FREE

February 2020 Foreign Exchange Report - Policy stance to ensure short-term stability

FOREIGN EXCHANGE                                                

Policy stance to ensure short-term stability                                                          

It is no news that the Naira is overvalued relative to the US dollar by about 10%-15%, confirmed by both the interest rate parity (IRP) and the international fisher effect (IFE) exchange rate models. For months, calls have been mounting on the Central Bank of Nigeria (CBN) to devalue the Naira due to a build-up of pressure on the external reserves and a gloomy outlook for oil and foreign investments. This is believed to be putting pressure on the central bank, constraining its ability to sustain the defence of the Naira.                                                       

 Foreign exchange market pressure still tolerable

 From our findings, the case for a strong depreciation pressure is being nullified by the foreign exchange market pressure (EMP) indices. Our preferred measure of exchange market pressure is Eichengreen’s EMP which consists of a weighted average of the exchange rate, relative interest rates and foreign exchange reserves. Our findings were also confirmed by Girton & Roper’s EMP index which excludes interest rate in estimating pressure in the foreign exchange market. The EMP index suggests that the current depreciation pressure in the foreign exchange market has not blown out to 2016/2017 levels, before the introduction of the I&E window, even though the risks of a possible devaluation have become more severe. Amid rising risks, the central bank has been able to keep foreign exchange utilization below pre-recession levels.

 Vulnerability indicators confirm reserves adequacy

Recovery in oil prices, Eurobond issuances and hot money (First mention) inflows have contributed to a modest increase in external buffers, post-recession. The improvement in the country’s external position is confirmed by selected indicators of external vulnerability. While the imports cover serves as a current account based measure of reserves adequacy, the broad money ratio can be an indicator of the potential impact of capital flight. The CBN reported that the country’s $39.00 billion in reserves as at Oct’19, could cover 9.15 months of imports. This exceeds the global minimum reserves requirements (3 months) and that of the West African Monetary Zone (6 months).