WED 04 AUG, 2021-theGBJournal- The Central Bank of Nigeria (CBN) on 27 June decided to discontinue supplying Bureau De Changes (BDCs) with FX and that banks will overtake the duty of supplying FX to the wider public.
The CBN Governor announced the decision during the MPC meeting, relating the action of the BDCs mishandling FX as putting the country’s financial system at risk as they looked for abnormal returns.
‘’At face value, the decision chops off nearly USD450mn/month of FX supply (c30% of total FX supply to the market). We expect the decision to put further pressure on the Naira in the parallel market as it did in two similar incidents back in 2016 and 2020, analysts at EFG Hermes said in their latest Nigeria economic note.
‘’While banks should supply dollars to the market, we think logistically (replacing more than 5000 branches of BDCs) and liquidity (system lacks significant FX liquidity) challenges are likely to feed into a weaker Naira. Moreover, the banking system is required to not provide FX for a range of goods (thanks to the CBN’s list of import controls), hence this would put further pressure on the Naira.’’
More importantly than the noise around the BDCs decision, and probably explaining the driver of the decision, is a more fundamental question: How come the CBN is not building any foreign reserves, considering the significant rise in foreign reserves? The question is all the more important considering that Nigeria has never faced an episode where reserves did not rise at this level of oil prices.
The answer to this question, according to EFG Hermes, is still not straightforward considering the limited transparency of reserves and balance of payments numbers.
EFG Hermes highlights four main factors they believe sheds some light to the disappointing behaviour of reserves so far.
The first two explain why reserve build-up would have been dented while the remaining two are real driver of the lack of reserve build-up.
First, Nigeria has been exporting less oil in the past year given its commitment to OPEC+ production cuts.
Crude oil export volumes are down 20% on average in the year to June, reducing the upside from higher oil prices by a good margin. Second, the country is losing anywhere between USD350-450mn a month due to the resurfacing of oil subsidies, shaving off close to 15% of the country’s oil revenues. This is the double-edged sword of rising oil prices that sometimes is downplayed for oil exporters.
The government has blinked again in the face of reforms and has kept domestic fuel prices unchanged despite the significant rise in oil prices. Prices were first de-regulated in April last year when global oil prices collapsed at the onset of the pandemic.
The premium motor sport, the most widely-used fuel in the country, was sold at NGN130/litre when oil prices stood at USD30/bbl. The PMS now sells for NGN166/litre, while oil prices have shot up to +USD70/bbl, leaving the gap to be covered by the national oil company, NNPC.
Taking into consideration the devaluation of the Naira over the past year and the cancellation of the CBN official rate (last priced at NGN380), PMS prices would need to be at least 50% higher than current levels.
The impact of the subsidy is all the more acute this time around as NNPC is solely importing fuel products after private importers were chopped off. Indeed, NNPC announced in April that it will not be remitting funds to the federation account for May due to the rising cost of subsidising imported fuel products.
Third, Nigeria has been one of the exceptional countries where remittances have been negatively impacted by the pandemic. Remittances have dropped 33% in the 12 months starting 2Q20; basically, the country has been losing an average of USD2bn a quarter over the past year (up to 1Q21, the latest point at which data is available). This is clearly a considerable loss to the FX system and could, in our view, partially explain why reserves have not been picked up despite the rise in oil prices.
We relate this surprising drop in remittances, which is contrary to the significant increase in inflows in most parts of the world, primarily to border closures and then the pandemic. Nigeria stands out from many of its peers in the fact that it receives nearly a third of its remittances from neighbouring African countries.
Disruptions to trade and movement of people has likely weighed heavily on those inflows. We also suspect that FX shortages and volatility have weighed on some of those flows with a notable rise in people using crypto currencies in order to circumvent a number of FX controls.
In parallel to falling remittances, we flag that elevated imports continue to weigh on the country’s current account balance, which has been in a consistent deficit for the past 11 quarters, i.e. since 3Q18. Nigeria has rarely been able to build foreign reserves when its CA is in a deficit. It is hard to square the elevated imports against the weak macro backdrop, hence this could be reflecting, in our view, some overbilling of imports.
Finally, anecdotal evidence suggest the CBN’s FX reserves may have also been pressured by the maturing of some FX swaps. There is hardly any official data about the size of outstanding swaps on the CBN’s balance sheet, hence it remains difficult to assess their real impact on reserves.
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