The Central Bank of Nigeria (CBN) announced a suspension of foreign exchange sales to members of the Association of Bureau De Change Operators of Nigeria (ABCON) yesterday. According to the apex monetary authority, the suspension was a response to ABCON’s request for market holidays in a bid to tame the spread of COVID-19 in Nigeria. In further justification of the action, the CBN explained that the COVID-19 induced shutdown of air and land borders across the globe has reduced the need for FX supply locally.
While we concur with CBN’s rationale for making this decision, we believe the apex bank may have acquiesced to ABCON’s request partly because of its weak capital buffers. These weakened buffers may have also driven the recent introduction of currency management measures such as naira devaluation across exchange rate windows, restriction of foreign currency transfers between domiciliary account holders, and the revision of spending and withdrawal limits on debit cards overseas by a number of banks. For us, foreign currency restrictions usually follow a steep decline in FX inflows, which is often catalyzed (in Nigeria’s context) by either a sharp drop in oil price and/or production irrespective of the primary trigger.
Direct from the 2016 playbook?
We can draw some parallels between recently enacted currency measures and the capital controls set in the 2015-2016 period prior to the huge devaluation of the naira about four years ago. In 2015, the CBN justified the capital controls as measures put in place to tackle inflation and stabilize the economy. The control measures included the publication of a list of 40 types of transactions that were made ineligible for foreign exchange access at the official market. Added to this, the CBN curtailed the use of FX-denominated Nigerian bank debit cards abroad in August 2015 and completely proscribed its use for overseas transactions in December 2015. By March 2016 (with the average oil price at $35/bbl), the CBN stopped foreign exchange transactions for payments for study abroad. Clearly, some recent policy measures appear pointedly similar to those enacted in the 2015-2016 period to conserve FX supply following the sharp decline in oil price and production. Whatever the justification, currency controls usually result in heightened speculation and greater divergence between exchange rates in the parallel/black market and those in more regulated windows. The chasm usually stems from greater demand in the parallel market as the exclusion/restriction of certain market participants, amid weak fundamentals, provokes panic buying in the segment.
Given the suspension of FX sales to ABCON, speculation is likely to drive rates across markets in coming weeks. Foreign investors have largely been on the sell side of both the domestic fixed income and equity markets amid lower oil prices and COVID-19 concerns. We believe the new capital controls are likely to further irk foreign market participants, who may also be forced to reprice naira risks. This suggests that the premium between Nigerian Eurobond and dollar FI instruments are likely to rise further in the coming months. This position is strengthened by S&P’s recent downgrade of Nigeria’s credit rating status to junk.