Further policy tightening to defend naira looks bleak

In spite of recent accretion in foreign exchange (FX) reserve, tight monetary and contractionary fiscal policy may impact negatively in the defense of the naira, analysts have said.

Already, naira is overvalued by 20 percent like Kenya shilling, and unlike other sub-Saharan African countries. Worse still is the fact that the Central Bank of Nigeria (CBN) has reached its limit in terms of monetary policy space.

A development, the analysts further argue, will be negative considering the declining rate in Nigeria’s main source of revenue, oil.

The situation is also further compounded by pent-up demand for FX by end users as a result of uncertainty in policy direction of the government.
This is even as inflation continues its purposeful rise for seven consecutive times since December 2014. Headline Inflation for June – measured year-on-year (Y-o-Y) – was estimated at 9.2 percent, 20bps higher than 9.0 percent reported in May.

SSA currencies have in recent months come under significant pressure. Of eight SSA currencies analysed by Renaissance Capital, the Kenyan shilling was found to be especially vulnerable (as it is an overvalued currency that depreciated by less than the EUR/$).

However, Nigeria’s limited policy space implies the naira should weaken more than the shilling. According to RenCap, macro imbalances and dollar strength place overvalued currencies at risk of sizeable depreciations, and imply the undervalued Ghanaian cedi and Tanzanian shilling, may remain so, for longer.

A report by RenCap on SSA economies revealed that the naira is also c. 20 percent overvalued, but because its depreciation was in line with the EUR/$1 depreciation, it is less vulnerable than the KES, by the analysts parameters.

“But given that Nigeria’s monetary policy is already exceptionally tight and fiscal policy is contractionary, we see little scope for further policy tightening to defend the NGN,” according to them.

Plugging of leakages may be improving FX reserves ($31.9bn on 7 July, according to the central bank). But as long as the price of the biggest source of FX inflows, oil exports, remains low, “we are reluctant to attach any significance to this. Plus reports of pent-up FX demand ($4bn, is one estimate from discussions with local banks) implies liquid FX reserves are lower than the official number,” they said.