End of Nigeria’s 15-month currency peg

Bloomberg

Pent-up demand for dollars may push Nigeria’s naira at least 20 percent weaker when the central bank allows the currency of Africa’s biggest economy to float freely, said analysts including Renaissance Capital Ltd. and the head of Ecobank
Transnational Inc.
Demand for foreign currency has built up to about US$3 billion since capital controls were imposed 15 months ago to defend the currency’s peg of 197-199 per dollar, according to Chapel Hill Denham Securities Ltd. Even as the naira weakens, local stocks may extend the best three-day rally since April 2015 in anticipation of a return by foreign investors and as the risk of exclusion from global indexes fades. Banks may gain as the policy change allows them to profit from foreign-exchange volatility and boost trading income, analysts at Exotix
Partners LLP said.
“We think the rate will be around 250 or 260 per dollar” when the naira starts trading on the interbank market, said Tajudeen Ibrahim, head of equity research at Lagos-based Chapel Hill Denham. The central bank will probably help clear demand by selling dollars, he said, moderating potential volatility.
Nigeria has held the peg since March 2015, spending about US$2.7 billion of its reserves, 9.3 percent of the total, this year alone, even as other oil exporters devalued their currencies as crude prices slumped by more than half since 2014.
Three-month non-deliverable naira forwards jumped to a record 333 per dollar on June 15 after Emefiele announced the changes. On the black market, dollars changed hands for 335 naira on Saturday, Lagos-based AbokiFX said.
The naira could start trading at 260 per dollar, potentially weakening to 390 by year-end, before retracing, Renaissance said in a June 16 note.

‘Never Imagined’
“We never imagined a free-floating naira,” Johannesburg-based Renaissance analyst Yvonne Mhango said. “This will release a pressure valve for the economy. We see the economy beginning to thaw and green shoots emerge possibly as soon as a year from now. Before then, we believe the macro picture will deteriorate.”
The naira could initially weaken beyond 300 to the dollar, before reaching “fair value” of 280 to 290, said Alan Cameron, London-based economist at Exotix.
Investment into Nigeria has shriveled as foreigners are deterred by capital controls, while local businesses have struggled to import raw materials and equipment. International carriers including United Airlines and Iberia have halted operations in the West African country, saying they couldn’t move revenue out.
“We see a lot of volatility from high dollar demand, because as of today, if you get 10 percent of your request, you’re lucky,’’ Olubunmi Asaolu, an analyst at Lagos-based FBN Quest said by phone.
While the naira could stabilize at about 290 per dollar, any move toward 350 “will cause mayhem” and prompt the central bank to moderate the drop by supplying additional
greenbacks.

Market Intervention
The central bank will select a group of primary dealers through which the naira will be traded. There will only be one official exchange rate and the bank will intervene in the market to buy or sell foreign exchange “as the need arises,” Emefiele said as he unveiled the new policy.
Demand for dollars won’t be satisfied on Monday alone and may take more than a week to clear, said Ibrahim at Chapel Hill. It might also be a while before buyers from abroad feel confident enough to acquire Nigerian assets, he said.
“The new market will start off slowly as investors will be cautious as they try to understand it,” Ibrahim said. “We’re unlikely to see foreign investors coming back very quickly. They’ll take their time. It might be a couple of weeks before we see new foreign money being invested.”
Heineken NV, which controls Nigeria’s largest brewer, views a rate of 250 to 280 naira per euro, or 283 to 316 per dollar, as “not that bad,” said Chief Financial Officer Laurence Debroux. Not having access to hard currency has been an obstacle to operating in Nigeria and a return of liquidity in Africa’s most-populous nation of 170 million people would be “great,” he told a June 16 investor meeting.
Countering Volatility
Three-month non-deliverable naira forwards rose 1.6 percent to 325 per dollar at 8:21 a.m. in London, a record on a closing basis, suggesting traders expect the Nigerian currency to trade around that level in the market. Stocks climbed 2.7 percent on June 17, capping an 8.2 percent three-day rally, the best since April 2015. The yield on Nigeria’s 2023 dollar bonds dropped 4 basis points to 7.19 percent. On June 15, the debt gained the most since 2014.
The turnabout in foreign-exchange policy came after gross domestic product contracted in the three months through March for the first time since 2004 and inflation accelerated to 15.6 percent in May. MSCI Inc. said June 15 — before the central bank’s announcement — it may drop Nigerian stocks from its Frontier Markets Index because of capital-mobility issues.
To help reduce currency volatility, the central bank will introduce over-the-counter naira futures trading, which would move non-urgent foreign-exchange demand from the spot to the derivatives market, Emefiele said. There will be no pre-determined spread on spot transactions, he said.
While the naira may open at 250 per dollar, it will probably fall rapidly to 280, according to Ade Ayeyemi, chief executive officer of Ecobank.
“It could even go beyond that,” he said. “The pent-up demand will drive the rate weaker pretty quickly. But that will lead to supply of dollars picking up and the rate stabilizing. We just encourage the government that the short-term pain will bring better days ahead. The overall economy will benefit.”