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Nigeria mulls lifting forex restrictions as economic growth slows

The Nigerian economy expanded by 3.96% y-o-y during 2015 Q1, down from 5.94% y-o-y in 2014 Q4. The National Bureau of Statistics (NBS) recorded a 11.57% q-o-q decline in real GDP during Q1, representing an even more severe contraction compared to the situation a year earlier. The NBS highlights that the oil industry contracted by 8.15% y-o-y in Q1, partly on account of a 2.7% y-o-y decline in crude oil output to 2.18 million bpd as well as lower international oil prices.

The energy industry (electricity, gas and steam) reflected particularly poor performance during the first quarter of 2015, contracting by 27.9% y-o-y and 37.5% q-o-q. A shortage of electricity supply has been a perennial problem in Nigeria for some time, but the situation seems to have deteriorated further. Authorities blame the country’s poor performance in this regard on damaged gas pipelines.

The non-oil sector continues to be the main driver of economic growth in Nigeria, with the construction, trade, telecommunications and agricultural industries all performing relatively well during 2015 Q1. That said, there is very little to be optimistic about at the moment from an economic growth perspective. We believe the naira could well come under pressure again when forex restrictions are lifted. This will have both direct and indirect consequences. In relation to the former, higher input costs will adversely impact the supply side of the economy, while electricity constraints will only serve to exacerbate the situation. Furthermore, rising inflation will put pressure on consumers’ purchasing power and could well prompt monetary tightening.

According to Bloomberg, the Central Bank of Nigeria (CBN) has commenced discussions with commercial banks and currency traders on how best to start lifting forex restrictions. The Financial Market Dealers Association (FMDA) represents one of the parties involved in the deliberations. The FMDA is reportedly drafting a proposal to be submitted to the monetary regulator outlining a strategy aimed at increasing liquidity in the interbank forex market while simultaneously trying to avoid excessive speculation against the naira.

The naira exchange rate has remained unsurprisingly stable following the introduction of the ‘order-based’ system in February. Nigeria’s foreign reserves trended steadily lower following the sharp drop in international crude oil prices during 2014 H2 and the pace of reserve erosion accelerated further in February on account of election-related risks.

That said, the pressure on the local unit appears to have eased off to an extent following the mostly peaceful presidential elections and the level of foreign reserves seems to have stabilised somewhat in recent weeks. The recent rally in Brent crude oil prices in addition to the US dollar losing some ground from mid-April may also have been supporting factors.

The current order-based foreign exchange system – characterised by tight foreign exchange liquidity – is unsustainable in our view as it serves to deter both portfolio and direct foreign investment. Thus, signs that authorities are contemplating abandoning the system and restoring forex liquidity are certainly positive.

The timing of the move is not that surprising given that the pressure on the local unit has eased off to an extent – for reasons already discussed above – and considering that the JP Morgan Emerging Market Bond review is looming in June. Nonetheless, we believe authorities will lift forex restrictions only gradually to attempt to shield the naira from speculative attacks. In general, we maintain that the Nigerian unit at its current level remains overvalued and another devaluation may be required before the naira reaches a level that will see foreign investment interest return.

Cobus de Hart (Economist)

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