CBNs inflation success bumps against costs of Naira defense

..analysts urge greater market role for currency

The Central Bank of Nigeria’s success at maintaining benign inflation expectations is bumping up against the steep cost of defending the naira (the nominal policy anchor), even as some analysts urge a greater role for the markets in determining the level of the currency.

Inflation in Nigeria dropped to 7.7 percent year on year in February 2014, from 8 percent y/y in January and December, the lowest levels since late 2007.

The monetary policy committee (MPC) of the CBN meets next week (24 – 25 March) and one of the outcomes for it to consider may be an increase in the naira trading band, according to analysts.

The CBN will however be looking at its success recorded so far in bringing down inflation, and weighing that against any positives from a shift to a less heavily defended currency management strategy.

“Our projections suggest that inflation will remain in single digits in the medium term and may well stabilise with a  7 percent handle in first half (H1) :2014 (7.5 percent y/y in March), before edging up moderately in H2:14,” said Samir Gadio, an emerging markets strategist at Standard Bank in London, in a response to questions

“The upside risks to this outlook stem from a potential readjustment of the mid-point (155) of the RDAS FX band.” 

The CBN has spent $7.27 billion year to date to prop up the naira at its bi-weekly foreign exchange auctions. The local currency has lost about 2.3 percent year to date versus the dollar, despite heavy CBN intervention.

The commercial bank regulator aims to keep the naira within a trading band of N155 plus or minus 3 percent.

The naira traded at N164.7 as at 4.17 pm, Nigerian time on the interbank FX market, according to data from the FMDQ, putting it outside the CBNs trading band target.

The CBN should consider extending the limit for the naira’s daily moves against the U.S dollar, to give the markets a greater role in determining the naira’s value, said Bola Onadele, Managing Director/ Chief Executive Officer (CEO), of the Financial Markets Dealers Quotations (FMDQ).

“The naira trading range should be widened to perhaps as much as 10 percent plus or minus N155 per dollar,” said Onadele in a March 12 interview on the sidelines of the RMB Nigeria executive breakfast session, held in Lagos.

“This would unwind one way bets against the naira and enable the forwards (options/ futures) markets play a greater role for those who want to hedge their naira exposure.”

The CBNs gross external reserves are down 11.26 percent year to date to $38.6 bn on March 14 from $43.5 bn on Jan 2, 2014.

The spike in forex demand in February to $3.1bn, equivalent to a 7-month high and plunge in external reserves to a 17-month low makes naira exchange rate depreciation imperative, said Bismarck Rewane, an economist and CEO of research firm Financial Derivatives Company (FDC).

“The naira is now under speculative arbitrage attack and panic buying,” said Rewane in March 5 presentation of the Lagos Business School, executive breakfast meeting.

“Lower oil revenues, depletion in reserves, and reversal of FDI flows to Nigeria and other emerging markets are some of the factors influencing forex pressure.”

The MPC of the central bank may vote to move the naira trading band higher in combination with an increase in the cash reserve ratio (CRR) for public deposits in banks to 100 percent at their meeting next week.

Such a move by the CBN however will not improve external competitiveness in an economy where oil accounts for 95 percent of exports, said Gadio.

“Overall, the root cause of the weak confidence in the FX regime remains the marginal level of fiscal savings. A more flexible exchange rate will most likely exacerbate the continued upward pressure on USD/NGN in the current environment, with little gains in terms of import substitution given the prevalent infrastructure and energy bottlenecks.”