Naira-Dollar Currency Exchange Outlook & Forecast

Babajide EwuosoClick here to view Babajide Ewuoso’s profile
Babajide Ewuoso
Founder/Executive Chairman, Greenfield Advisors Limited
Published Jul 20, 2015
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THE NAIRA-US$ DOLLAR EXCHANGE RATE - RESEARCH ANALYSIS & ANALYST PROJECTIONS FOR H2/2015

BACKGROUND

The US Dollar $ remains the global economy’s most powerful convertible currency, preferred medium of exchange and ‘safe haven’ currency in which most nations’ external national reserves is held. Trade and exchange in virtually all major commodities (silver, gold, oil, gas, wheat, sugar, steel, cocoa, coal, corn etc.) are predominantly denominated in US$; hence the currency (and the demand for it) remains central to the modern global economic system. The US is still the biggest economy and single largest national market in the world.

KEY FACTORS AFFECTING THE OUTLOOK FOR THE CURRENCY EXCHANGE RATE

With about 9.5 million barrels per day (bpd) in daily crude oil production now, the new US domestic energy reality has profoundly altered currency dynamics globally.
US Shale Oil & Gas, coupled with existing strong production bases in Texas and the Gulf of Mexico amongst others, has fundamentally changed the balance of payments and trade against the OPEC and other oil exporters because the US doesn’t need to expend as much in US$ dollars terms as it did in the past to import crude. This is equally true for other major importers such as the EU and China -2nd biggest economy in the world (whose annual crude oil import bill, for instance, has reduced from an estimated $350b annually to around $212b because of the huge decline in the cost of crude oil within the last four consecutive quarters – with a fiscal savings in foreign outflow of…you guessed right, US$,...to the tune of about $140b in one year.)
This changing market structure as well as on-going Geopolitics has consequently impacted upon the market prices for all blends of exported crude including Nigeria’s Qua Iboe and Bonny Light (which refiners often buy because of the low sulphur content in order to be blended with other heavier crude blends such as Iran Heavy, Mexican Isthmus etc. - though not for such exclusively.).
Led by the Saudis and the other Gulf Arab producers, OPEC is playing a long-game. The calculation is that the only way to permanently address and perhaps reverse OPEC’s declining share of total global crude production (and sales), is to discourage further investment in additional production capacity (a glut spurred on by then record crude prices) particularly in the non-OPEC sphere – by depressing market prices and forcing high-cost producers out. With about $800b in external foreign currency reserves, the Saudis can afford to wait out the shake-out. As well as UAE, Kuwait and Qatar, they also have US$ Trillions in Sovereign Wealth Funds, first-class (existing) physical infrastructure and relatively manageable population sizes. These GCC states control the bulk of OPEC quotas; therefore one can say they call the ‘shots’.
Hence, it is our considered judgment (on basis of an analysis of the evidence) that the outlook for the price per barrel of crude oil is likely to remain at best uncertain and the chances of experiencing $100 Oil in the market any time soon remaining remote. With much more Iranian production coming on stream (even Libyan following recent efforts to reconcile rival factional governments) and buyers already buying less, not more, of Nigerian Crude (reflected in foreign currency revenue terms and also in terms of volume as our recent unsold shipments as shown), net sovereign foreign exchange earnings would likely stagnate or even decline.
The weakness in the Naira therefore in part derives from such declining or flat forex earnings as much as it does from the weakness of, and funding deficit in, the local productive sector – necessitating the excessive need to import.
Were Nigeria to have very robust sovereign savings and foreign reserves like others in the OPEC cartel and also the likes of Norway, Alberta (Canada), Russia (we don’t… even if the volume of our cumulative earnings easily suggests we should); and also not be so import-reliant and in the habit of expending on average 3% of GDP or now close to N1.5 Trillion annually to service debt mostly spent on servicing an inefficient bureaucracy and unsustainable fuel subsidy (most of which thankfully is domestic debt; which nonetheless effectively prices-and-crowds out more-efficient private sector borrowing), the Central Bank of Nigeria would not have reportedly needed to spend about $26.6m daily, at a point, defending the value of Naira in the forex market and thus further deplete our external reserves.
It is the level of other countries’ demand for our products and services (hence implicitly demand for our currency) vis-à-vis the level of our demand for other nations’ products and services (hence our derived demand for their currency or usually the US$); that simplistically speaking, along with the fiscal health of each respective public treasury that determines the exchange rate.
This informed interplay of demand and supply; not monetary policy in of itself , nor psychological thresholds, regulatory directives and/or preferences; ultimately determines the rate at which currencies exchange on a day-to-day basis ceteris paribus.
As our population and development aspirations grows, we are importing more but receiving less for our own exports because of declining oil revenue receipts and systemic leakages across the Oil & Gas value-chain and because our non-oil exports, whilst growing impressively, isn’t of such a significant enough quantum yet in proportion to our needs, to positively reflect on the strength of the domestic unit a.k.a. local currency. Unless an unlikely major geopolitical event (such as a direct Saudi-Iran military confrontation beyond mere animosity and proxy conflicts for instance; yet another ‘Ukraine’ in Europe or armed conflict over the South-China Sea) occurs and subsists over a lengthy period, the market fundamentals (especially being reportedly over-supplied by over 3.5m bpd) do not support an optimistic outlook for the price of Bonny Light.
One legacy of the last Administration was the Agricultural Transformation Agenda which thankfully resulted manifest reduction in food import volume and food import bill because of a huge jump in annual tonnage of local food production over the past 4 farming seasons thus creating an effective ‘fiscal buffer’; otherwise the situation with domestic price inflation (c9.2%) would have been even worse particularly if the dire fuel subsidy imbroglio continues. We nonetheless note with caution the continuing impact of the security situation in the North-East on domestic food production.
Sadly, most State Governments are already over-borrowed; and the resultant debt service obligation, being a first-line charge on their declining Federation Account earnings, significantly reduces their capacity to bear basic obligations much less fund a Development Agenda (where one actually exists!). While this liquidity deficit might somewhat inadvertently help tame some inflation and importation, it is a systemic decline that shows an absence of buffers and scenario planning which negatively impacts on people’s lives and the developmental prospects of the nation – not to mention its undesirable potential to ignite civil disorder which is one thing our security situation at the moment certainly can afford to do without.
It is therefore important to situate the outlook for domestic inflation and the currency exchange rate within the context of these existing macro-economic, structural and socio-political realities.

