Nigeria’s Foreign Exchange Policy Note

May 2021

Nigeria’s Foreign Exchange Policy Note

Navigating Through the Tides of Uncertainty

2

• COVID-19 resulted in a real GDP contraction of -1.92% in 2020. The pandemic caused both demand and supply shocks in Nigeria.

• Crude oil price fell by 24% in 2020, due to lower demand and supply glut.

• Nigeria’s major foreign currency generating sector - crude petroleum and natural gas – declined by 9% in 2020 and by 2.2% in 2021Q1.

• External reserves declined by 8.2% in 2020. Foreign capital inflows fell by 60% from US$24 billion in 2019 to US$9.7 billion in 2020. Nigeria recordedits largest trade deficit of N7.4 trillion in 2020.

• Although GDP has recorded two consecutive expansion in 2020Q4 and 2021Q1, external reserves and exchange rate remain under pressure.

Nigeria’s economic recovery is yet to relieve pressure on Reserves & Exchange rate

Data Source: National Bureau of Statistics (NBS), Central Bank of Nigeria (CBN) and U.S. Energy Information Administration

Nigeria’s real GDP growth Nigeria’s External Reserves and Brent Crude Oil Spot Price

2.0%

2.3% 1.9%

-6.1%

-3.6%

0.1% 0.5%

-7.0%

-6.0%

-5.0%

-4.0%

-3.0%

-2.0%

-1.0%

0.0%

1.0%

2.0%

3.0%

2019Q1 2019Q2 2019Q3 2019Q4 2020Q1 2020Q2 2020Q3 2020Q4 2021Q1

30,000

35,000

40,000

45,000

50,000

5

15

25

35

45

55

65

75

85

Jan 31, 2019 Oct 31, 2019 Jul 31, 2020 Apr 30, 2021

Europe Brent Spot Price FOB (Dollars per Barrel) LHS External Reserves (US$ million) RHS

Foreign Exchange Policy Note

3

The effect of lower crude oil price was a depreciation of the Naira across markets…

• Since the first quarter of 2020, the Naira has depreciated across the different foreign exchange (forex) markets.

• The gap between the CBN rate and rates in the I&E window and parallel market expanded due to forex shortage.

• In 2020, the CBN adjusted the official exchange rate twice following a wide spread between the official rate and the rate in the I&E window.

• Having multiple exchange rates has been a key factor that has limited the inflow of foreign exchange into the Nigerian economy.

• The recent adjustment of the official exchange rate in May 2021 to reflect rate in the I&E window is a significant move that provides clarity and improves market confidence.

Exchange Rate (N/US$)

Data Source: CBN, FMDQ

Parallel Market Exchange Rate (N/US$)

150

200

250

300

350

400

450

CBN Official I & E Window

150

200

250

300

350

400

450

500

550


4

…but despite a recovery in oil price, FX inflows in 2021 have been limited

• Foreign exchange liquidity has been a problem across the markets.

• Higher crude oil price in the first five months of 2021 was not enough to eliminate pressure on Nigeria’s reserves and exchange rate. Despite a +36% increase in crude oil price from January to May 2021, Nigeria’s external reserves have remained below pre-COVID-19 levels.

• Year to date (May 27), reserves have lost 3.9% of its value from US$35.65 billion in January to US$34.3 billion.

• Output cap on crude oil by OPEC and rising demand for foreign currency for imports and services payments have increased pressure on the Naira.

• Inflows into the I&E window are yet to return to pre-COVID-19 level –US$564 billion in April 2021. This is despite CBN’s efforts, such as diaspora remittance rule etc., to improve liquidity across the forex markets.

• What is needed, in our view, is alignment of forex management policies with fiscal, monetary and industrial policies to improve liquidity in the forex market.

