macroeconomic volatility that came in the wake of these developments, the firm said, risk perception of the Nigerian market heightened, with the attendant pricing of these risks on fixed income securities, both at the primary market and secondary market. A number of these risks range from credit risk, to interest rate risk as well as foreign exchange risk.

Currently, foreign investors are technically out of the market for reasons bordering on foreign exchange risk, at the turn of eventual policy direction on foreign exchange (further devaluation or floating of the currency), the return of foreign investors is expected to push yields lower.

Afrinvest said in that its view, local municipal bonds and corporate bonds will still be relatively illiquid as most investors continue to adopt the “held to maturity “trading strategy. Sovereign and corporate Euro bonds will also continue to portend an upside opportunity for local investors in anticipation of forex outlook (a probable near term devaluation).

It may be recalled that Central Bank of Nigeria’s Monetary Policy Committee left the benchmark interest rate (MPR) unchanged at 13 per cent at the conclusion of its meeting amidst the need to keep Nigeria’s yield environment attractive to foreign portfolio investors (FPI).

It believes that the direction of interest rate going forward is expected to depend on the overall macroeconomic policy direction of the Buhari administration. Consequently, a swift adjustment in rate is not expected in the interim.

Therefore, yield environment is anticipated to maintain relative calmness in the near term. Interest rate risk profile for fixed income investment thus appears contained in the near term.

The firm also mentioned that 2015 budget was passed by the National Assembly amid weaker economic realities. According to the report, fiscal stance still appears to be less contractionary, with 84 per cent of the budget (N4.5 trillion) allocated to recurrent spending relative to capital expenditure which was scaled down to N557.0 billon which is 11.1 per cent of the budget. That is to say that budgeted recurrent expenditure will be approximately five times the capital expenditure.

In the face of lower oil revenue as noted, about half of budgeted government borrowing which is N473.0 billion of N882.0 billion for the fiscal year had already been spent to cover overheads and salaries. Yet, a number of states have months of unpaid salaries due to drops from federal allocation.

Federal Accounts Allocation Committee (FAAC) inflow for April-2015 worth N388 billion was also shared for May expenditures amongst the Federal, State and Local Government authorities, adding to the level of liquidity in the system. Consequently, average level of liquidity in the month settled around N373.6 billion with a high and low of N853.0 billion and N136.3 billion.

“We expect government borrowing to increase; our conservative estimate is additional N500.0 billion, given the current position of the treasury even as recent plea for bailout by the Buhari-led Government by some APC Governors gives further credence to our reasoning. Hence, supply of fixed income securities is anticipated to increase markedly.

The firm noted as well that Nigeria’s credit rating from Fitch and S&P since 2014 has been a non-investment grade, following the plummet in global oil prices which account for a significant basis for the country’s sovereign rating.

On the back of the weakened external sector, macroeconomic volatility and strain on domestic polity, Standard and Poor’s (S&P) rating agency in March 2015 downgraded Nigeria’s sovereign rating to B+ with a stable outlook from BB — (Negative).

Fitch Ratings Agency however affirmed Nigeria’s Long-Term Foreign and Local Currency Issuer Default Ratings (IDRs) at ‘BB-‘ and ‘BB’ respectively, albeit reviewing the outlook on both from stable to Negative. Moody’s ratings however maintained Nigeria’s credit rating at Ba3 with a stable outlook.

The credit ratings published were on the back of the increased tension in the country which raised the political risks within this period. However, the successful conclusion of the election and subsequent transition to a new government has doused the political risk.

As a result, there has been a significant repricing, discounting for political risks, of assets since the conclusion of the election even as the market awaits the review of Nigeria’s Sovereign ratings.

Despite the high risk perception expressed in the low sovereign ratings, the firm views the possibility of a default as a low probability risk. Non-Oil sector driven growth and a coordinated fiscal and monetary policy responses has relatively constrained the corollary effects of the contracting oil sector on growth.

