Preventing a speculative attack on the naira

The Nigerian currency, the naira, has come under pressure in recent times as concerns mount over the rapid slide in oil prices. Beyond the structural issues that underpin the weakness of the naira vis-a-vis the dollar, there is also an emerging trend of market speculators wishing to take advantage of the lack of clarity and decisive actions coming out of the Central Bank of Nigeria (CBN).

The currency on Thursday plunged to an all-time low of N173.95 against the dollar despite three interventions by the CBN last week. The naira is also clearly trading outside the N150-N160 band which the CBN has indicated it would like it to trade.

Pointers from some market participants are that with Nigeria’s foreign exchange reserves running at four-month lows and the oil price collapse preventing any replenishment, the naira is a prime candidate for an attack by speculators, who build short positions by borrowing and selling a currency in hope of profiting from a swift exchange rate plunge.

Data from the CBN show that its liquid reserves have declined since the start of the year by $5.77 billion or more than 15 percent to $36.69 billion by last Tuesday. Market participants are clearly asking for clarity from the CBN, which may have inadvertently worsened pressure on the naira by some recent policy pronouncements.

On November 6, the regulator restricted banks’ use of the standing deposit facility, or SDF, which allows companies to earn interest on excess cash, in an attempt to encourage lending to local businesses.

The changes reduced the interest banks can earn using the facility, increased naira liquidity and placed pressure on the currency.

The CBN recently also directed forex demand for the importation of finished goods, electronics, IT, telecoms equipment, generators, and invisible transactions to the interbank market and away from the official window, which offers forex at a considerable lower rate. This move again led to increased pressure on the naira on the interbank market.

There is an estimated $8.5 billion in Nigerian fixed income assets by foreign investors and another $10 billion in equities, according to banking and investment firm Standard Chartered. Together, these sums are equivalent to almost 50 percent of the CBN’s FX reserves. The NSE-ASI has also lost some 14 percent of its value year to date.

Going back in history, one of the lessons learnt from the Asian financial crisis is that decisive action and clarity of purpose often help to defeat speculators in a time of crisis. Prior to the 1997 Asian financial crisis, the Malaysian ringgit was an international currency, which was freely traded around the world. Just before the crisis, the ringgit was traded RM2.50 to the dollar. Due to speculative activities, the ringgit fell to as much as RM4.10 to the dollar in a matter of weeks.

The Kuala Lumpur Stock Exchange’s composite index fell from approximately 1,300 to nearly merely 400 points in a few short weeks.

Bank Negara Malaysia, the nation’s central bank, imposed capital controls and pegged the Malaysian ringgit at 3.80 to the US dollar.

Malaysia refused economic aid packages from the IMF and the World Bank, surprising many analysts.

By refusing aid and thus the conditions attached thereof from the IMF, Malaysia was not affected to the same degree in the Asian financial crisis as Indonesia, Thailand, and the Philippines.

To rejuvenate the economy, massive government spending was made and Malaysia continuously recorded budget deficits in the years that followed. The Malaysian economy recovered from the 1997 Asian financial crisis sooner than neighbouring countries, and has since recovered to the levels of the pre-crisis era.

While we do not recommend currency controls at this time, we believe the CBN should signal the markets more clearly on its intentions and back up those intentions with decisive actions. Actions may include defending the currency whenever it drops below the CBN’s stated naira band, hiking interest rates and the CRR to drain liquidity from the system or letting the naira trade in a much wider band.

Fortunately for the country, the low debt levels will enable the fiscal side of the equation to stimulate the economy if monetary policy tightens. Nigeria is able to post budget deficits for the next year or two because of low debt, enabling it to maintain spending with lower oil prices, Fitch Ratings Ltd said in an outlook on Friday.