A report by the Bank of America Merrill Lynch Global Research has predicted that the naira may weaken for the current levels of over N160 to N170.
The report noted that although the Central Bank of Nigeria had the political will to defend the naira, the dwindling amount in the reserves may undermine this effort.
The report read in part, “We believe that the political will to defend the naira is high, but the running down of reserves will weigh on external debt performance. We recommend an underweight position. Despite our expectation of tighter monetary policy this year, we still forecast the naira to weaken further to average N170 in 2014.
“The sustainability of the 150-160 exchange rate band ultimately will be determined by the market, in our view. We believe the current level of reserves ($41.2bn as of February 20) will be sufficient to support the naira, if market pressure does not rise to extreme levels.”
According to the BofA Merrill Lynch report, signs of stress are already evident in the dollar-naira street rate, noting that the decision of President Goodluck Jonathan to suspend the CBN Governor Lamido Sanusi had raised the risk premium on Nigerian assets.
The increasing divergence between the official interbank dollar-naira rate and the parallel market, represented by the street rate, has been in part driven by the CBN restrictions on the operations of the Bureaux de Changes, which recently have been removed, according to analysts.
However, due to the recent turmoil at the CBN, this spread could widen further as risk aversion increases, report showed, adding that “this means the CBN will have to work even harder to keep the naira in check.”
The report recalled that similar thing had happened in November 2011, when the midpoint of the exchange rate band was moved from 150 to 155.
In the month preceding the move, there was a large amount of volatility in the spot rate caused by declining risk appetite.
According to the BofA Merrill Lynch, the naira reached highs of 165, six per cent above the upper end of the band at the time.
However, it noted that the warning signs came earlier with the street exchange rate starting to trade at elevated levels from July 2011, peaking at a spread of seven to eight per cent compared to the official rates by the end of that month.
Consequently, there was significant increase in the amount of dollar that the CBN sold at auction to shore up the naira, adding that between June and September 2011, total foreign exchange supply at auction increased by 60 per cent to reach $4.8bn. This represented 15 per cent of total reserves, which were $32bn at the time.