Flexible Exchange Rate Policy; Frequently Asked Questions.
A new dawn in Nigeria’s exchange rate policy was ushered in on Monday June 20th by the Central Bank of Nigeria. The new policy is expected to enable an exchange rate that will be determined by the forces of demand and supply.
We have covered this subject in detail at Nairametrics by featuring quality articles that help our readers understand better. However, we decided to dedicate a page to frequently asked questions that we know small businesses and individuals may wish to have answers for. The page will be updated frequently as things become clearer. We will also include new questions and suggested answers to ensure that our readers remain informed.
What do they mean when they say “a currency is floating?”
The term “floating” in exchange rate context refers to the exchange rate of a country that is not fixed but “floats” to the direction of demand and supply. If demand is high and supply is low, the exchange rate floats higher. When demand is low and supply is high, the exchange rate floats lower. When demand and supply are nearly equal we have an exchange rate balance or equilibrium.
Difference between floating a currency and devaluation
A devaluation can also occur in an interbank market when the home currency depreciates significantly against the dollar or any other benchmarked currency. In Nigeria and most developing countries, devaluation is more synonymous contextually with the Central Bank depreciating the currency by fiat. For example, when the CBN moved the exchange rate from N165 to N197 it was a devaluation.
Will we still have two exchange rates? If yes, which one do I rely on for transactions
Whilst the parallel market rate has never been an official rate, it is still very much referenced as the closest to an ideal market determined rate. The interbank market rate and the parallel market rates will therefore remain for some time. The parallel market rates will most be cash based and will serve the retail end of the market for buyers and sellers of forex who do not wish to transact through banks. However, we expect that the difference between both rates will be slim (perhaps plus or minus 5% max).
Will this new policy eliminate black market operators and do I still need to track parallel market rates?
Parallel markets will still remain, however we believe their influence will be mostly minimal and not like we have them today. As such, tracking that rate is still important provided that is where you still buy and sell dollars. As our forex markets develop, the CBN will introduce structures that will cater for the very retail end of the market. For example, some retail FX operators can deal only in online transactions, others purely cash while some card based transactions.
If I want to renew my Visa on Monday or pay for my import duties, at what rate will I pay?
Let’s take them one by one. Visas fees in the past are based on the official exchange rate set by the CBN. If a Visa fee is $200 then you pay about N39,400 (using N197). Now that rates are determined by market forces, Embassies are no longer compelled to use the official rate of N197. They will likely use the interbank rate or a monthly average of the exchange rate.
For tickets, airlines also quote tickets prices in forex but convert them to Naira using the official exchange rate. Now that the exchange rate is now market determined, we expect that ticket prices will fluctuate depending on how the exchange rate swings. Ticket prices will likely rise when the market takes effect.
Import duties are also paid based on the free on board value of goods being imported. That is typically on forex and need to be converted to dollars. Again, that too used to be based on the official exchange rate of N197. Going forward, we expect it to be determined by the interbank rate.
What will be the roles of BDC’s? Will we still need them?
BDC’s are expected to eventually play a crucial role in this new exchange rate policy. They will handle the retail end of the market where the ordinary Nigerians goes to buy and sell forex. Their roles will be similar to what the likes of Travelex do in Europe.
How do I buy or sell forex going forward? Is it still possible to buy forex in cash?
You will still be able to buy forex officially by bidding through your bank. Your Form M’s and other documents used by importers to pay for goods abroad will be based on the interbank market rate. If what you want is a cash transaction, then you’d have to rely on the parallel market at least for now.
Is there a limit to how high or low the price can get to?
Before now, the CBN can determine how high or low they want the exchange rate to trade. With this new exchange rate policy, there is no limit to how high or low the interbank market price can go. It all depends on the forces of demand and supply. This in effect means that we can see the Naira trading at N400 or N500 or N200 or N250 it all depends on the forces on demand and supply.
Will there always be dollars available for me to buy whenever I need them?
One of the major issues we had with the previous fixed exchange rate policy was scarcity. Because of the scarcity of forex, people tended towards front loading purchase even if they really did not need the money immediately. Some even bought just to hoard and hope that prices will rise again. Whilst, scarcity can’t be ruled out completely we believe you will always have access to buy dollars provided you meet regulatory or the banks criteria. The only difference is that the price could be high if supply is limited and low if supply is readily available.
What of other needs such as school fees, medical tourism etc. how do I pay for them?
All qualified forex transactions such as school fees, medical tourism, Personal travel allowance etc. will be paid via your commercial banks using the interbank rates. We believe your banks will still be able to sell to you whenever you need it.
How do I pay for other expenses such as buying things online?
