However, subsequent inflation from an easing of currency controls means investors are likely to avoid Nigerian debt in the short term, especially local currency bonds.
The governor of the Central Bank of Nigeria (CBN), Godwin Emefiele has said that a more flexible foreign exchange system would soon be implemented.
The government has artificially supported the naira against the US dollar at between 197 and 199 to the US dollar since March last year, despite the currency trading at over 300 on the black market, reaching 350 to the US dollar last month. It is currently trading at 198.970 to the dollar.
While it is difficult to pin down where the naira should be trading according to Joe Delvaux, Senior Fund Manager – Duet Africa Credit Fund, Duet Asset Management, “what is clear is that while in January of this year a devaluation might have let the naira fall from 199 to the dollar to probably between 230 and 240 to dollar, it now it seems that the market is pricing in between 270 and 300.”
Despite the Nigerian MPC’s economic assessment that the lack of foreign currency convertibility has had a negative effect on domestic output, suggesting that there would be a devaluation of the naira, President Buhari’s opposition to allowing the currency to fall could impede proceedings.
“It no longer seems to be a question of whether President Buhari would interfere with the process; the focus is more centred on how a new FX system would work, since it seems that it might be a multi-tier FX system,” said Delvaux.
It is likely that certain industries will retain fixed exchange rates, while other areas of the economy will be given greater flexibility.
“At this stage, we expect to see the FX interbank market gain greater flexibility, and be allowed to move within a controlled range rather than a free float. However the CBN will retain a small window for the funding of ‘critical transactions’ at a set rate.”
A semi free floating naira would increase the country’s oil revenues, which account for around 70% of government revenues and over 90% of its foreign exchange reserves.
Oil production disruptions combined with low prices have resulted in lower dollar earnings for the country, which has further increased the pressure on FX.
“Once the naira FX band has been reset, it will lessen the strain on the country’s FX reserves and dollar-based oil income will generate higher naira revenues for the government,” Delvaux said.
He added however that the current FX backlog would be cleared at the new rate; meaning that entities currently waiting in the CBN’s FX queue would get fewer dollars for their naira than the current 199 official rate would give them.
Fewer currency controls alongside increasing naira revenues from dollar oil exports will affect foreign investment within Nigeria, but not in the short term.
Investors seem likely to welcome higher FX liquidity and an adjustment in the naira, but in the immediate aftermath of a fall in the naira we will likely see net outflows, especially from those waiting in the CBN’s FX queue.
Despite looser currency controls, investors are unlikely to jump at the opportunity to invest in the country’s bonds, especially its local currency notes.
“On the local currency side, the naira devaluation will result in a rise in inflation, as Nigeria is heavily dependent on imports. Local currency bond yields are over 13%, and with the latest inflation print for April at 13.7%, investors would run a negative real yield.”
The 2016 Budget has a NGN2.2tn shortfall, which is now most likely higher due to lower than expected oil production, suggesting that one can expect more government issuances to come to the market, pushing yields higher.
“This combined the possibility of higher monetary policy rates in order to stem the higher inflation would mean that most investors are likely to be staying on side-lines for longer before re-engaging with Nigeria,” Delvaux added.