The smooth transition process that saw the successful takeover of power by President Muhammadu Buhari, despite the presence of insurgency in the North East region, is positive for sovereign rating. Low fiscal deficit to gross domestic products (GDP) ratio is additional layers of fiscal strength despite the current challenges.

Against the backdrop of policy measures put in place by the Apex Bank to check speculation on the Naira, exchange rate has witnessed an episode of induced calmness in recent times.

Interbank market rate steadied at N199.10/$1.00 on special intervention by the Central Bank of Nigeria (CBN) at N197.10/$1.00 – after the shutdown of the official window. Nevertheless, external reserves is down to N29.6 billion after tumbling 16.4% year to date (YTD) as lower oil prices and Apex bank’s efforts to defend the domestic currency continues to deplete the country’s external buffer.

Thus, high currency risk factors continue to define the yield environment as most foreign investors are somewhat staying aloof amidst the high possibility of a further devaluation post May-29, 2015. The Naira has fallen 20.0 per cent from N160.00/$1.00 to N199.00/US$1.00 between Nov-2014 till date.

Nigeria’s real return, MPR less inflation rate, which has been gradually thinning out from 5 per cent earlier in the year to 4.3 per cent will likely face further declining pressure as inflation expectation remains upbeat. Afrinvest said that it expects inflation risk premium on fixed income instruments to be broadly driven by macroeconomic concerns.

The investment banking firm articulates that Monetary Policy authority continues to maintain its tightening stance on the back of the need to sustain FPI amidst exchange rate depreciation. This has been sustained in the face of high cost of borrowing for the government as the fixed income yields track the benchmark interest rates.

The reality of the state of the economy does not suggest a possible near term adjustment in the policy rate from the current 13 per cent. However, with potential increased investment in the fixed income market post transition to the new government, there is a high possibility of lower yield environment.

Similarly, the uncertainty regarding probable future devaluation or floating of the Naira remains a tail risk factor to foreign investors.

The firm views the recent stability of oil prices above the $60.0 per barrel and marginal increase in the external reserves as confidence boosts that will be important in sustaining investors’ -especially foreign- appetite for fixed income investment going forward.

According to the detail on its note, the headline inflation is expected to continue its upward trend in the interim while foreign exchange rate policy depends on the trajectory of crude oil prices and corresponding effect on external reserves.

Headline inflation rate edged higher to 8.7% in April 2015, tiptoeing northwards for the fifth consecutive month since December, 2014. This remained in line with expectation given sustained pressure on exchange rate which occasioned the devaluation of the local currency twice in less than six months – from N155.30/$1.00 in November 2014 to N197.00/$1.00 in February 2015.

Moreso, the recent episodes of fuel scarcity resulting from concerns on subsidy payment by oil marketers are expected to push general price level further northwards given the direct correlation among fuel scarcity, transport cost and food prices in Nigeria.

However, with the depressed outlook for equities, fixed income investment will remain attractive for income investors and we expect pricing of yield spread over inflation rate to remain within a range of 4.5 – 5.0 per cent, similar to other B+ rated African Sovereigns.

“We do not expect another round of rally within the fixed income space in the short term and we project average yields on domestic Sovereign curve will remain priced within a yield band of 13.5 and 14.0 per cent, Afrinvest stated.

Our measure of liquidity for the month settled at 0.4 implying a modest liquidity level. Towards the end of the month, CBN’s harmonization of cash reserve ratio (CRR) at 31 per cent which quarantined a total liquidity of approximately N1 trillion from the system further tightened liquidity.

But Phillips Ikeazor, Managing Director/Chief Executive Officer, Keystone Bank however said that overall harmonisation of CRR will make for level playing field and improve liquidity which will encourage increase lending to the real sector by banks.

That noted, Afrinvest is of the opinion that illiquidity still largely characterizes issued local and state bonds in Nigeria given their non-availability for trading at the Financial Market Daily Quotation (FMDQ) platform.