By Monica Johnson, International Banker
On June 14, just days after Nigeria’s new president, Bola (Ahmed Adekunle) Tinubu, decided to suspend the under-fire Central Bank of Nigeria’s (CBN’s) governor, Godwin (Ifeanyi) Emefiele, authorities removed key currency restrictions on Nigeria’s official foreign-exchange (FX) market. In so doing, the overvalued naira underwent a massive devaluation, broadly aligning the currency with its black-market rate. For many, such a devaluation was badly needed to harmonise the naira’s value and thus boost confidence in Nigeria as an attractive destination for global investors. But the likely impacts of a weaker naira on Nigeria’s domestic corporate and banking spheres paint a more complex picture.
The currency had already been gradually weakening since Tinubu came to power in late May, around two weeks before the devaluation, as the new president immediately began pressuring the central bank to close the gap between the country’s official and parallel exchange rates. Having come to power amid a period of sluggish economic growth, mounting public debt and waning oil production, Tinubu’s bold decisions to devalue the naira and remove a fuel subsidy that cost the government $10 billion in 2022 received considerable support. In 2021, Rand Merchant Bank’s (RMB’s) Milk Index found that the naira was overvalued by at least 250 percent, while analysts more recently calculated a 50-percent overvaluation just prior to the central bank’s move to abolish segmentation.
“The Central Bank of Nigeria wishes to inform all authorised dealers and the general public of the following immediate changes to operations in the Nigerian Foreign Exchange Market: Abolishment of segmentation. All segments are now collapsed into the Investors and Exporters window,” the central bank announced, such that all segments of the FX market would be unified and replace the previous structure of various exchange-rate “windows” that served different purposes. The newly adopted market model is known as the “willing buyer, willing seller” model, which is now operational at the investors and exporters (I&E) window, which is the market trading segment for market investors, exporters and end-users that allows for foreign-exchange trades “to be made at rates determined based on prevailing market circumstances to ensure efficient and effective price discovery within the Nigerian FX market”.
The massive devaluation that followed on June 14 pushed the naira to 750 against the US dollar on the same day (a 36-percent drop from the June 13 close), moving it more broadly in line with the prevailing black-market rate at the time. By the end of July, the official rate had weakened by more than 40 percent since the start of the year.
Devaluation makes a domestic currency less expensive than other currencies, which has two main implications, according to the International Monetary Fund (IMF). “First, devaluation makes the country’s exports relatively less expensive for foreigners,” the Fund explains on its website. “Second, the devaluation makes foreign products relatively more expensive for domestic consumers, thus discouraging imports. This may help to increase the country’s exports and decrease imports, and may therefore help to reduce the current account deficit.”
And in Nigeria’s specific case, the free float of the naira ended the central bank’s previous regime of foreign-exchange rationing for importers, which limited their capacities to obtain foreign currency, particularly to service their international debt and payment obligations. The move should also incentivise investment inflows into the country. “The devaluation and unification should bring an end to the multiple foreign exchange markets and rates, which have disincentivised business activities and deterred foreign investments,” Ayodeji Dawodu, head of Africa research at UK-based BancTrust, noted to investors on the same day as the devaluation was announced. “We note that most of the goods and services in the economy were actively being priced closer to the parallel market rate, which could limit the inflationary impact of the move for now.” Jason Tuvey, emerging markets economist at Capital Economics, also recently explained to the Financial Times that the devaluation would enable foreign investors to return after being absent for many years. “In the near term, it will be portfolio investors [who return], but we could see foreign direct investment coming in as well.”
Investor confidence in Nigeria’s monetary and exchange policies should also be bolstered by the central bank’s new regime put in place by the incoming government. Indeed, Tinubu suspended the previous central bank governor, Godwin Emefiele, who oversaw thriving black-market FX activity as well as multiple exchange-rate markets, which led to foreign-currency shortages and frustrating roadblocks for investors looking to withdraw money from Nigeria. Emefiele was also dogged by allegations of corruption, leading to his being detained by police and eventually sending him into exile abroad, prompting Folashodun (Adebisi) Shonubi, a deputy governor in charge of operations at the bank, to take over the head role as acting governor.
But many expect activity in the parallel market to continue cooling in the aftermath of the devaluation. “Given that this new rate in the official market is the same as the parallel market, there is no incentive for people and businesses with genuine transactions to patronize the parallel market; hence FX trading activity in the parallel market will slow down significantly,” Abiola Rasaq, an economist and former head of investor relations at United Bank for Africa (UBA), was quoted in Nigerian news publication Business Day on June 14. “Subsequently, the official market should attract more FX supply, and rate should gradually ease in the I&E [Investors & Exporters] window, and such would cause rates in the parallel market to also ease.”
Therefore, the decision to float the naira freely became necessary, according to many. “A much-needed devaluation, which takes the currency from 50 percent overvalued to about 5-10 percent [cheaper],” Charlie Robertson, head of macro strategy at FIM Partners, told Reuters. “This should improve the current account and improve the long-term investment climate.”
Daniel Sodimu, a former Sub-Saharan Africa analyst at financial market-intelligence firm FrontierView, meanwhile, noted that investors generally had “positive sentiments” toward Nigerian exchange-rate unification. “Multiple exchange rates have been a source of confusion for investors,” Sodimu explained to African Business. “When they bring in funds at the official exchange rate and can only repatriate their earnings at the black-market rate, they make conversion losses on their investments. Investors recognise that a unified exchange rate should help alleviate these problems and improve the ease of doing business in Nigeria.”
Investors should be aware, however, of the extent to which the newly devalued currency is proving challenging for Nigerian firms, with mounting foreign-exchange losses severely eroding profit margins. London-based telecommunications company Airtel Africa, for example, reported a sizeable $151 million in losses due to the devaluation. “Profit after tax was negative ($151m), driven largely by a foreign exchange loss of $471m recorded in finance cost before tax and $317m after tax, because of the devaluation of the Nigerian naira in the month of June 2023. This impact has been classified as a non-operating exceptional item,” the company stated, with its chief executive, Segun Ogunsanya, noting, “This quarter saw the announcement of the change to the FX market in Nigeria, which resulted in significant naira devaluation.”
As for Nigerian banks, moreover, weaker capital ratios and higher impaired loans loom following this devaluation. According to Fitch Ratings, the depreciation will inflate Nigerian banks’ foreign-currency-denominated risk-weighted assets and put pressure on capital ratios, as well as inflate foreign-currency-denominated problem loans that will, in turn, boost banks’ prudential bad-loan provisions. “Since the devaluation, Fitch has affirmed the ratings of the vast majority of Nigerian banks, with Stable Outlooks, reflecting capital headroom to absorb the negative impact of the devaluation and the second-order economic effects of the reforms on asset quality,” a July 26 report confirmed. “Nevertheless, Fitch expects widespread declines in banks’ capital ratios at end-1H23, and recently placed three banks’ ratings on Rating Watch Negative, mainly reflecting thinner capital buffers and the risk of breaching minimum capital adequacy ratio requirements.”
That said, the credit-rating agency also acknowledged that banks generally have small foreign-currency-denominated risk-weighted assets and net-long foreign-currency positions, which can deliver FX-revaluation gains. But along with the government’s decision to remove the fuel subsidy, the naira devaluation will lead to higher near-term inflation and tighter monetary policy, which will put pressure on borrowers’ debt-servicing capacity and cause impaired loans to rise sharply, although more stringent foreign-currency lending standards mean that deteriorations in loan quality should be less problematic than after the last major naira devaluation in 2016.