As we warned last week was likely, Nigeria's decision to throw in the towel on maintaining its currency peg has resulted in a collapse in the Naira. Ending a 16-month-long effort to 'fix' its currency, Nigeria's shift to a free float has resulted in a 30% crash in the currency as the central bank began auctioning dollars to try and clear backlogs of orders for hard currency. However, as the forward market suggests, the pain is far from over as the hyperinflationary endgame remains more than likely.
The Central Bank of Nigeria used capital controls to stem an outflow of dollars after the naira crashed to a then-record in February 2015 as oil prices slumped. While stabilizing the currency, the controls deterred foreign investors and starved manufacturers of foreign currency needed to pay for raw materials and equipment. Nigeria’s gross domestic product contracted in the three months through March for the first time since 2004 and inflation accelerated to an almost six-year high of 15.6 percent in May.
The shift to a free float, however has resulted in a collapse from 200 to around 260 Naira to the US Dollar…
And, as Bloomberg reports, there may be “higher volatility until the market becomes more functional,” Samir Gadio, head of Africa strategy at Standard Chartered in London, said in an e-mailed response to questions.
“Foreign investors will need to be convinced that the new foreign-exchange platform is sustainable before they resume the purchase of local assets.”
Few trades went through in the hour or so after the market opened, making it hard to tell what the naira’s fair value is, according to Craig Thompson of Nyon, Switzerland-based brokerage Continental Capital Partners SA. The central bank seems to want to stabilize the currency at around 250-260 per dollar and most local banks will be nervous about pushing through trades much weaker than that, he said.
While allowing the naira’s exchange rate to be “market-driven,” the central bank would intervene when necessary, Governor Godwin Emefiele said when he announced the new system on June 15.
“I think it will move to 300 at some stage,” Thompson said by phone. “There’s all that pent-up demand. But you don’t want to be seen by the central bank to be pushing it lower. It won’t sit well. There’s a bit of moral suasion to keep it here. But as the client orders come through, the banks will have to pay up to supply their clients.”
Forwards markets suggest the depreciation has much further to go. Three-month naira non-deliverable forward contracts rose 0.3 percent to 321 against the dollar, while one-year contracts climbed 0.6 percent to 356, heading for a record close.
For Nigeria's 175 million-strong population, this means that Nigeria is about become the next Venezuela, with imminent hyperinflation on deck, as prices soar to keep up with the collapse in the spot rate.
Of course, what is bad news for the population is great news for capital markets as the "devaluation as a bullish case for stocks" arguments spew forth. Stocks always surge as a country is about to tumble into the hyperinflationary abyss. The question is whether the nominal price increase will keep up with the all too real collapse in the Naira's purchasing power which is about to slam Nigeria. If Venezuela is any indication, the answer is no.
Finally, for those wondering how to trade here, the answer may once again revolve around the Niger Delta Advisors: if Nigeria is unable to export more oil due to supply disruptions and thus inject much needed dollars into its Treasury, the country's financial situation wil get even more dire, leading to an acceleration in the naira's devaluation. On the other hand should Nigeria's government be successful in taming its offshore funded militants, the naira may be a buy, however that trade would be offset by a short in oil as the world's most acute crude supply disruption comes to an end.
In any case, watch out for unsolicited Nigerian emails from financially erudite locals asking you to buy stocks, bonds, or any other asset class. Those will result in guaranteed losses.
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