You can still pay for transactions via your authorized debit cards. However, banks can still impose exchange controls on how much you can spend periodically. We believe some of those controls will still remain, however it will loosen as the market picks up over time.
When I earn money in dollars online, at what rate will it be converted to?
We believe the conversion rate will be the interbank rates except if the you wish to withdraw the money from the bank. Withdrawing forex in cash from your bank account still depends on the exchange controls imposed by your bank.
Is there still a restriction on transfer of forex out of the country?
Again, retail transactions such as transferring money to a loved one abroad will still depend on the exchange controls currently in place. These controls to the best of our knowledge hasn’t been changed by the CBN however we expect them to be loosened. Exchange controls currently limit your ability to make transfers.
If I have dollars in my domiciliary account, can I withdraw it as cash?
This also depends on the current exchange controls in place by your bank. Currently, there are restrictions on withdrawals and depositing of forex into your domiciliary accounts. We expect some of these controls to be relaxed in the coming weeks.
What major roles will FMDQ play in this new market?
The CBN Governor informed everyone that the FMDQ will be the market platform where the interbank market will be traded. As such, all trades will be through the FMDQ and will also be the platform for confirming daily closing prices.
Can I trade forex via the FMDQ? If yes, how?
Currently, the FMDQ platform only caters for wholesale transactions and not retail. For local retail investors looking to play in this new forex market, you will have to wait till the market is open for you.
What is FMDQ
The FMDQ is an acronym for the Financial Market Dealers Quotation. According to their website, the FMDQ concept was promoted by the Financial Markets Dealers Association (FMDA) in 2009 and sponsored in 2010 by the Bankers’ Committee. It is basically a market where over the counter trades on treasury bills, bonds and now forex are made.
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Why Insurance firms are selling off their PFAs
It has not been uncommon over the years to have insurance companies with pension subsidiaries.
The idea of mitigating risks and curtailing losses at the bare minimum begins from the insurance industry and only crosses into the pension space with the need for retirement planning. For this reason, it has not been uncommon over the years to have insurance companies with pension subsidiaries. However, controlling the wealth of people is no easy feat – and crossover companies are beginning to think it might not be worth it competing with the big guns; that is, the pension fund administrators (PFAs) that already cater to the majority of Nigerians.
A few months ago, AXA Mansard Insurance Plc announced that its shareholders have approved the company’s plan to sell its pension management subsidiary, AXA Mansard Pensions Ltd, as well as a few undisclosed real estate investments. It did not provide any reason for the divestment. More recently, AIICO Insurance Plc also let go of majority ownership in its pension arm, AIICO Pension Managers Ltd. FCMB Pensions Ltd announced its plans to acquire 70% stakes in the pension company, while also acquiring an additional 26% stake held by other shareholders, ultimately bringing the proposed acquisition to a 96% stake in AIICO Pension. The reason for the sell-off by AIICO does not also appear to be attributed to poor performance as the group’s profit in 2019 had soared by 88% driven by growth across all lines of business within the group.
So why are they selling them off?
Pension Fund Administration is, no doubt, a competitive landscape. Asides the wealth of the over N10 trillion industry, there is also the overarching advantage that pension contributors do not change PFAs regularly. Therefore, making it hard to compete against the big names and industry leaders that have been in the game for decades – the kinds of Stanbic IBTC, ARM, Premium Pension, Sigma, and FCMB. Of course, the fact that PFAs also make their money through fees means the bigger the size, the more money you make. With pressure to capitalize mounting, insurance firms will most likely spin off as they just don’t have the right focus, skills, and talents to compete.
The recent occurrence of PENCOM giving contributors the opportunity to switch from one PFA to another might have seemed like the perfect opportunity for the smaller pension companies to increase their market shares by offering better returns. More so, with the introduction of more aggrieved portfolios in the multi-fund structure comprising of RSA funds 1, 2, & 3, PFAs can invest in riskier securities and enhance their returns. However, the reality of things is that the smaller PFAs don’t have what it takes to effectively market to that effect. With the gains being made from the sector not particularly extraordinary, it is easier for them to employ their available resources into expanding their core business. There is also the fact that their focus now rests on meeting the new capital requirements laced by NAICOM. Like Monopoly, the next smart move is to sell underperforming assets just to keep their head above water.
Olasiji Omotayo, Head of Risk in a leading pension fund administrator, explained that “Most insurance businesses selling their pension subsidiaries may be doing so to raise funds. Recapitalization is a major challenge now for the insurance sector and the Nigerian Capital Market may not welcome any public offer at the moment. Consequently, selling their pension business may be their lifeline at the moment. Also, some may be selling for strategic reasons as it’s a business of scale. You have a lot of fixed costs due to regulatory requirements and you need a good size to be profitable. If you can’t scale up, you can also sell if you get a good offer.”
