Implications of CBN’s Exchange Rate Unification – PFI Capital Limited

Culled—Porshare

July 13, 2020

PFI Capital Limited 

On Friday 3 June, it was reported that the CBN asked bidders in the SMIS window to increase their bidding price to N380/$ and it would not accept anything below it. On Tuesday 7th July, the CBN official rate was quoted at N381/$ at the FMDQ while the I&E FX window closed at N386.50/$ and the SMIS window closed at N380.69/$, indicating that the CBN has finally unified the official rate with the NAFEX rate. This also reflects devaluation of the Naira by 5.54% when compared with the previous official rate of N361/$. We recall our previous report on Crude oil and the Naira on 10th March where we explained that the CBN was likely to devalue the currency in 2020, while comparing the 2016 economic situation with the situation now. We also recall our follow up report titled “Is Another Adjustment to the Naira on the Way?” which we wrote on 12th May, explaining that we expected further devaluation of the currency away from the N361/$ majorly due to the adjustment on the forward rates. For now, we therefore expect no further devaluation (provided that the CBN provides the required liquidity needed at the market) as the gap between the two major windows (official and I&E) has been significantly narrowed. This unification rate is however less than our fair value estimate of N428.43/$ by -11.07%.

Proshare Nigeria Pvt. Ltd.

Source: CBN, PFI Capital Research 

One major implication of the unification is that the naira has been weakened and as such, the rate of exchange is now higher when compared to the previous rates. This tends to increase the prices of imported goods and services in the country. Nigerian citizens will therefore see increase in price of finished products whose raw materials are imported. The increase becomes aggravated for goods whose demand is relatively inelastic as income level is already low and costs as borne by the final consumers of these goods and services. On the aggregate level, this will translate to increase in the rate of inflation. So far in 2020, inflation rate has averaged 12.27% while it has grown from 12.13% in January to 12.40% in May.

Another implication of this new development is that firms holding dollar denominated debts will face increased debt repayments as the real value to be repaid will be higher when compared to before. This tends to raise their cost of production, and as such reduce their level of activities. We further note the report in the media that the Manufacturers Association of Nigeria (MAN) has launched an appeal with the CBN to exempt manufacturers who have outstanding debt to be paid to foreign suppliers of raw materials from Q2’19 till date, from the unified exchange rate. This is because if they are not exempted from the unified rate, it means the value of their debt would be increase.

For the government, the unification which is also devaluation is a boost in revenue as dollars will now be exchanged at higher naira rates. As such, we expect more inflows to come in for the government in form of higher revenue, which will also translate to increased Federal allocation to the three tiers of government on the basis of oil price hovering at the current range of $38/barrel and $43/barrel.

In terms of debt for the government, the unification of the exchange rates means that the government will now have to pay more to refinance its foreign debt obligations. In Q1’20, 99.22% of the FGN revenue was used in debt servicing and total external debt stock outstanding stood at N9.99 trillion during the same period (c.35% of total public debt portfolio).

Proshare Nigeria Pvt. Ltd.

Source: CBN, PFI Capital Research

In summary, while we view the unification to be positive on the revenue side, it tends to be negative on the debt and external sector activities. We however can only hope it will make export of goods and services to be competitive so as to reduce the level of trade deficit in the longrun.  

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