CBN halts quotation of offer rates for naira-settled OTC FX futures contract, eyes further reforms
•Fitch forecasts nation’s currency to end 2023 at N700/$1
•Predicts CBN’s policy rate to slump by 150 bps to 17.00% by year-end
•Projects petrol subsidy removal to trigger inflation in neighbouring countries
Emmanuel Addeh, James Emejo in Abuja and Nume Ekeghe in Lagos with agency report
The naira’s official and parallel rates converged yesterday, after days of volatility sparked by the Central Bank of Nigeria’s (CBN) move to allow the market freely determine the price of Nigeria’s currency.
Specifically, the naira strengthened by 1.8 per cent to N756.61 to a dollar at the close of trade yesterday, according to the FMDQ Exchange.
On the other hand, it hovered at N757 to a dollar in the parallel market, the executive officer of Forward Marketing bureau de change Ltd in Lagos, who compiles the parallel market data, Abubakar Mohammed, told Bloomberg.
Thus the rates practically closed the gap between them a day after the official value was 1.6 per cent weaker than the parallel market.
The convergence adds strength to President Bola Tinubu’s incoming economic plan, aimed at restoring fiscal stability and growth by eliminating subsidies, freeing up the currency and reducing debt.
Nigeria has seen a rash of reforms since Tinubu was sworn in last month to replace Muhammadu Buhari, who pursued unorthodox policies that had resulted in an almost 60 per cent spread between the official and parallel market rates.As part of the reforms, the CBN last week abolished segmentation in the FX market and collapsed all rates into the I&E window.
The naira weakened as much as 29 per cent on June 14 after the central bank lifted its controls and then briefly recovered, remaining volatile since then.
“We are allowing the market itself to set a price,” Deputy Governor, Economic Policy Directorate, CBN, Dr. Kingsley Obiora said in an interview in Rabat, Morocco on Monday.
The central bank plans to announce further measures to loosen foreign exchange controls “in the next couple of weeks” Obiora said.
Still, Nigeria is not going to set the currency totally free even now, Obiora said.
“There is no country in the world, even the US, that has a completely free float,” he said. The central bank will continue to pursue a managed float, Obiora said.
It may be too early to determine if the naira’s exchange rate to the dollar has bottomed out, Obiora said. He pointed to analysis done by the International Monetary Fund and international banks, which correctly suggested that the naira should not be as weak as the parallel market indicated, he said.
Obiora expects that the supply of foreign exchange will eventually be unlocked once the price of the dollar reaches a level that both buyers and sellers consider “fair.”
Tinubu’s early decisions since becoming president have caught the attention of investors after he scrapped fuel subsidies that cost $10 billion last year and removed the central bank governor who had been seen as the architect of the earlier unorthodox policies. Dollar bonds have gained and the stock market jumped to a 15-year high as a result of the changes.
The removal of subsidies, along with the convergence of the exchange rates will drive economic growth, especially from next year when the policies start making an impact, Obiora said.
“I completely expect us to do five per cent to six per cent growth next year,” he said. “Over the next four years, you may see the GDP approach something like $600 billion to $700 billion.”
Meanwhile, following recent reforms in the nation’s forex market, the CBN has put on hold the quotation of offer rates for the Naira-Settled FX Futures contract effective June 15, 2023.
This was disclosed by the FMDQ Securities Exchange Limited in a circular dated June 20, 2023, and addressed to all market participants.
It explained that the stoppage was due to the reforms in the Investors & Exporters’ (I&E) FX Window market by the central bank.
The exchange, however, assured the participants that they would be duly notified once the central bank resumes the quotation of offer rates in the market.
The Naira-settled OTC FX Futures product was introduced in 2016, with the CBN as the pioneer seller of the OTC FX Futures contracts.
The apex bank currently offers non-standardised amounts for different tenors, from one month through to 60 months to authorised dealers, who in turn offer the same to customers with trade-backed transactions or trade same with other authorised dealers; settling on bespoke maturity dates.
Essentially, the Naira-settled OTC FX Futures are non-deliverable forwards – contracts where parties agree to an exchange rate for a predetermined date in the future, without the obligation to deliver the underlying US Dollar – (notional amount) on the maturity/settlement date.
