The difference in exchange rates between the Naira and the dollar decreases as demand for dollars declines.

Busy Bee November 7, 2023
Updated 2023/11/07 at 12:44 PM

In just one week, the difference between the official and parallel segments of the foreign exchange market narrowed significantly as demand for dollars decreased. The exchange rate spread decreased from N494 per dollar to N226.72 per dollar.

On the black market, the naira strengthened against the dollar to 1,020/$, up from a low of 1,310/$ the previous week. However, on the official market, the naira depreciated to N793.28/$ on Thursday compared to N786.02/$ the day before.

According to Ibukun Omoyeni, an economist at Vetiva in Lagos, the central bank allowed the exchange rate to float in the official market after the removal of subsidies. While the initial depreciation in the official market briefly aligned it with the parallel market, the FX gap reappeared due to a lack of supply and the backlog of FX demand from foreign portfolio investors, airlines, and importers.

After implementing measures to unify the FX regime in Nigeria, such as integrating Bureau de Change operators into the Nigerian Foreign Exchange Market and removing FX restrictions on certain items, the lack of available foreign exchange, combined with low net reserve stock, has caused the value of the naira to decline significantly in both the official and parallel markets.

This decline has been further exacerbated by the outstanding forward obligations totaling $6 billion, which were supposed to be fulfilled since February 2023.

Following the announcement of government plans to increase liquidity in the market, speculators have started selling the dollars they had been hoarding. Finance Minister Wale Edun disclosed on October 23 that the country is expecting up to $10 billion in new foreign currency inflows in the coming weeks to alleviate the severe dollar shortages in the foreign exchange market.

Additionally, the Central Bank of Nigeria has recently begun clearing the backlog of FX transactions and has already delivered on over 75 percent to 80 percent of the outstanding matured FX forwards in certain banks.

“While we acknowledge that there is a disconnect between Nigeria’s US dollar and naira-denominated markets at present, we question the favorable implications of such an influx of funds in Eurobonds,” commented Coronation Research analysts in a note dated October 30.

Regarding the expected $10 billion foreign exchange inflow, they remarked, “The foreign exchange market is undeniably the crucial point. It is worth mentioning that the exchange rate in the parallel market did not experience significant appreciation following the announcement made at the Nigeria Economic Summit.

The main concern, which remains challenging to answer, is whether the substantial amount of US dollars, the exact sum of which remains uncertain, will effectively address all outstanding US dollar obligations and meet the existing demand. Should this occur, we may witness a remarkable appreciation in the parallel exchange rate. We urge observers to closely monitor this development.”

JP Morgan has suggested several steps that the Federal Government should take to normalize Nigeria’s domestic financial market and reopen the local markets for investment. These steps include enforcing regulatory limits on foreign exchange (FX) net open positions for commercial banks, considering the introduction of a Cash Reserve Ratio (CRR) on FX deposits, issuing dollar assets onshore, and requiring all taxes to be paid in local currency. JP Morgan also suggests that oil exporting companies should sell their FX proceeds on the interbank market instead of directly to the central bank.

Additionally, the government should reconsider the current willing buyer-willing seller nature of the FX market, as it generates extreme volatility and hampers price discovery. It is anticipated that some of these measures may already be incorporated in the government’s upcoming revision of guidelines concerning the foreign exchange market.

Additionally, it is recommended that companies exporting oil should be encouraged to sell their foreign exchange proceeds on the interbank market instead of directly to the central bank. It may also be beneficial for authorities to reconsider the current willing buyer-willing seller nature of the foreign exchange market, as it contributes to extreme volatility and hinders price discovery.

Some of these measures may already be included in the government’s upcoming revision of guidelines for the foreign exchange market. The expected $10 billion in foreign exchange inflows over the next few months consists of $7 billion from the securitization of future gas dividends to the government and $3 billion from the securitization of future oil-related dividends.

JP Morgan has stated that it may be difficult for the government to raise significant amounts of money through certain channels. This is due to delays in receiving $3 billion from Afrexim, as well as Nigeria LNG Limited’s dividends to the government being lower than the expected $2 billion per year.

Additionally, the capacity of the company’s Train 1-6 fields is currently at 50% and plans to expand processing capacity with Train 8 are no longer feasible. However, there are indications that the government is in the final stages of securing a $3.5 billion package from the World Bank, which includes direct budget support and project-linked funds. There are also reports suggesting the possibility of funding from sovereign wealth funds in the Middle East.

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