In case you didn’t know, Nigeria’s external reserve hit $47 billion on Wednesday, the highest in over 4 years. We had an inkling of this achievement last week when the CBN Governor, Godwin Emefiele revealed the feat despite public official records putting it at about $46.6 billion.
Not a lot of people feel different about the improvement in external reserves and we are pretty sure that it won’t make any major difference in your life, at least in the interim. However, this is a good development for the wider economy and more specifically, investments in Nigeria. Let’s explain why.
Nigeria’s stock market is dominated by two sets of investors: Foreign Investors and Local Investors. The presence of foreign investors in the stock market help to provide the liquidity needed to deliver a viable and active stock market. Despite the apathy to stocks over the years, it is still a N14 trillion market and a source of income to hundreds of thousands of Nigerians and millions more via their pension fund contributions.
The rising exchange rate gives foreign investors the confidence they need to continue to invest in Nigeria, thus giving local investors confidence that the market can continue to sustain its positive gains provided that companies meet their earnings goals.
Fixed Income Market
This market comprising Treasury bills, FGN Savings Bonds, Fixed Deposits, all makeup fixed income securities. Since the economy started picking up, investors have flocked into Nigeria’s fixed income market buying government bonds denominated in naira or in dollars. Blue chip companies have also taken advantage of the situation and sold various levels of bond issuance in the last one year.
Just as with stocks, increased participation in the fixed income market is also driven by foreign investor participation. At over 14%, Nigerian bond yields are attractive compared to foreign ones which trade for less than 7%. With a stable exchange rate backed by a strong external reserve, foreign investors can better calculate their exchange rate risk, giving them the comfort to invest more in the country.
Exchange rate market
The Nigerian economy is hugely dependent on the exchange rate. Being an import-dependent one, the exchange rate is typically a pass-through to the price of goods and services in the country. One of the reasons why the exchange rate has been stable over the last one year was the introduction of the Investor/Exporter Window introduced by the CBN.
This is a window that determines the exchange rate by relying on the forces of demand and supply. With the comfort of strong reserves, the CBN has a buffer to intervene in the IE window whenever there is a temporary liquidity squeeze. They can sell dollars whenever there is scarcity and buy if there is no one to buy. They can also sell forward contracts on the back a track record of growing external reserves.
Latest data from the National Bureau of Statistics estimates Nigeria’s import bill at about N9.5 trillion ($26 billion) in the whole of 2017. This means that we have enough for nearly two years.
We already mentioned that Nigeria is an import-dependent economy. To pay for imports, you need growing reserves. This gives export partners abroad the confidence to sell goods to Nigerian importers without having to worry for their payment. Traders can also hedge against exchange rate risk and pass that through to the price of their goods. This means that the prices of imported items can be stable over the short to medium term, thereby helping with planning.
Finally, an improved external reserve could also translate to better job security. It can also lead to increased hiring as companies get more bullish about the economy. The Purchasing Manager’s Index, which the CBN issues monthly, has risen for the twelfth consecutive month at 56.7%. This index measures how positive companies feel about the economy.
A rate higher than 50% is often viewed positively. The unemployment rate is still high in Nigeria; however, it is likely to stabilize soon and may trend lower in the coming months. To be certain, there is no direct link between improved reserves and the lower unemployment rate, however, economic behaviour suggests that there are chances of a positive correlation.