WED, FEBUARY 22 2017-The NGN is close to its fair value, according to our 13-year REER average. Some might find that hard to believe, given that on the parallel market the NGN is trading at a 60% premium over its value on the official interbank market.
We believe a crisis of confidence partly explains the disconnect between the fair value, as per our REER model, and the parallel rate. The fragmentation of the FX market (with at least six different FX rates) and capital controls (including a de facto ban on 41 types of imports and targeted FX sales to preferred sectors) have distorted the market. In addition, market expectations of further depreciation have also fuelled strong demand for transaction-related FX.
Despite our fair value estimate, we still expect a substantial depreciation post further FX policy liberalisation, as we saw in Egypt, where the currency has more than halved in value since November.
We know the Nigerian authorities would prefer to improve their FX reserves position before loosening their hold on the NGN – this is what central bank officials told us when met with them in May 2016. At the time, the central bank was seeking to boost FX reserves via FX swaps, so it could meet pent-up demand post-liberalisation.
Since November, we have seen a strong ($4bn) improvement in FX reserves, to $27.8bn on 25 January (Figure 8). Following several months of declines, we find this increase over a couple of months remarkable. We attribute the improvement largely to non-oil inflows and other receipts, as well as fresh swap inflows.
FX reserves are $1.5bn higher now than they were when we met the central bank last May (when they stood at $26.4bn). We think this increases the likelihood of FX policy being liberalised further in 2017. In recent weeks, Vice-President Yemi Osinbajo has talked of closing the gap between the official interbank and parallel FX rates. We expect to hear more of the authorities’ plans for FX policy when the government launches its economic recovery plan in February.