Forex Inflow in the I&E Window (US$’Million)


429

935

1,166 1,169

1,366

735 566 551 564

Aug-20 Sep-20 Oct-20 Nov-20 Dec-20 Jan-21 Feb-21 Mar-21 Apr-21

30

32

34

36

38

40

5/2

7/2

021

05/0

7/20

214/

20

/202

13/

31

/202

13/

15

/202

103

/01/

2021

02/1

1/20

211/

27

/202

101

/11/

2021

12/2

3/20

2012

/09/

2020

11/2

5/20

2011

/10/

2020

10/2

2/20

2010

/06/

2020

9/1

7/2

020

09/0

1/20

208/

14

/202

07/

27

/202

007

/09/

2020

6/2

3/2

020

06/0

4/20

205/

14

/202

04/

27

/202

004

/07/

2020

3/2

0/2

020

03/0

4/20

202/

17

/202

01/

30

/202

01/

14

/202

0

Nigeria’s External Reserves (US$’Billion)


5

Relative to comparable countries, Nigeria’s exchange rate has significantly depreciatedEnd Period Exchange rates (LCU/US$) in Nigeria and select Countries

Data Source: investing.com

Year Nigeria GhanaWAEMU

CountriesSouth Africa Egypt Indonesia Malaysia

Naira (N) Cedi (C) CFA Franc Rand (Z) Egypt Pound Rupiah Ringgit

2011 156.70 1.58 509.38 8.08 6.03 9067.50 3.17

2012 155.76 1.88 498.49 8.46 6.36 9637.50 3.06

2013 155.74 2.16 477.76 10.50 6.95 12170.00 3.28

2014 168.00 3.20 541.75 11.57 7.15 12385.00 3.50

2015 197.00 3.80 613.90 15.48 7.83 13787.50 4.29

2016 305.00 4.20 628.92 13.74 18.13 13472.50 4.49

2017 306.00 4.42 573.51 12.37 17.74 13567.50 4.05

2018 307.00 4.82 572.72 14.36 17.91 14380.00 4.13

2019 307.00 5.54 581.75 13.99 16.05 13882.50 4.09

2020 379.00 5.76 530.50 14.69 15.69 14050.00 4.02

21/05/21 412.00 5.73 536.75 13.96 15.61 14350.00 4.14

Period

Change162.92% 262.0% 5.4% 72.8% 158.8% 58.3% 30.6%

• Over a period of 10+ years, the Naira has significantly lost its value relative to some comparable countries.

• The official Naira rate has depreciated by 162.9% from N156.7/US$ in 2011 to N412/US$ as at May 2021.

• This is unimpressive when compared with performances of large economies such as Indonesia (58.3%), Malaysia (30.6%), Egypt (158.8%) and South Africa (72.8%) during the same period.


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Nigeria has also witnessed high frequency of policy shift in Forex management

Sources: CBN, Ali, A. I., Ajibola, I. O., Omotosho, B. S., Adetoba, O. O. and Adeleke, A. O. (2015), “Real Exchange Rate Misalignment and Economic Growth in Nigeria”, CBN Journal of Applied Statistics, Vol. 6 No. 2.

Exchange Rate Regimes/Policy in Nigeria PeriodAverage Exchange

Rate (N/US$)

Managed Float 1973 – 1978 0.63

Basket of Currencies Approach 1978 0.78

Dual Exchange Rate System (Introduction of Second Tier FEM) September 1986 3.87

Dutch Auction System (DAS) of Bidding 1987 3.90

Single enlarged Foreign Exchanged Market with various pricing methods July 1987 4.40

Creation of Interbank Foreign Exchange Market (IFEM) January 1989 12.98

Pegged Exchange Rate system 1994 22.00

Autonomous Foreign Exchange Market (AFEM) 1995 81.93

Reintroduction of IFEM October 1999 102.81

Retail Dutch Auction System (RDAS) of foreign exchange management July 2002 129.14

Wholesale Dutch Auction System (WDAS) 2006 – 2013 142.66

Retail Dutch Auction System (RDAS) of foreign exchange management October 2013 159.43

Interbank Foreign Exchange Market (Closure of Official Window) February 2015 197.25

Tightly Managed Floating February 2016 197.00

Tightly Managed Floating Jun. 2016 – till date 324.49


Timeline of Recent Foreign Exchange Policies in Nigeria

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August 2020The CBN adjusted

the official exchange

rate to N380/US$1

from N360.1/US$1

August 2020Resumption of forex

sales to BDC after

the halt due to

COVID-19

November 2020Amendment of the

diaspora remittances

rule to allow recipient to

receive foreign currency

in cash..