Upon maturity, both parties are assumed to have transacted at the Spot FX market rate. OTC FX Futures contracts are cash-settled in Naira and the differential between the contract rate and the Nigerian Autonomous Foreign Exchange (NAFEX) Fixing rate on the maturity day determines the settlement amount – the gain/loss inherent in the contract.
Relatedly, Fitch Solutions, a global financial information services company, has predicted that the naira would stabilise at N700/$ at the end of 2023, after the recent policy by the CBN to compel rates’ convergence.
In a country risk report titled: “Economic Reforms Will Fuel Inflationary Pressures in Nigeria”, the firm further forecasted that despite the anticipated rise in inflation, the CBN will cut interest rates by 150 basis points by end-2023, reversing its monetary tightening cycle that started in early 2022.
Besides, Fitch in deploying its analytical tools, explained that it believed that consumer price inflation in Nigeria will increase further in the coming months – from 22.4 per cent y-o-y in May – on the back of the removal of the fuel subsidy and the unification of Nigeria’s exchange rate windows.
“Despite the anticipated rise in inflation, we expect the Central Bank of Nigeria to cut interest rates by 150 basis points by end-2023, reversing its monetary tightening cycle that started in early 2022.
“The removal of Nigeria’s fuel subsidy will also drive up inflationary pressures in neighbouring countries, including Benin, Cameroon, Chad and Niger.
“We believe that consumer price inflation in Nigeria will increase further in the coming months. Inflation reached an 18-year high of 22.4 per cent y-o-y in May, driven by rising food and transport prices,” Fitch stated.
Stressing that a weaker naira following the unification of Nigeria’s exchange rate windows would increase imported inflation, it recalled that on June 14, the CBN had informed local banks that the exchange rate would be determined by supply and demand dynamics rather than by a fixed rate set by the central bank, breaking away from a tightly managed exchange rate policy.
“As a consequence, the naira fell from N472/USD to a record low of N655/USD on June 15. In the immediate term, we believe that the exchange rate will converge with the parallel market rate – a better indicator of the naira’s real value – which trades around NGN765/USD.
“The unit will then pare back some of its losses in the short term given improved dollar supply and stronger investor sentiment towards Nigerian assets, and end 2023 at N700/USD,” Fitch projected.
It stated that the consumer price growth would average 27.9 per cent in 2023 – the highest annual rate since the 1990s, informed by the removal of Nigeria’s longstanding fuel subsidy.
Despite transport only accounting for 6.5 per cent of Nigeria’s inflation basket, Fitch said it believed that the sharp hike in retail pump prices will add significant pressure to headline inflation.
To the firm, rising transport costs would have a cascading effect on various sectors of the economy, especially those that are particularly reliant on fuel, including the already-under-pressure agricultural sector.
It projected higher operational costs for farmers – as well as transporters and retailers – which will drive up food prices, which account for 51.8 per cent of Nigeria’s consumer price index.
The substantial weakening of the naira, it said, would sharply increase prices of imported goods and services, including refined petroleum, machinery and mechanical appliances, pharmaceutical products, and iron and steel.
“As Nigeria is reliant on these imports, we expect this to ripple through the economy, sharply increasing inflationary pressures in the months ahead,” Fitch predicted.
According to the firm, the tenure of the Acting Governor of the CBN, Folashodun Shonubi will be temporary, pointing out that in the coming weeks – Nigeria’s Senate would likely appoint a new governor who aligns with the president’s view that high interest rates are harmful to the economy.
“As such, we now believe that the CBN’s policy rate will be lowered by 150 basis points (bps) to 17.00 per cent by end-2023, compared to our previous forecast of an additional 50bps hike to 19.00 per cent.
“While this will make inflation somewhat more entrenched, the overall impact of unorthodox monetary policy on inflation will be limited given Nigeria’s relatively weak transmission mechanism and the supply-side nature of price pressures,” the report stressed.
The removal of Nigeria’s fuel subsidy, Fitch noted, will also drive up inflationary pressures in neighbouring countries since historically, Nigeria has offered heavily subsidised fuel prices, which – given Nigeria’s ‘porous borders and weak law enforcement’– have resulted in smugglers channelling fuel to neighbouring countries where petrol prices are traditionally higher.
As a result, Fitch revised up its inflation forecasts for Benin, Cameroon, Chad and Niger – the countries most impacted by fuel smuggling.
It further stated that there is a possibility that rapidly rising prices could result in a public backlash, which could force the new administration to roll back some of its reforms, posing a risk to the economy.