2012 Review: Exchange rates

The Naira enjoyed a good year in 2012 as it closed the year at N156.2/$ with a 3.8% appreciation against the US dollar and was one of the best currencies in Africa in 2012. As can be seen below the South African rand and the Ghanaian cedi in particular had a pretty torrid year.

Just in case you’re not up to speed on currency, there are several exchange rates in Nigeria; the official rate is the rate you obtain if you’re importing something of economic importance and for government transactions. This rate is usually lower and very stable throughout the year – it closed 2012 at N155/$ posting a 0.6% gain against the US dollar from 2011.

The second major rate or more exactly class of rates is the interbank rate which is the average rate at which forex can be bought or sold across Nigerian banks. Now a digression, you would think since the official is low why not go through there to finance you international trade deals – well the documentation involved for the official transactions is humongous for legal reasons and usually you’re better off trying your luck at the interbank especially for transactions that are not of significant amounts. In addition, it is illegal to use forex obtained at the official for reasons other than that stated on your request.

The third rate is the most popular and its often referred to as the black market rate although the name is wrong as since the late 1980s, they are no longer illegal but actually allowed, they are referred to as Bureau-De-Change BDC operators. This rate is much higher than the former two and due to information asymmetry varies from geographically within ranging bands.

Figure 1: Performance of Selected African currencies in 2012

Source: Bloomberg

Now that we are on ‘even stevens’, the decent performance of the Naira in 2012 was largely due to strengthened foreign flows (read supply) to the interbank that resulted in a concurrent decline in total sales at the twice weekly official Wholesale Dutch Auction System (WDAS) sales by the Central Bank of Nigeria (CBN). Infact, WDAS sales came in for the year at a four year low at $18.952billion and foreign reserves closed the year at $44.178billion – a figure not seen since May 2009.

The main reason for this lower figures and partly for the naira’s performance is as a result to some changes in import demand in 2012 as the Q3 international trade figures reveal. Oil imports declined by some 26% from 2011 levels possibly due to the tight payment system witnessed in 2012. If you watch the Nigerian stock market closely, many petroleum marketers had an awful year as while the Broader Nigerian Stock Exchange had a bumper year posting a 35% return the petroleum sector had a 33% decline on account of higher interest payment on short term borrowings – many marketers essentially went red. This was as payments were only approved after a lengthy verification process via a presidential committee which created lags and delays and which inevitably led many marketers to slow down imports hence the scarcity we had towards the tail end of 2012.

In addition, non-oil imports the larger component of imports fell by 13% due to tariff changes and trade restrictions on cement, wheat and rice in 2012 to bring total imports as at Q3 down 18% from the Q3 2011 figures. Now as majority of imports is financed by forex sourced officially this can be seen adduced to have slowed down import demand creating less pressure on the naira.

Nevertheless the story isn’t all that rosy as the naira came under severe pressure in the middle of the year over June-July – an event which saw the CBN get aggressive and jump into the interbank market as a participant. This also coincided with the period in which global oil prices weakened possibly due to the #GREXIT which sort of became a global risk event until Mario Draghi made his famous “the euro is irreversible speech“.

Figure 2: Naira-dollar exchange rate and Brent Crude prices

Source: EIA, FMDA

So why did foreigners suddenly begin flocking the Nigerian interbank market in 2012? Well the most probable reason would be the August 2012 announcement by J. P Morgan of its decision to include Nigerian bonds in its Emerging Market Government Bond Index, Barclays also came out in November with the announcement that it would include them in March 2013. Now why did this make much difference? – another digression.

You must have heard about the word “quantitative easing” which quite simply is a loose unconventional monetary policy tool in which central banks in countries with already zero interest rates seek to stimulate their economies by carrying out large scale purchases of financial assets financed by ‘printing money’ essentially. In 2012, the US Fed Reserve began QE3 in addition to Operation Twist, not to be left out the BoE and BoJ no slouches themselves joined the fray. The result returns on fixed income assets like treasury bills and bonds hit record lows, however, Emerging markets usually riskier have higher yields so the opportunity cost of you investing there depending on your risk appetite was significant enough to result in increased portfolio flows out of the big western markets into emerging markets to which Nigerian fit snugly into this category.

With growth rates of 6-7% over the last 5years and high oil prices, foreign investors stood to make good gains in Nigerian bills and bonds. However for so long the Nigerian CBN had a sort of capital control in place that was only loosened in Q3 2011 – foreigners were allowed to hold Nigerian bonds if only they held it for more than a year. The lifting of this restriction and increasing liquidity as a result of larger issuance of some select bonds the 5-year, 7-year and 10-year helped. So with the inclusion in August, foreign fund managers no longer had a reason to sit on the fence with an index to track. Thus shortly after the announcement, yields across the curve fell 300-400bps. In addition, the CBN nicked off some demand by proscribing concurrent access to its standing lending facility (SLF) and the WDAS.

Now what of other currencies, with the exception of the Japanese yen which weakened against the naira due to deliberate weakening action by Japan towards the end of the year, other currencies held up fairly largely because of the cross effect. Anyway they are insignificant unless you’re a student or do trade regularly with the European Union, you are likely to deal with the Naira.

With no major political event in 2013 that could trigger a sovereign ratings downgrade, the outlook for the naira in 2013 is hinged largely again to oil prices. Foreign fund managers essentially view Nigeria through the oil price lens, with strong oil prices, they believe Nigeria is a good investment case and vice versa. Now what will happen to oil prices in 2013 will be the subject of another blog post. However, I leave hints with the recovery in China’s economy after the leadership change which I personally believe resulted in some of the slowdown, their growth engine with gradually kick into gear providing ample support for oil demand. Furthermore, Japan has taken all but two of its nuclear reactors offline several Europeans are scheduled to do this as well plus we are bound to have political uncertainty from the Middle-East from time to time to support prices as Algeria recently showed. Nevertheless the boom in the US oil production will provide some weakness but as Shale oil extraction is only economical above with WTI (West Texan Intermediary Oil) prices above $70 that sort of acts as a floor below which in the worst case scenario prices can fall. Therefore barring any sudden collapse of oil prices I expect the Naira should remain stable over the year.

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