December 2020Instruction to banks

to transfer all

diaspora remittances

to beneficiaries

March 2021

Introduction of the

‘Naira 4 Dollar

Scheme’ for diaspora

remittances

May 2021The CBN adopted the

NAFEX (I&E Window)

rate as the official

rate

January 2020Inclusion of fertilizer

in the list of items

restricted from

foreign exchange

February 2020Restriction on Forex

supply to authorized

milk and diary

product dealers

March 2020CBN devalued the

official exchange rate

from N307/US$1 to

N360/US$1

April 2020Adjustment of exchange

rate for import duty

payment from N326/$ to

N361/$

July 2020Increase of forex

bidding price for

SMIS operators to

N380/$1

July 2020CBN added maize to

the list of imported

goods banned from

official access to forex

N


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Recently, the CBN appears to be more embracing of market fundamentals


We wait to observe whether these actions by the apex bank will be sustained in months to come.

The limited intervention in the I&E window as shown by the reduced CBN FX sales since January 2021

The Recent unification of exchange rate (official and NAFEX) in May 2021

1.

2.

Two crucial moves point to a deviation from previous approaches adopted by the CBN:


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1. Reduced scale of intervention in the I&E window since January 2021

• In the first quarter of 2021, there was a change in the scale of CBN’s intervention in the I&E window.

• We observe the limited inflow from the CBN in the I&E window as shown by the data on forex inflows by sources.

• The decline in overall inflow into the market was largely driven by over 90% drop in CBN interventions.

• In the first four months of 2021, inflows from the CBN intervention in the I&E Window totaled US$226.6 million. This is significant drop of US$2.27 billion in the last four months of 2020.

• If sustained, perhaps, this signals a breakaway from the heavy interventionist role of the apex bank. This could improve reserves position and boost market confidence.

• To get inflows into the window to pre-pandemic level, fresh injection of huge amount of forex, particularly from private sources would be needed.

Forex Inflow in the I&E Window (US$’Million)

Data Source: FMDQ

Sources Aug-20 Sept-20 Oct-20 Nov-20 Dec-20 Jan-21 Feb-21 Mar-21 Apr-21

FDI 36.2 30.8 31.7 65.0 54.2 69.8 7.5 29 12.3

FPI 9.2 36.8 48.1 54.8 23.6 116.1 17.9 175.2 31.1

Other Corporate

19.1 22.4 43.4 22.9 24.0 17.3 9.3 9.7 25.3

CBN 434.5 558.2 453.6 823.9 74.1 2.9 6.4 143.2

Exporter 37.4 206.8 117.2 134.8 111.5 209.5 175.7 125.5 109.4

Individuals 14.8 29.4 26.3 29.8 12.3 20.9 2.5 14.4 16.5

Non-bank corporate

31.2 175.5 304.8 407.7 316.5 227.2 350.1 191.2 226.4

Total 428.7 935.2 1,165.7 1,168.6 1,366.0 734.9 565.9 551.4 564.2


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2. Unification of the official Exchange Rate by the CBN

Data Source: Central Bank of Nigeria

• On Monday, May 24, 2021, the CBN displayed the NAFEX exchange rate on its website.

• The Naira exchanged at N410.25/US$, an adjustment of 8.2% from N379/US$ in the early part of May 2021.

• Recall that the IMF in its Article IV recommended “establishing a market-clearing unified exchange rate with the near-term focus on allowing greater flexibility and removing the backlog of requests for foreign exchange”.

