INSIGHTS

How Investors in Nigeria can Ease the Pain of Oil Price Drop: Watch your Currency




Anyone who thought 2019 was a hard time for global markets definitely did not foresee what 2020 had to offer. The first quarter of the year is barely over and stock markets of major economies have declined sharply. The Coronavirus epidemic has not only led to businesses revising their revenue projection downwards due to supply halt, but it has also led to a decline in consumer demand of major industries such as aerospace.

Luckily, African countries have been able to limit the spread of the virus within the continent. Celebrations were high in Nigeria as the second case of coronavirus in the country tested negative. However, another blow hit the country as rumors of an oil price war submerged.


Oil Plunges 24% for worst day since 1991

On Monday 9 March 2020, the price of crude oil plunged by almost 25% after the world's top oil exporter, Saudi Arabia announced its plans to step up oil production in the coming months, flooding the global markets with its supply and most likely depressing petrol and diesel prices. It is no surprise that this news quickly led market watchers to question Central Bank of Nigeria’s (CBN) ability to sustain the stability of the Naira as crude oil sales make up about 90% of Nigeria’s FX earnings.


In Nigeria’s 2020 budget, the country projected oil revenue benchmark of $57 per barrel and pegged oil production at 2.18m barrel per day. The coronavirus outbreak already negatively impacted Nigeria's oil revenue as oil prices decreased to about $51 per barrel. To curtail the impact of the price drop, there were speculations of increased oil production to act as a cushion against the impact of the oil price decline. However, the price of crude oil currently stands at just over $30 per barrel, so it is hard to see how an increased supply will solve this problem. Moreover, the speculated solution of increased supply does not carry weight since low demand caused by the coronavirus is unlikely to balance out the impact of the oil drop.


The above lays serious concerns as to whether the CBN can sustain the current value of the Naira. On the 12th of March 2020, the CBN released a statement with the heading “Market Fundamentals Do Not Support Naira Devaluation at This Time” the press release further proclaimed “The size of Nigeria’s foreign exchange reserves remains robust and comfortable, given the current realities of Nigeria’s genuine and legitimate FX demand. As such, the CBN remains able and willing to meet all genuine demand for foreign exchange for legitimate transactions.


The central bank reserves have decreased by 20% in the past two years to the lowest since November 2017. The threshold set by the Governor Godwin Emefiele for the country to consider a devaluation is $30 billion. The gross reserves as of 12th March 2020 are sitting at about $36 billion. So we are close.

Furthermore, the Covid-19 outbreak and associated health concerns have led to less inflow of dollars into Nigeria. Surprisingly, there also has not been a large outflow.

Many are concerned that portfolio outflows will deplete FX reserves and pressure the Naira, but the reality is, times are bad globally. In 2019, the monetary authorities put measures in place to keep foreign investments in the country such as restricting the subscription of Open Market Operation bills to foreign investors. It also helps that interest rates are near 0% or negative in advanced economies so we expect less capital reversal.


The chain of events in the world is enough for investors to be concerned about the heightened currency risk embedded in their portfolio so here are some common ways currency risks are hedged in Nigeria:


1. Non-Deliverable Forwards (NDF):

The Naira-settled Over The Counter (OTC) FX Futures is a common way investors hedge their currency risk in Nigeria. It is a Non-Deliverable Forward contract where parties agree to an exchange rate for a predetermined date in the future, without the obligation to deliver the underlying US Dollar (notional amount) on the settlement date. On the maturity date, it will be assumed that both parties would have transacted at the Spot FX market rate. All hedge transactions with the investors must be backed by trade (visible and invisible) transactions.

On the maturity date, it will be assumed that both parties would have transacted at the Spot FX market rate. All hedge transactions with the investors must be backed by trade (visible and invisible) transactions.


Other products are;

2. FX Swaps

3. Cross-Currency Interest Rate Swap (CCIRS)

For investors with long-term investment horizons, the maximum tenor allowed for FX Forwards, FX Swaps and CrossCurrency Interest Rate Swaps is 5 years. However, Authorized dealers can seek approval for longer tenors.


© 2020 by AfriKnowledgeBank

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