Nigerian Foreign exchange Market: The Impact of Recent escalation of dollar rate on the Nigerian Forex Market

This article hopes to provide useful information and guide to investors and prospective investors in the Nigerian Forex market.  Given the current volatile state of the nation’s economy, this article will arm prospective forex traders and investors in the Nigerian Forex market with useful information and offer them chances of executing more favorable and profitable trades.

 

Currency Effects

Currency fluctuations impact heavily on the economy of any nation but the majority of times,

individual and businesses that operate only locally are unaware of these consequences. Floating exchange rates of major world economies usually result to currency fluctuation. A common fallacy is to think that a strong local currency is better than a weak local currency. However, an exceedingly strong currency can cause a huge overall economic drag which would result to job losses and render businesses noncompetitive.

Although domestic consumers suffer in a weaker economy due to increase in the prices of imported goods and higher costs of overseas travel; in reality a weak economy is more beneficial economically. The worth of the domestic currency in the forex market is a significant instrument for every central bank and forms the foundation for the nation’s monetary policy.

Foreign exchange investments

The exchange rate of one currency against the other is determined by a lot of factors like relative supply and demand of the currency pairs, economic outlook and inflation stance, differences in interest rates, cash flows and so on. The constant fluctuations of these factors from time to time results to the fluctuations of currency values. As these factors are generally in a state of perpetual fluctuation, currency values fluctuate from one moment to the other.

Despite the fact that a nation’s currency rate ought to be determined by the primary economy, oftentimes, the reverse is the case, due to the fact that massive flow of a currency can determine the wealth and growth of a nation’s economy.  Investing in foreign countries involves a greater degree of risk and increased volatility. Changes in currency exchange rates and differences in monetary and taxation policies in foreign countries can improve or reduce returns.

Nigerian forex market and currency effects

The economy of Nigeria is badly hit this year. Nigeria has suffered a shocking downturn in 2015 due to insufficient supply of foreign exchange occasioned among other factors by sharp decline in the global price of oil. Nigeria is ranked as the 12th and 8th global largest producer and exporter of crude oil respectively with petroleum accounting for the largest chunk of the country’s foreign exchange earnings. Crude oil accounts for 80% percent of total government revenue and about 40% of the nation’s GDP.  

National Bureau of Statistics (NBS) Quarterly Real Gross Domestic Product review of 2013- 2015 indices in (%)

The steady fall in the price of crude oil and the corresponding decline in the supply of forex resulted to depreciation of naira against US dollars given that the Nigerian economy is currently crude oil dependent.  The lowered supply of forex (dollar) and increase in the demand for dollar caused the official rate of a dollar to reach 198 naira in the official market and 280 naira at the street market on the 18th of December, 2015.

In an effort to tackle the precarious financial situation of the country, CBN introduced monetary policies that imposed certain restrictions on forex. The restrictions forced businesses to resort to the street market for access to forex and this led to massive December 18 dollar exchange rate.  Bureau De Change operators said that the sharp decline in the value of naira to dollar was due to further drop in the broadsheet sales of dollar by CBN.

Overview of Nigerian Forex Market

The Forex market is the most traded Nigerian financial markets and officially operates under three sections:

  • The Central Bank (CBN) which is the Primary Market,
  • The OTC which is Secondary Market and;
  • The Bureau-de-Change which is the street Market/ black market.

The CBN is the largest dealer and leader in the Nigerian Forex market while the OTC market is the most influential and decisive market. The currencies that are being traded in Nigeria Forex market are: the USD, Canadian Dollars (CAD), Swiss Francs (CHF), Euros (EUR), Pound Sterling (GBP), Japanese Yen (JPY) and South African Rand (ZAR) while the most traded currency pair is the USD/NGN. This explains the upward trend of dollar rate against naira in forex market given the global fall in oil price.

2015 Forex Market Analysis

The Nigerian forex market analysis by FMDQ OTC securities illustrated in the figure below shows that forex transactions between member-client exerted a dominant effect consisting of 67.43% total volume of trade. Member- member trade volume accounted for 14.13% trade volume while member-CBN trade accounted for 18.25% trade participation within the year. The index also shows that trade participation in the Forex market YTD amounts to a total of 279,309 trades implying a daily trade volume of 1,390.


Source: FMDQ OTC Securities Exchange

Nigeria’s foreign Forex reserves fell 3.14 per cent to $30.48 billion by September 23 from $31.47 billion in August, according to data published by Central Bank of Nigeria. This trend of insufficient supply of forex by the greenback in the Nigeria foreign exchange market is adversely affecting businesses in Nigeria who want to use or transfer US dollars abroad.

A few factors that have contributed to the distortion in the Nigeria forex market are:

  • Huge drop in foreign exchange inflow due to anxiety over the election year.
  • The significant fall in the price of oil and the fact that Nigeria is oil dominated economy.
  • A rise in interest rates: The US Federal Reserve also raised interest rates for federal funds by 0.25 percent to 0.5 percent. This as well contributed to a further strengthening of dollar.