• Likewise, the Federal Government’s Economic Sustainability Plan (ESP) proposed to “unify exchange rates to maximise naira returns to FAAC from foreign exchange inflows”.

• The adoption of rates in the I&E window is long awaited and is among measures to regain market confidence and unlock funds from multilateral agencies including the World Bank and the IMF.

• Previous exchange rate adjustments by the CBN were not aligned with prevailing market rates. They were below the rate in the I&E window.

• This time, however, the CBN adopted the rate in the I&E window as its official rate.

• We believe this is a first and major step towards gaining back investor’s confidence on the economy, which in turn could improve forex inflows into the economy.

• The government has also hinted the issuance of Eurobond which is expected to improve reserves position and ease pressure on the exchange rate when issued.

Potential Impact


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Key factors that will shape the movement of the exchange rate in 2021


Crude oil price movement and OPEC cutsPersistent OPEC cuts and compliance among member-countries

would mean that Nigeria may not reap the benefits of higher crude oil price. This implies lower petrodollar inflows in the short

term.

Movement of external reservesReserves currently hover at US$34 billion. Reserves accretion is expected to slow down in the short term due to lower than anticipated foreign investment and oil inflows. Possible issuance of foreign denominated bonds will improve reserves position.

CBN Forex PoliciesManagement of forex is crucial in regaining investors’ confidence on the economy and in turn, attracting the much-needed inflow. Recent moves by the CBN to unify the exchange rate is expected to yield positive impact as regards the inflow of forex.

Interest rate movementThe gradual increase of interest rates on government securities is expected to lead to higher inflows but this will largely depend on forex liquidity and capital restriction policies.

Ease of doing business reforms and insecurityEase of doing business reforms are crucial in attracting and retaining Foreign Direct Investment in Nigeria. The security situation, however, could serve as a setback for real sector

investment in the country.

Real sector performanceEconomic recovery and pick-up in imports and exports are

fundamental factors that will influence exchange rate movement in 2021H2. Following the gradual economic recovery and the

opening of the land borders, we expect improvement in non-oil exports; albeit below pre-pandemic level. Trade deficit is expected to narrow in coming quarters with reduced pressure on exchange

rate.


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• The recent action by the Central Bank to unify the exchange rate is a positive move for the economy. This was a recommendation in our Macroeconomic Review for 2021Q1. With this move, the CBN has taken a step towards ensuring clarity and improving market confidence. Nigeria can also unlock funding from several multilateral organisations such as the IMF and World Bank and ease the pressure on the exchange rate in the medium term. However, exchange rate unification is not a sufficient factor in attracting significant capital into the country. What should follow the CBN’s recent actions, in our view, are a set of consistent forex policies that seek to improve market liquidity and prevent every form of forex arbitrage and unnecessary forex subsidies. The CBN will also need to clear forex backlogs to further instil confidence in the market. In February 2021, the IMF estimated backlogs at US$2 billion. We believe this will be done gradually.

• As much as Nigeria needs effective management of forex and unification of exchange rate to boost confidence, the supply shortage of forex is still a major problem. Increasing forex supply from non-CBN sources is vital in maintaining exchange rate stability in the I&E window and reducing speculative activities. In addition, the planned issuance of Eurobond by the government is expected to provide some relief in the market and boost external reserves in the short term.

• From the fiscal and trade perspective, Nigeria will need to leverage on the African Continental Free Trade Area (AfCFTA) Agreement to boost non-oil exports and increase forex inflows. Providing direct incentives for businesses to produce for exports, implementing port reforms as well as developing a comprehensive industrial and trade strategies are important steps that the government must take.

• We believe that the Naira will settle around N430/US$ in the later part of 2021. Forex inflows are expected to also improve, especially when the Eurobond is issued, but increasing demand pressures from imports and other payments, will continue to exert pressure on the rate.

Analyst views on Nigeria’s Foreign Exchange Situation


13

• The Economy remains fragile and the macroeconomic outlook is subdued given recent developments

• Annual Inflation showed signs of stability for the first time in 19 months due to a slowdown in food inflation but inflationary pressures remain. High inflation may continue to create challenges as long as structural bottlenecks are not addressed.

