By Chinwendu Obienyi
Following recent positive sentiments around Nigeria’s local currency, U.S multinational financial services firm, J.P Morgan, has urged the Federal Government and the Central Bank of Nigeria (CBN) to maintain a willingness for a greater exchange rate which is projected to close at N850/$1 at the end of the year.
This, the firm, said is necessary with the combination of a tighter policy, attractive rates and FX levels to deter the increment of dollars and attract foreign capital into the economy.
According to report titled ‘Nigeria local markets strategy: Getting set for re-opening’, seen by Daily Sun on Thursday, JP Morgan, whilst praising the government and the apex bank in their efforts to restore a flexible FX regime, said this can be sustained with the country’s willingness to accompany it with tighter monetary conditions.
“The interbank FX rate has risen in recent days to over 900, from 750, thereby significantly closing the gap to the parallel rate which is now just above 1000. We expect USD/NGN to eventually move lower towards 850 by year-end as the combination of tighter policy, as well as more attractive rates and FX levels deter incremental dollarization and perhaps attracts some foreign capital”, the firm said.
While noting that unifying the various FX windows and eliminating the longstanding list of ineligible transactions helps simplify the FX policy framework, JPMorgan said that due to still limited FX liquidity in the official market, and the fact that Naira isn’t a fully convertible currency, some of the FX demand will inevitably find its way to the parallel market.
“In our opinion, when authorities refer to the FX backlog, they are actually referring to US $6.8 billion in FX forward commitments which the central bank has not honored – the majority of which has been covered by commercial banks.
However, we estimate there is up to a further $3-4 billion (probably less given the FX adjustment) in unmet FX demand needed for goods and services imports. CBN will need to clear both backlogs, a difficult task given the low levels of net FX reserves”, the report said.
JPMorgan also believes the current -300 basis points (bp) / +100bp corridor around the 18.75 per cent policy rate needs to be narrower in order to increase the market (and real economy) relevance of the policy rate.
“Indeed, as we have noted previously, the CBN appears to be in the process of normalizing monetary policy, despite the fact that a monetary policy committee (MPC) meeting hasn’t held since July. Assuming the OMO auctions are held on a more regular basis, we expect it will result in tighter liquidity conditions, which will in turn help slow dollar demand,” it said.
JPMorgan Chase & Co said its economists expect the CBN to keep the policy rate unchanged at 18.75percent for the foreseeable future.
“While optically and for signalling purposes, this may appear odd, especially if the OMO rate is set above 21percent for an extended period, it may be a necessary compromise given the political sensitivity and preference for lower interest rates (recall the Presidents inauguration speech signaling the need for lower interest rates, see here) particularly as the MPR should typically serve as the base rate for bank loans.
Similarly, the CBN might also remain cost conscious by not wanting to pay significantly higher rates on both OMOs and SDFs. In effect, the policy rate won’t matter if short-term rates can move nearer 25 per cent in order to narrow the current negative real rates while continuous OMO auctions and CRR debits can help to further tighten liquidity conditions, ease FX and inflationary pressures,” it noted
It further said that given that domestic debt makes up around 62 per cent of Nigeria public sector debt, “a further rise in interest rates will increase the interest burden, even as authorities explore ways of improving oil and non-oil revenues. Higher interest rates will also come at a cost to the central bank, a cost which will eventually be absorbed by the federal government.
Commenting on the country’s plan to obtain $10 billion in foreign currency inflows in the next few weeks to ease liquidity in the foreign exchange market, the firm said that the ability of the government to raise such an amount may be challenging given the $3 billion expected from Afreximbank has been delayed for months, while Nigeria LNG Limited’s (NLNG) historical dividends to the government has fallen well short of $2 billion annually.