What the future holds
With the smaller PFAs spinning off, the Pension industry is about to witness the birth of an oligopoly like the Tier 1 players in the Banking sector. Interestingly, the same will also happen with Insurance. The only real issue is that we will now have limited choices. In truth, we don’t necessarily need many of them as long all firms remain competitive. But there is the risk that the companies just get comfortable with their population growth-induced expansion while simply focusing on low-yielding investments. The existence of the pandemic as well as the really low rates in the fixed-income market is, however, expected to propel companies to seek out creative ways to at least keep up with the constantly rising rate of inflation.
Nigerian Banks expected to write off 12% of its loans in 2020
The Nigerian banking system has been through two major asset quality crisis.
The Nigerian Banking Sector has witnessed a number of asset management challenges owing largely to macroeconomic shocks and, sometimes, its operational inefficiencies in how loans are disbursed. Rising default rates over time have led to periodic spikes in the non-performing loans (NPLs) of these institutions and it is in an attempt to curtail these challenges that changes have been made in the acceptable Loan to Deposit (LDR) ratios, amongst others, by the apex regulatory body, CBN.
Projections by EFG Hermes in a recent research report reveal that as a result of the current economic challenges as well as what it calls “CBN’s erratic and unorthodox policies over the past five years,” banks are expected to write off around 12.3% of their loan books in constant currency terms between 2020 and 2022, the highest of all the previous NPL crisis faced by financial institutions within the nation.
Note that Access Bank, FBN Holdings, Guaranty Trust Bank, Stanbic IBTC, United Bank for Africa and Zenith Bank were used to form the universe of Nigerian banks by EFG Hermes.
Over the past twelve years, the Nigerian banking system has been through two major asset quality crisis. The first is the 2009 to 2012 margin loan crisis and the other is the 2014 to 2018 oil price crash crisis.
The 2008-2012 margin loan crisis was born out of the lending institutions giving out cheap and readily-available credit for investments, focusing on probable compensation incentives over prudent credit underwriting strategies and stern risk management systems. The result had been a spike in NPL ratio from 6.3% in 2008 to 27.6% in 2009. The same crash in NPL ratio was witnessed in 2014 as well as a result of the oil price crash of the period which had crashed the Naira and sent investors packing. The oil price crash had resulted in the NPL ratio spiking from 2.3% in 2014 to 14.0% in 2016.
Using its universe of banks, the NPL ratio spiked from an average of 6.1% in 2008 to 10.8% in 2009 and from 2.6% in 2014 to 9.1% in 2016. During both cycles, EFG Hermes estimated that the banks wrote-off between 10-12% of their loan book in constant currency terms.
The current situation
Given the potential macro-economic shock with real GDP expected to contract by 4%, the Naira-Dollar exchange rate expected to devalue to a range of 420-450, oil export revenue expected to drop by as much as 50% in 2020 and the weak balance sheet positions of the regulator and AMCON, the risk of another significant NPL cycle is high. In order to effectively assess the impact of these on financial institutions, EFG Hermes modelled three different asset-quality scenarios for the banks all of which have their different implications for banks’ capital adequacy, growth rates and profitability. These cases are the base case, lower case, and upper case.
Base Case: The company’s base case scenario, which they assigned a 55% probability, the average NPL ratio and cost of risk was projected to increase from an average of 6.4% and 1.0% in 2019 to 7.6% and 5.3% in 2020 and 6.4% and 4.7% in 20201, before declining to 4.9% and 1.0% in 2024, respectively. Based on its assumptions, they expect banks to write-off around 12.3% of their loan books in constant currency terms between 2020 and 2022, a rate that is marginally higher than the average of 11.3% written-off during the previous two NPL cycles. Under this scenario, estimated ROE is expected to plunge from an average of 21.8% in 2019 to 7.9% in 2020 and 7.7% in 2021 before recovering to 18.1% in 2024.
Lower or Pessimistic Case: In its pessimistic scenario which has a 40% chance of occurrence, the company projects that the average NPL ratio will rise from 6.4% in 2019 to 11.8% in 2020 and 10.0% in 2021 before moderating to 4.9% by 2024. It also estimates that the average cost of risk for its banks will peak at 10% in 2020 and 2021, fall to 5.0% in 2022, before moderating from 2023 onwards. Under this scenario, banks are expected to write off around as much as 26.6% of their loan books in constant currency terms over the next three years. Average ROE of the banks here is expected to drop to -8.8% in 2020, -21.4% in 2021 and -2.9% in 2022, before increasing to 19.7% in 2024.
