Nigeria takes short-term pain

Nigeria takes short-term pain

21-06-2016 | Emerging markets alert

The Central Bank of Nigeria ended a 16-month currency peg and moved to a floating exchange rate regime on 20 June. As a result, the Nigerian naira fell by 29%. This decision should boost Nigeria’s economic growth and foreign direct investments in the long run. However, Robeco Afrika takes a cautious stance until tangible improvements are clear.

  • Jeroen van Oerle
    van Oerle
    Portfolio Manager
  • Cornelis Vlooswijk
    Director African & Emerging Markets Equities

Speed read

  • Nigerian naira falls by 29% after currency peg is abandoned
  • Move to boost economic growth and foreign direct investments
  • Robeco Afrika cautious until tangible improvements are clear

Although the exchange rate will be market-driven, the CBN will continue to intervene in the interbank market in order to prevent excessive volatility. The naira’s sharp devaluation caused it to end the day at around 280 per US dollar. Compared with the old exchange rate band of 197-199 that is a devaluation of around 29%.

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Peg policy was unsustainable

As Nigeria depends on oil revenues both for its government budget and its access to foreign currencies, the steep decline of the oil price had weakened Nigeria’s economy and the government’s financial position. In a free market this should have led to a significant depreciation of the currency. However, president Buhari and the Nigerian central bank chose to maintain a fixed exchange rate against the US dollar. Even despite repeated requests by Nigerian businessmen, foreign investors and the International Monetary Fund (IMF) the Nigerian policy makers refused to devalue the naira for a long time. This stubbornness led to a significant contraction of the economy.

Consequences of the old policy were:

  • Capital controls chased away foreign investors.
  • While stabilizing the currency, the controls starved manufacturers and trading companies of foreign currency needed to pay for imported materials and equipment. Economic growth fell during 2015 and the economy even shrunk 0.4% in the first quarter of 2016.
  • Inflation accelerated to an almost six-year high of 15.6% in May 2016, while controlling inflation was supposed to be the main objective of maintaining the exchange rate stable.

On June 20, the central bank auctioned a total of amount of USD 4 billion (USD 500 million in the spot market and USD 3.5 billion in the forward market), thereby clearing the backlog of orders to convert nairas into US dollars. This backlog was estimated at USD3-4 billion by a local investment bank.

Positive move for the long run

We believe that the decision to finally allow a significant devaluation of the naira was long overdue, but it is still a positive development. Better late than never. We expect the new foreign exchange regime to lead to a resumption of capital inflows: foreign corporates and investors should become more keen to plan new investments and deploy capital in Nigeria. Many foreign corporates had delayed planned investments in Nigeria because a devaluation appeared unavoidable and because of capital controls. Foreign investors had stopped buying Nigerian stocks for the same reasons. It is likely that at least some investors will return to the market.

We also believe that the naira devaluation should have a positive impact on the government’s fiscal position. It should increase revenues measured in local currency for the government. Economic growth should rebound as manufacturers and trading companies can operate more smoothly as they get access to foreign currency necessary for running their businesses.

We had expected local shares to rally on Monday as the economic outlook has improved because of the policy change, but that did not happen. After an initial rise most stocks even declined. Apparently local investors had been pricing in a sharp devaluation and some had probably expected a steeper decline of the naira. Given the subdued stock market reaction it looks like foreign investors have not yet responded to the policy change.

Robeco Afrika cautious for now

Nigeria is Africa’s second largest equities market and has a lot of long-term growth potential. When last year’s elections went smoothly and anti-corruption candidate Buhari won, the future looked bright for Nigeria. Robeco Afrika has however refrained from significantly increasing exposure because of the inefficient foreign currency policy on which the central bank and Buhari had agreed. Before the devaluation the Nigeria weight in the portfolio was 15.2%, but 1.3% of that was through a position in a London-listed stock for which a devaluation was already priced in. So the actual exposure to the Nigerian Naira was 13.9%, which was less than many other Africa funds. As, surprisingly, share prices in local currency did not rise, the impact of the devaluation on the net asset value of the fund was around 4%. Going forward we expect the Nigerian economy to get a boost from the devaluation of the currency. Many Nigerian equities are very cheap on valuation multiples, with some banks trading at less than half of their book value. An improvement in the economy and a normalization of the business environment should at some stage lead to a rerating. However, until we see some tangible improvements, Robeco Afrika will take a cautious stance on Nigeria.

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