Explainer: What is pushing the Nigerian naira to record lows?

A man counts Nigerian naira banknotes at a market in Yola, Nigeria, February 22, 2023. REUTERS/Esa Alexander/File Photo Acquire Licensing Rights

ABUJA, Oct 27 (Reuters) – The Nigerian naira is on the brink of breaching the 1,000-per-dollar level after falling to an official record low of 999 last week, according to Refinitiv data tracking its weakness in the unofficial market where it is traded free circulation.

President Bola Tinubu removed Nigeria’s currency controls in June in a bid to once again allow transactions to flow in the official market and help standardize naira exchange rates.

However, this only deepened the currency’s weakness and increased inflationary pressure.

Here’s what you need to know about the naira.

WHY IS THE NAIRA FALLING?

The central bank has a backlog of accumulated foreign exchange demand in the official market, effectively forcing individuals and companies to go to the black market if they need dollars.

However, dollar flows into Nigeria have been declining over the past few years due to falling investment and lower crude oil exports, which account for more than 90% of the country’s export earnings.

Investors cheered when Tinubu abolished currency controls, hoping that a unified exchange rate would make it easier to access foreign currency, but that has yet to happen.

HOW MUCH ARE PAYMENTS IN FOREIGN CURRENCY?

Nigeria has almost $7 billion in outstanding Forex futures contracts that corporations bought from local banks. Banks then repaid foreign credit lines from their own funds when the central bank failed to disburse the funds.

This means businesses are unable to obtain new letters of credit while banks are owed dollars. New central bank governor Yemi Cardoso said clearing the backlog was a priority, but gave no timetable for how long it would take.

Some analysts say forward contracts could be pushed back 24 to 36 months, giving the central bank more time to find dollars to repay corporations.

HOW BIG ARE NIGERIA’S FOREX RESERVES?

The country’s foreign exchange reserves fell to $33.5 billion in September from $37 billion in January, according to central bank data.

In August, the central bank published audited financial statements for the first time since 2018 and disclosed that its reserves included exposure to derivatives worth $19 billion, reducing the floating amount of reserves.

JPMorgan calculated that the country’s net foreign exchange reserves at the end of 2022 were $3.7 billion, “significantly lower” than earlier estimates.

Nigeria’s oil surplus stands at just $473,755, the National Economic Council said in August, down from a peak of $20 billion in 2008 as successive governments withdrew dollars to support the naira and budget spending.

WILL THE CENTRAL BANK RESTORE OPEN FOREX POSITIONS?

Nigerian banks are prohibited from holding open positions in the dollar, which means they cannot buy forex for their own account from the market or speculate on the value of the currency.

Banks use their net open foreign currency positions to finance short-term trade lines without resorting to central bank bidding. This means that banks “create a market” for dollars and provide two-way pricing for buying and selling the currency, effectively creating a fully functioning forex market.

The trader said that if banks were allowed to sell in the dollar, the local currency could weaken further because it would sell to customers at rates determined by supply and demand.

Nigeria’s 2024 budget assumes a reference exchange rate of 700 naira to the dollar. The Finance Minister says the parallel market rate of 1,300 naira does not reflect the true value of the local currency.

“Given that the naira remains significantly weaker in the parallel market, further devaluations and rising inflation are likely,” Capital Economics said in a research note.

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