 

Inclusion and delisting of Nigerian in JP Morgan’s BI-EM Broad

GBI-EM Broad is the all-encompassing investable index that incorporates all qualified countries irrespective of money controls and/or regulatory and tax hurdle for oversea investors. It incorporates only countries whose forex markets can be directly accessed by the majority of foreign investor’s base. 

 

The countries that were included with Nigeria in  the 2013 JP Morgan’s index of emerging market economies are  Brazil, Chile, China, Colombia, Hungary, India, Indonesia, Malaysia, Mexico, Nigeria, Peru, Philippines, Poland, Romania, Russia, South Africa, Thailand, and Turkey.

 

After South Africa, Nigeria was the second African country to be included in the index with a weight of 1.8 per cent. In September, the projected capitulation for Nigeria bonds on the index was 14.83 %. This makes Nigerian bond the second most ranked after 15.75 per cent bond rate of Brazil.

The inclusion of Nigeria in the JP Morgan’s catalog of emerging economies in 2013 attracted massive investment into the country. However, the effect of global market situations which is mostly determined by global market situations and beyond Nigerian control put massive pressure on the nation’s currency value.

Reacting to this financial crisis, the Nigerian CBN was forced to introduce stringent monetary policy aimed at stabilizing the naira. The policy imposed certain restrictions on forex. This move led to delisting of Nigeria from JP Morgan’s index this year.  The bond indices released on the 17th of December in the diagram below, showed that JP Morgan has finally delisted Nigeria. Some analysts say that the development will result in negative market sentiment and low investment.

 

 

The 2015 downward trend of Nigeria economy and fall of the value of Naira

The year 2015 started with depreciation of naira against the US dollar at the rate of N202 per a dollar at the street market in January. This downward trend continued throughout the year and hit its worst this December. Brent crude which averaged $52 per barrel in January dropped to $37 per barrel on 18th of December, 2015. The economic tension of 2015 forced the CBN to devalue Naira two times and although many foreign investors and financial analyst advocated for further devaluation of the Naira, the Federal Government and CBN has remained adamant to the call.

CBN hopes that the tight monetary policies and measures taken to minimize liquidities will reduce inflation, increase reserve and strengthen naira.  The benchmark interest rate was left for the major part of the year at 13 per cent and finally reduced to 11 percent, the lowest since 2009.  There is a significant drop in the trade volume of NGN/USD this year from what it was last year, 2014 as shown in the diagram below:

The Naira (NGN) vs. USD currency pair (Image source: Bloomberg)

The present inflation in the country is the greatest since 1999 as a result of almost total dependence on oil which is by and large determined by the global market.

 

    

 

Nigerian naira is projected to strengthen gradually to 159 per a dollar by the year, 2020, according to statistics from trading economics.

 

The position of Nigerian Government and CBN

Despite frowns from oversea communities, the Nigerian government is happy with the result achieved by the restrictions on forex. The move stabilized Nigerian foreign-exchange reserves and reduced current-account deficit which the Vice President Osibanjo says, “it is good in the short term.”

A spokesman of Nigerian CBN, Mu’azu , reacting to JP Morgan’s reason for delisting Nigeria from emerging market index argues that Nigeria “makes use of an order-based, two-way foreign-exchange market”  to even out the naira and lessen  market speculation. The governor of Nigerian Central Bank, Emefiele also argues that there’s sufficient liquidity in the money market for nationals of other countries who wishes to trade in Nigerian bonds.

 

PDF Source: 2015, National Bureau of Statistics (NBS) Quarterly Gross Domestic Product

The result obtained in the NBS quarterly Gross domestic product shown in the figure above implies a positive move from oil dependent economy to a more diversified economy. To reduce the deterioration of the reserves, the CBN has been imposing some restrictions on importation of non-essentials.

Although the Forex controls have helped to stabilize the Nigerian currency, a few foreign investors and CBN governors of some foreign countries think that the naira is overvalued and is kicking against the move.

My candid opinion

To expedite the strengthening and stabilization of the value of Naira, the Nigerian government must invest massively in domestic production and cut down on the volume of importation of non-essential goods. The government must also as a matter of urgency consider diversifying the economy, investing on other sectors and diverting attention from oil.

Expectations for Nigeria Forex market for 2016 and beyond

As the year is draws to a close:

 

  • We look forward to an improved economy and a more vibrant forex market in the coming year.

 

  • We hope to get 2015 comprehensive assessments of the Nigerian forex market with predictions for 2016 and as a guide for trade in the coming year.

 

  • We also look forward to a global outlook and evaluation of major African forex markets.  

 

  • We expect a better economic stance for various sectors of the economy and look forward to an all-inclusive economic report that will guide trading decisions of investors in the financial market.

 

  • We look forward to global economic analysis and position, African financial market analysis and stance together with a more stable oil prize in 2016.  

 

  • We, as well, anticipate that in the coming year, major financial market trends and outlook will help to stabilize oil prize.

 

  • We look forward to honest evaluation and stance of capital markets together with specific sector reviews and recommendations.

 

Share your view!

 

What is your take on the current state of the Nigerian financial market? What are your opinions and projections for the coming year? How do you think that the market can be stabilized to proffer more liquidity and attract more investors and Forex inflow given the depreciation in the prices of oil?

 

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