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Nigeria Strategy Report H2 2017 Excerpts - CBN’s Volte-face narrows FX markets premium

• We continue with the serializations from our core strategy document – The Nigeria Strategy Report, with today’s review focusing on developments in Nigeria’s currency market over H1 2017. This is followed by a careful delineation of our NGN outlook for the coming months.

• In our H1 17 Strategy Report, we noted that the CBN could maintain its hard peg on the naira at N305/$ as higher oil receipts and proceeds from FG’s planned external borrowings bolster FX reserves. Unsurprisingly, following a strong rise in the nation’s reserves (+17.1% over H1 17 to $30.3 billion), the CBN raised its dollar sales towards the end of February. This, together with the creation of new FX windows and relaxation of some stringent policies, lowered dollar demand at the parallel market. Against this backdrop, the premium between the interbank and parallel market contracted to a 20-month low at the end of June even as the once-elusive portfolio flows began to trickle in.

• In framing our outlook for the NGN, we start by shaping our view on the country’s fundamental picture through Balance of Payment analysis. On the export leg, we expect higher crude offtake, stemming from the re-opening of Trans Forcados terminal, to moderate impact of declining crude oil prices. On the other hand, we forecast a 14.1% YoY rise in imports to $19.3 billion over H2 17 as improved dollar liquidity spurs demand for foreign non-oil goods. Overlaying the implied goods trade surplus of $0.5 billion with a $4.5 billion Service deficit (mean 4-year deficit: 4.1% of GDP), we estimate a balance of trade deficit of $4.0 billion. However, we expect the current account to print at surplus of $5.3 billion. On the financial account, we expect a combination of high interest rate environment, improving economic picture and a flexible exchange rate system to sustain the demand for naira assets over the second half of the year. Overall, the positive balance of payment picture suggests little downside risk for the naira.

• Having resolved the BoP considerations, we then look to evaluate the potential liquidity picture across the FX market by running scenarios estimating CBN’s dollar sales per month. In our base case scenario, we expect a moderate decline in monthly dollar sales by the CBN to $2.0 billion (May 2017: $2.2 billion, H1 17 average: $1.3 billion) against the backdrop of reduced pent-up demand. Overall, we expect FX rates to hover at current levels at the various FX windows.