In a recent projection, global investment bank Morgan Stanley stated that the naira is expected to appreciate at the parallel market rate.
The bank stated this in a publication titled Nigeria Sovereign Credit Strategy “No Longer Pumped.”
The report suggests that as more flows are redirected through formal banking channels, the unit will experience appreciation in the near term, leading to a convergence between the Investors and Exporters (I&E) rate and the parallel market rate.
Before the foreign exchange (FX) adjustment that took place on Wednesday, the parallel market rate stood at N759 to the US dollar, indicating that this is the rate at which the currency should ideally be trading in the interbank market.
Currently, the one-month non-deliverable forward (NDF) contract is trading at N738 against the spot rate of N664, suggesting that the clearing level will be higher than the current spot level.
What Morgan Stanley is saying
While it is challenging to predict the exact settling point for a managed currency like the naira, Morgan Stanley expects that the currency will appreciate in the parallel market as more flows are channeled through formal banking channels. This convergence between the I&E rate and the parallel market is likely to be below the current unofficial level but higher than the current spot rate.
- “Prior to Wednesday’s FX adjustment, the parallel market rate was at 759, suggesting that this is where the currency ought to be trading in the interbank market. The 1m NDF is currently trading at 738 versus spot of 664, suggesting that the clearing level will be higher than the current spot level.”
- “While it’s difficult to be scientific about where the currency will truly settle for what has been a managed currency like the naira, we do expect that the unit will appreciate in the parallel market in the near term as more flows get redirected through the formal banking channels. Consequently, the convergence level between the I&E rate and the parallel market should be somewhere lower than the current unofficial level but higher than the current spot rate.”
Factors of appreciation
Morgan Stanley has attributed the naira’s recent appreciation to positive policy shocks and successive reforms in Nigeria. The removal of fuel subsidies and the FX adjustment have been significant drivers of the currency’s outperformance compared to other emerging market peers.
- The federal government’s decision to eliminate fuel subsidies has led to cost-reflective prices and a reduced burden on the fiscal balance. Additionally, the FX adjustment, despite the potential short-term challenges, is expected to contribute to a faster economic recovery.
- Morgan Stanley also indicated that the impact of the currency adjustment on inflation is expected to be limited, as most goods have already adjusted to the parallel market rate.
- However, the International Monetary Fund (IMF) has noted that a 15% currency adjustment would have a 0.93% impact on inflation by June 2024. With the current FX level surpassing this threshold, some inflationary pressure may be anticipated.
Goldman Sachs commentary
Goldman Sachs has, however, welcomed Nigeria’s new foreign exchange rate regime. The bank views the recent policy announcements as positive surprises, supporting a constructive view on Nigeria’s sovereign credit.
- On the flip side, it expressed doubts about the true intent of the policy and highlighted the need for higher local interest rates to attract more inflows and meet the significant pent-up demand for foreign exchange, estimated at $12 billion.
- The direction of Nigeria’s FX policy remains a key concern, as it is unclear whether the historically heavily managed currency regime will be maintained or if there will be a transition towards a more flexible exchange rate.
Goldman Sachs believes that any FX liberalization or easing of restrictions would require higher local interest rates to counteract depreciation pressure on the currency.