GREENFIELD ADVISORS LIMITED’S EXCHANGE RATE ANALYSIS & FORECASTS FOR YEAR-END 2015

It is salutary to see the CBN so gallantly defend the Naira (amongst its other roles) for this long. We however believe it cannot continue to allow reserve depletion indefinitely; and that its decision to officially bar 41 imported commodities from the Official Inter-Bank Forex Market portends significant inflationary consequences.

This weighty decision, the latest in a series of policy initiatives aimed at addressing the Naira’s decline some of which have prompted some market participants to essentially accuse the CBN of ‘non-transparency in price determination’, while not entirely surprising is yet paradoxical given the fact that the Apex Bank’s Monetary Policy Committee (especially Governor Godwin Emefiele, CON) has always maintained that the Parallel Market is inconsequential; accounts for only a small share of total forex transactions in Nigeria and is in any case merely a market for unsanctioned transactions.

Without delving into the debate on the rationale and the timing, one nonetheless recognises the effect of such measure on domestic price inflation and the Naira in the short and medium term. Coupled with the situation with petroleum product imports; forcing buyers of iron rods, food products etc. to procure dollars from the so-called ‘Black Market’ will likely induce the US Dollar to further strengthen against the Naira (in the near to medium term) even as the US Fed imminently unwinds Quantitative Easing. In point of fact, the relative present scarcity of dollars reported in the Parallel or Black Market is as a result of the general expectation among traders that the rate will continue to trend higher.

Should this inflationary scenario play itself out, the CBN might be find itself with no option but to further devalue the currency for the sake of price stability and reserve preservation, and perhaps reverse its stance by re-admitting some excluded imported items into the Official market in an eventual effort to stabilise the exchange rate and in an attempt to harmonise rates between Official and Parallel markets (circumstances permitting).

Long-term, our domestic output and non-oil exports must expand (fast!) and we must moderate our reliance on importation and possibly bring it to a bearable minimum. This imperative however faces strong headwinds such as; the near absence or inadequate supply and/or quality of immediate locally-made substitutes, the government out-competing with producers/ borrowers for loanable funds by paying double-digit interest on tax-free bonds and treasury bills; uncompetitive physical and regulatory environment as well as a disenabling infrastructure deficit.

Also If domestic industry and entrepreneurs’ can’t get ample access to affordable financing, job creation would remain weak; hence total domestic production is likely to remain low, further inducing increased importation and inflation - which negatively impacts on exchange rate stability and balance of payments.

It amounts to a case of what Chief Kola Jamode (an industrialist and former Minister of Commerce & Industry) describes as "exporting jobs and importing poverty".

These aforementioned issues remain the key priorities which the National Economic Management Team must urgently address its efforts to - in order to sustainably develop the economy thus effectively strengthening the Naira's value long-term (against all currencies, not just the Dollar).

What the CBN Governor said
Speaking on Nigeria’s foreign debt, Emefiele said “We have ensured that any of our debts due is given utmost priority, particularly foreign debts. It’s like first line charge.

“The minister talks to me about it and we will ensure that wherever we find the dollar we pay most of our debt before we service any obligation. That is a rule if it is Nigeria automatic sovereign debt.

“But when you talk about Azura. Azura is not, in our view, an authentic sovereign FX debt.“

The CBN Governor stated that the commencement of the Dangote refinery will be a major saver of foreign exchange for Nigeria, while also insisting that Nigerians will benefit greatly from the project.

He said, “The Dangote refinery once it begins production would be a major FX saving source for Nigeria.

“In Nigeria, from the FX we spend on imported items, importation of petroleum products consumes close to about 30%. Dangote refinery has the capacity to produce 650,000 barrels per day of refined crude oil. If the 650,000 is sold in Naira it would be a major FX saver for Nigeria.“

Emefiele said that the project costs about $17.5 billion and Dangote’s equity is about $9 billion. He added that $9 billion has been contributed by a combination of foreign banks, local banks and the CBN.

“That project is one of Nigeria’s backward integration programmes and we are very proud it is coming to light and indeed we know that refineries abroad are already scared because they know the market they will lose because Nigerians will prefer to patronise that than foreign imported refined products where we will save [on] transportation and logistics,” he said.

The central bank governor said that Nigeria could save close to 40% of foreign exchange imports through a combination of the Dangote refinery and a petrochemical plant that will be launched in June-July 2022. He added that when the project commences full operations, the currency would be floated and it would cease depreciation.

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