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Improving economy and contentious Naira value

By Lukman Otunuga   |   08 May 2017   |   4:21 am

While currency devaluation could weaken the Naira considerably in the short to medium term, the long term benefits, which include a potential increase in foreign investor confidence may be advantageous for economic growth.

Nigeria has displayed some resilience against the ongoing recessionary headwinds in 2017, with domestic data currently suggesting early signs of a potential recovery in economic growth.

An appreciation in oil prices at the start of the year and increased oil production domestically have positively impacted the nation, while interventions by Central Bank of Nigeria created some form of economic stability.

With the solid Sales Manager Index for April suggesting that the Nigerian economy is slowly creeping out of recessionary territories, the overall outlook could start to appear encouraging. Sentiment may be in the process of turning bullish and the projections of growth hitting 0.8 per cent by the International Monetary Fund should compound to the positivity over a recovery in economic momentum.

The Naira clawed back some losses against the dollar this year, with prices trading around N391 on the black market as of writing. The sharp acceleration of external reserves allowed the Central Bank to increase the supply of foreign exchange in the interbank markets, which consequently narrowed the gap between the official and black market exchange.

Although the Naira has the ability to appreciate further if the CBN continues to supply foreign exchange, questions may be repeatedly asked over the sustainability of this method and the impact it will have on the nation’s external reserves. A situation where oil prices start to depreciate sharply and Nigeria’s reserve diminishes could expose the Nigerian Naira to downside risks.

As the largest economy in Africa embarks on a quest to regain economic stability, the Central Bank of Nigeria should strive to allow market forces to decide the true value of the Nigerian Naira.

While currency devaluation could weaken the Naira considerably in the short to medium term, the long term benefits, which include a potential increase in foreign investor confidence may be advantageous for economic growth.

With the multiple exchange rate system still a grey area that needs to be rectified, speculation could heighten further over the CBN taking some form of action in the future. On the foreign exchange front, repeated Dollar weakness from the receding U.S. rate hike expectations may support the Naira further on the black market exchange.

Taking a deeper look into Nigeria’s macro fundamentals, inflation in March displayed early signs of cooling with consumer prices reaching 17.26 per cent. Expectations have heightened over the nation’s inflation trending downwards this year if the Naira stabilises and such may improve the purchasing power of Nigerians.

An increase in purchasing power may boost the demand for consumer and industrial goods ultimately feeding back to economic growth. Although the Central Bank of Nigeria continues to maintain a passive approach as the nation slowly recovers, a hawkish monetary stance could be adopted by year-end if the upside momentum gains further traction.

External risks such as oil market volatility and the actions of the Federal Reserve may impact Nigeria this year, with much attention directed towards the ongoing OPEC developments.

Oil markets remain gripped by the oversupply concerns with the resurgence of US Shale obstructing OPEC’s efforts to stabilizing the oil markets. Although OPEC has shown optimism over a potential extension of the supply cut agreement reviving the oil markets, price action states otherwise.

From a technical standpoint, WTI Crude has found itself pressured on the daily charts with repeated weakness below $50 opening a path towards $45 in the medium to longer term.

While diversification still remains a dominant theme when focusing on Nigeria, investors have started to direct some attention towards the nation’s inflation, foreign exchange market and other forms of hard economic data.

With expectations mounting of lower inflation, and speculations heightened over the CNB stabilising the foreign exchange market, sentiment towards the largest economy in Africa could receive a further boost.

As the second quarter of 2017 gets underway, markets will continue to observe how the Central Bank deals with the multiple exchange situation and if the CBN officially allows the forces of supply and demand to determine the equilibrium value of the Naira.

• Otunuga is the Research Analyst at FXTM


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