Upper or optimistic case: In a situation where the pandemic ebbs away and macro-economic activity rebounds quickly, the optimistic or upper case will hold. This, however, has just a 5% chance of occurrence. In this scenario, the company assumes that the average NPL ratio of the banks would increase from 6.4% in 2019 to 6.8% in 2020 and moderate to 4.8% by 2024. Average cost of risk will also spike to 4.2% in 2020 before easing to 2.4% in 2021 and average 0.9% thereafter through the rest of our forecast period. Finally, average ROE will drop to 11.6% in 2020 before recovering to 14.4% in 2021 and 19.0% in 2024.
With the highest probabilities ascribed to both the base case and the pessimistic scenario, the company has gone ahead to downgrade the rating of the entire sector to ‘Neutral’ with a probability-weighted average ROE (market cap-weighted) of 13.7% 2020 and 2024. The implication of the reduced earnings and the new losses from written-off loans could impact the short to medium term growth or value of banking stocks. However, in the long term, the sector will revert to the norm as they always do.
Even with a 939% jump in H1 Profit, Neimeth still needs to build consistency
Neimeth has been one of the better performers in the stock market in the last one year.
Neimeth’s profit after tax for H1 2020 might have jumped by 939% from H1 2019, but there’s still so much the company needs to do to remain in the game.
For the first time in years, Pharmaceutical companies across the globe are in the spotlight for a good reason. As the COVID-19 pandemic rages on, the world waits patiently for this industry to produce a vaccine that can once again lead us back to the lives we all missed. Nigeria is also not an exception, it seems. One of Nigeria’s oldest pharmaceutical companies, Neimeth, has been one of the better performers in the stock market in the last one year. However, there is still so much the company needs to do to earn profits consistently.
Neimeth’s recently released H1 2020 results show a jump of 19.4% in revenue from ₦976 million earned in H1 2019 to ₦1.165 billion in H1 2020. While this is impressive, its comparative Q2 results (Jan-March ‘ 20) show a drop in revenue of 25.4% from ₦748.8 million earned in Q2 2019, to the ₦568.7 million revenue in Q2 2020. In similar vein, while its profit-after-tax soared by 939% from ₦5.447 million in H1 2019 to ₦56.596 million in H1 2020, its quarter-by-quarter results show a drop of 118%. While there is a truth that some months are better performers than others, Neimeth’s extreme profit jump in the half-year results juxtaposed with the more-than-100% drop in the first quarter of this year, reveal wide-gap volatility in its earning potential. Its revenue breakdown attributes the quarter-by-quarter drop in revenue to a comparative drop in its ‘Animal Health’ product line by a whopping 897.42%. The ‘Pharmaceuticals’ line also only experienced a marginal jump of 2.57%.
Full report here.
Current & Post-Covid-19 Opportunities
A 2017 PWC report had revealed that by 2020 the pharmaceutical market is expected to “more than double to $1.3 trillion. Mckinsey had also predicted that come 2026, Nigeria’s pharma market could reach $4 billion. The positive outlook of the industry is even more so, following the disclosure by the CBN to support critical sectors of the economy with ₦1.1 trillion intervention fund.
The CBN governor, Godwin Emefiele, had stated that about ₦1trillion of the fund would be used to support the local manufacturing sector while also boosting import substitution while the balance of ₦100 billion would be used to support the health authorities towards ensuring that laboratories, researchers and innovators are provided with the resources required to patent and produce vaccines and test kits in Nigeria.
While manufacturing a vaccine for the Covid-19 pandemic might be nothing short of wishful, the pandemic presents a global challenge that businesses in the healthcare industry could leverage. Through strategic R&D, it could uncover a range of solutions, particularly those that involve the infusion of locally-sourced raw materials.
In order for the company to attain sustainable growth, it needs to come up with structures and systems that are dependable, while also tightening loose ends. One of such loose ends is its exposure to credit risk. It’s Q2 2020 reports reveal value for lost trade receivables of N693.6 million carried forward from 2019. To this end, it notes that while its operations expose it to a number of financial risks, it has put in place a risk management programme to protect the company against the potential adverse effects of these financial risks.
At the company’s last annual general meeting (AGM), the managing director, Matthew Azoji, had also spoken on the company’s efforts to gain a larger market share through its initiation of bold and gradual expansion strategies.
The total revenue growth and profitability of the half-year period undoubtedly signals a potential in the company. However, we might have to wait for the company’s strategies to crystalize and attain a level of consistency for an extended period before reassessing the long-term lucrativeness of its stock or otherwise. That said, it certainly should be on your watchlist.