• The slowdown in GDP growth indicated by the Q1 2021 data is a reflection of fragile economic recovery. Non-oil GDP slowed to 0.8% from 1.7% in Q4 2020.

• Trade , a key sector (16% of GDP) continued to contract, possibly due to FX shortages and weak aggregate demand.

• We believe that targeted infrastructure spending and enhanced structural policy implementation is critical for economic recovery and sustained growth

• Our 2021 forecasts for key indicators Real GDP growth of 1.3%; an average exchange rate of N430/$ and an Inflation rate of 16.6% .(see Table 1 : Macroeconomic projection ).

Analyst highlights on macroeconomic outlook


Credit to Private Sector (N’Trillion)

Sectoral Utilization of Credit (%)


Dec-19 Dec-20 Jan-21 Feb-21 Mar-21 Apr-21

Currency/M2 8.49 7.71 7.50 7.31 7.35 7.29

Currency/GDP 1.69 1.91 1.86 1.82 1.84 1.84

M2/GDP 19.96 24.75 24.78 24.97 25.09 25.20

CPS/GDP 18.51 19.79 20.12 20.03 20.64 20.89

Stock Market Capitalization/GDP

8.99 13.56 15.38 14.44 14.17 14.46

Financial Deepening Indicators (%)

Lending Rates (%)

Monetary Policy: Key statistics

-5

0

5

10

15

20

25

30

35

MPR Prime Lending Maximum Lending Inter Bank Treasury Bill

26.7 26.828.4 28.9 29.3 29.6 30.2 30.4 29.7 29.1 29.4 30.1 30.6 30.5 31.4 31.8

0

5

10

15

20

25

30

35

CPS YoY Growth CPS (RHS)

5.2

37.2

4.86.5

8.6

37.7

Agriculture Industry Construction Trade Government Services

Dec-19 Dec-20 Jan-21


14

Monetary Policy: Outlook and Expectation

Outlook and expectations

• As economic activities resume across several activity sectors, we anticipate improved economic recovery in subsequent quarters.

• However, the inherent fragility due to structural factors such as infrastructural deficit, security challenges, foreign exchange instability, among others, will keep the growth rate tepid.

• Given that the recent driver of inflationary pressure remains structural rather than monetary, future MPC meetings will put this into consideration, raising the possibility of a rate reduction.

• However, the need to continue to capital inflows to boost foreign reserves, support the budget and ensure exchange rate stability would motivate the MPC to keep interest rates high.

• Consequently in the coming MPC meeting, we anticipate the committee to retain their policy position while observing the domestic and global developments.

Key factors that influenced monetary policy decisions at the MPC meeting included:

• The need to support economic recovery • Inflationary pressure• The need to improve consumption and investment• Credit to the private sector • Persisting security challenges and infrastructural deficits

The CBN Monetary Policy Committee (MPC) held its third meeting of2021 and the Committee maintained its previous policy stance for thefourth consecutive meeting. Hence, the MPC decided as follows:

• Retain the MPR at 11.5%;

• Retain the Asymmetric Corridor at +100/-700 basis points around the MPR;

• Retain Cash Reserve Ratio (CRR) at 27.5 percent; and

• Retain the Liquidity Ratio at 30 percent.


15

16

• The Policy Trilemma explains Nigeria’s foreign exchange and monetary choices. The trilemma refers to the trade-offs a government faces when making crucial monetary policy decisions.

• In the framework, it is argued that all three objectives cannot be achieved at the same time. Only two of the three objectives can be achieved at a time.

• With COVID-19, Nigeria maintained the two objectives of having a fixed/managed official exchange rate and monetary autonomy (POINT C), at the expense of free movement of capital. This was evident in the capital controls and forex backlogs.

• The recent move by the CBN to adopt the I&E market rate as the official rate could move the country to POINT B: the CBN can control interest rate (monetary autonomy) while capital controls can be relaxed, but exchange rate will have to be flexible.

