Less than a month ago, when looking at Nigeria's deplorable economic and reserve situation, made far worse by the collapse in Nigerian oil exports courtesy of the Niger Delta Avengers, we predicted that "Nigeria Currency Devaluation Looms As FX Forwards Crash To Record Lows." Specifically we warned that "having urged investors "not to panic" last year, and seeing dollar reserves drying up rapidly earlier this year, recent "lies" about the nation's statistics have raised fears of a looming devaluation as FX forwards have crashed to 291 Naira to the dollar (current peg is 199)."
Specifically, the chart we were looking at was the one showing the dramatic divergence between the Naira spot rate and the 3M forwards which had blown out to record wides:
Ealier today this prediction came true when Nigeria’s central bank finally threw in the towel when it announced that the it will allow the Naira exchange rate to be market-driven, setting the stage for a devaluation of the currency when the new system comes into effect June 20.
Instead of depleting its much needed (and virtually non-existent) foreign reserves, 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 exchange rate and the bank will intervene in the market “as the need arises,” Governor Godwin Emefiele told reporters in Abuja, the capital, Wednesday.
Cited by Bloomberg, Emefiele said that “we’re talking about an open, transparent two-way system. It’s intended we don’t have speculators and rent-seekers. I don’t expect that any other exchange rate will be recognized.”
As Bloomberg adds, Emefiele has faced calls for more than a year to devalue the currency, as other oil exporters from Russia to Kazakhstan and Angola have done, amid a rout in crude prices since mid-2014 to around $50 a barrel. Investment into Nigeria has shriveled as foreigners are put off by capital controls needed to defend the currency’s peg of 197-199 per dollar, while local businesses have struggled to import raw materials and equipment. Emefiele said last month the central bank would implement a “flexible” exchange-rate policy to help alleviate a dollar shortage that has strangled the economy. Nigeria's GDP contracted in the three months through March for the first time since 2004 and inflation accelerated to 15.6% in May, the highest rate in more than six years. It is about to explode much higher.
To be sure, the market reaction was instant: three-month non-deliverable naira forward contracts, already trading at a high premium to spot, surged as much as 9.5% to a record 333 per dollar after the announcement, suggesting traders expect the currency to trade around that level in the market, compared with the current official rate of 199.
For now it remains to be seen just how the devaluation will take place: “It is something the market will want to see in operation to fully be able to take decisions concerning future investment, especially foreign investors,” Kunle Ezun, an analyst at Ecobank Transnational Inc., said by phone from Lagos. “The takeaway is that the central bank has not committed to any exchange rate.”
To some this was a favorable outcome: “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.”
To others, such as Nigeria's 175 million-strong population, this means that Nigeria is about become the next Venezuela, with imminent hyperinflation on deck, as prices soar to keep up with the collapse in the spot rate. The naira will probably trade in a range of 280 to 350 against the dollar after the central bank implements its decision, analysts at Johannesburg-based Rand Merchant Bank said in a note on Wednesday before the announcement.
Of course, what is bad news for the population is great news for capital markets, and since the central bank will have more reserves left now that primary dealers will be left holding the bag on FX trading (and thus devaluing the naira with double digit precision), it means that Nigeria will have more dollars left to pay off its liabilities. Immediately Nigeria’s 2023 dollar bonds gained most since 2014, with the yield falling 55 basis points to 7.1 percent, and stocks surged 3.1 percent.
The devaluation as a bullish case was best described by Old Mutual Global Investors, who said they would look to buy Nigerian bonds denominated in USD after Nigerian central bank said it will allow the naira exchange rate to be market-driven, John Peta, head of emerging market debt, says in interview. It added that with a free float, "the central bank can service the external debt without using USD reserves." It cautioned however that is would wait for future developments before getting involved in new market-driven regime for naira, and concluded that the decision to allow naira rate to be market-driven may play in favor of an inclusion of Nigeria in JP Morgan index again; which may explain why stocks surged today.
On the other hand, stocks always surge as a country is about to tumble into the hyperinflationary abyss. The question is whether the nominal price increase will keep up with the all too real collapse in the Naira's purchasing power which is about to slam Nigeria. If Venezuela is any indication, the answer is no.
Finally, for those wondering how to trade here, the answer may once again revolve around the Niger Delta Advisors: if Nigeria is unable to export more oil due to supply disruptions and thus inject much needed dollars into its Treasury, the country's financial situation wil get even more dire, leading to an acceleration in the naira's devaluation. On the other hand should Nigeria's government be successful in taming its offshore funded militants, the naira may be a buy, however that trade would be offset by a short in oil as the world's most acute crude supply disruption comes to an end.
In any case, watch out for unsolicited Nigerian emails from financially erudite locals asking you to buy stocks, bonds, or any other asset class. Those will result in guaranteed losses.