$20bn of Nigeria’s $33 billion foreign reserves is entangled in derivative deals – EIU

The Central Bank of Nigeria (CBN) is confronting a daunting liquidity crisis, posing a grave threat to the stability of the Nigerian naira and the nation’s economy as a whole.

Findings from a recent report by the Economist Intelligence Unit (EIU), disclosing that approximately $20 billion of the nation’s $33 billion foreign reserves is entangled in derivative deals, underline the severity of the situation. This staggering revelation leaves the CBN with severely constrained resources to boost the naira.

A derivative is a financial contract that derives its value from an underlying asset, commodity, or index. The value of a derivative is based on the performance of underlying market factors, such as interest rates, currency exchange rates, and commodity, credit, and equity prices.

The EIU’s comprehensive Country Report on Nigeria paints a bleak tableau for the naira, forecasting heightened volatility throughout the year. The report sounds an alarm on potential regulatory fluctuations that could severely impact businesses, particularly those reliant on foreign currency reserves.

The heart of the matter lies in the CBN’s liquidity crunch, necessitating recourse to foreign borrowing to resuscitate its reserves and instill confidence in the naira. The EIU’s prognosis suggests that this arduous process might extend until the latter part of 2024, signaling an enduring period of economic turbulence.

“For most of this year, the naira will be highly volatile, leading to regulatory erraticism that can affect businesses, especially those holding foreign currency.

“The CBN lacks the liquidity to support the naira itself; out of US$33bn in foreign reserves, a large share (estimated at nearly US$20bn), is committed to various derivative deals,” the report said, emphasizing the need for Nigeria to seek loans.

Nigeria has already embarked on a trajectory of foreign borrowing, securing substantial loans from eminent financial institutions such as the African Export-Import Bank and the African Development Bank, while concurrently seeking additional financial assistance from the World Bank.

However, the path to financial recuperation remains fraught with formidable challenges, necessitating a concerted and strategic approach to stabilize the currency.

The EIU’s projections offer a nuanced outlook, envisaging a gradual convalescence of foreign reserves spanning the period between 2024 and 2028. Yet, it maintains a cautious stance on the naira’s valuation, citing persistent inflationary pressures and negative real short-term interest rates as critical determinants exerting a downward force on the currency.

Projections ominously indicate a potential nosedive to N2,381/$ by 2028. However, it predicts an end-2024 rate of N1,770/$ and N1,817/$ by the end of 2025.

Despite modest prognoses for short-term recovery, concerns loom large concerning the long-term trajectory of the naira. The report attributes the currency’s inherent fragility to a precarious mix of lax monetary-fiscal policies and the capricious oscillations in global oil prices, which could precipitate a protracted depreciation.

Imminent threats to the naira’s stability emanate from looming restrictions on the repatriation of earnings by oil conglomerates and plausible convertibility constraints. Such regulatory alterations could further exacerbate the currency’s volatility, thereby posing formidable impediments to businesses operating within Nigeria.

The report sheds light on the conundrum facing the CBN, as it grapples with the delicate balance between monetary policy imperatives and the broader economic vision articulated by President Bola Tinubu. The President’s ambitious mandate, encapsulating a fervent desire to double the nation’s GDP by 2031 while simultaneously harboring a palpable aversion to high interest rates, presents formidable obstacles to attracting foreign investment through conventional monetary tightening.

“Deficit monetization and high inflation will undermine the currency. A possibility is that monetary policy will be tightened to a point at which foreign investors view the naira more favorably,” it said.

“The CBN’s independence has been heavily eroded in recent years; because fiscal firepower is so limited, the government will continue to rely on monetary policy to achieve job-creation and development objectives.”

Moreover, the specter of deficit monetization and stubbornly high inflation rates looms large, casting a pall over the efficacy of monetary measures aimed at stabilizing the currency. The encroachment upon the CBN’s autonomy, coupled with the government’s proclivity to rely on monetary mechanisms to fulfill its developmental objectives, further exacerbates the challenges confronting currency stabilization efforts.

Despite the prevailing adversities, recent reforms instituted by the CBN have yielded promising results, reigniting investor enthusiasm in Nigeria. Overseas remittances have surged, catapulting to $1.3 billion in February 2024, compared to a meager $300 million in the preceding month, according to the CBN. Similarly, foreign investors have demonstrated a renewed appetite for Nigerian assets, with portfolio flows surging to $2.3 billion in the early months of 2024, a marked improvement from the previous year.

The recent recalibrations in benchmark interest rates have acted as a potent catalyst, stimulating investor interest in short-term sovereign debt and thereby bolstering foreign exchange inflows. The CBN hiked interest rate by 400 basis points to 22.75% last month.

These positive developments offer a glimmer of hope amidst the prevailing economic uncertainty, albeit against a backdrop of formidable challenges. The path to currency stability remains fraught with obstacles, necessitating judicious and resolute policymaking to safeguard the future trajectory of the naira.