• Whether the Naira appreciates or depreciates will depend on the level of capital inflows and outflows, CBN’s involvement in the market and the external reserves position. This means only way to maintain a stable exchange rate is to attract even more capital into the economy or intervene heavily in the forex market using the external reserves.

The Policy Trilemma: a useful guide for monetary policy decision


Fixed Exchange Rate

Monetary Autonomy

Free Capital Mobility

A B

C

The Policy Trilemma

17

• At POINT B, exchange rate is expected to be flexible and market determined. This, to a large extent, reduces arbitrage and round-tripping and could move the Naira towards its fair value.

• The CBN’s move is expected to instil confidence in the market as foreign investors are more likely to participate in a less fragmented market that can be fairly predictable.

• Given this framework, the options available for the CBN include:

• Raise interest rates to incentivise the inflow of capital into the economy. This could hurt economic recovery in subsequent quarters.

• Relax capital control rules/restrictions and simultaneously increase market interventions to prevent significant depreciation of the Naira. This could result in external reserves depletion.

• “Allow” the Naira to move freely and grow the external reserves.

• As a way forward, we believe the Monetary Policy Committee will hold rates in the subsequent meeting to support economic recovery while the CBN adopts other measures to increase capital inflows. Forex restrictions will likely continue until reserves position improves.

The Policy Trilemma: a useful guide for monetary policy decision


Fixed Exchange Rate

Monetary Autonomy

Free Capital Mobility

A B

C

The Policy Trilemma

Macroeconomic Projection for 2021

18

19

Scenario Assumptions Possible Outcome

Best Case(Economy opens up and government fully implements interventions to stimulate the economy)

• Oil price rises significantly above US$53 per barrel• Demand for Nigerian crude improves as economies recover-

Nigeria produces 1.9 million barrels per day• Government capital spending at N1.7 trillion• Full implementation of sectoral support interventions

• GDP Growth at 2.3%• Inflation Rate at 14.5%• External Reserves at US$38bn• Exchange Rate at N380/US$

Moderate Case(the economy recovers moderately and embraces the new normal)

• Oil price averages US$45 per barrel• Gradual re-opening of cities, schools, airports, businesses, etc. • Crude oil production at 1.6 million barrels per day• Government capital spending at N1.4 trillion• Partial implementation of sectoral support interventions

• GDP Growth at 1.3%• Inflation Rate at 16.6%• External Reserves at US$34 billion• Average Exchange Rate at N430/US$

Worst Case(Death toll from COVID-19 increases rapidly, weak implementation of business support initiatives)

• Oil price below US$30 pb• Another wave of COVID-19 infections results in lock down of

schools and restriction of gathering, etc. • Lower crude oil production- Nigeria produces 1.2 million barrels

per day• Government capital spending at N700 billion• Weak implementation of sectoral support interventions• Civil unrests/protests disruptions productive activities

• GDP Growth at -2%• Inflation Rate at 19%• External Reserves at US$28 billion• Exchange Rate at N460/US$

Macroeconomic Scenario for 2021

20

Macroeconomic Projection for 2021

2017 2018 2019 2020 2021f*

Real GDP Growth 0.8% 1.9% 2.3% -1.9% 1.3%

Inflation rate 16.5% 12.1% 11.4% 13.2% 16.6%

Average Exchange rate (N/US$) 365.58 361.97 361.93 382.07 430

Investment as a % of GDP 14.7% 19.0% 24.6% N/A 23.0%

Monetary Policy Rate 14.0% 14.0% 13.5% 11.5% 11.0%

External Reserves (Average, US$ Billion)

31.3 44.6 43.0 35.9 34.0

*Please note that there is still a high degree of uncertainty around the forecast for 2021. Actual figures could exceed or fall below these forecasts. A lot depends on the path of COVID-19, vaccine effectiveness, oil price movement and possible disruptions in the local economy.

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Nigeria’s Foreign Exchange Policy Note

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