Nigeria’s Besieged Naira

Today, Nigeria’s naira is suffering from a triple-whammy; structural risks, the plunge of oil prices, and currency wars. When will things change for the better?

Only days before last Christmas, the plunging oil prices were exacting a painful toll on Nigeria as the central bank imposed new foreign-exchange controls aimed at stopping the 15% plunge in the naira in 2014. In turn, lower oil prices diffused into the Nigerian economy through multiple channels.

The impact on foreign exchange revenue and import financing has been the most obvious channel. Further, the plunge of oil prices is reflected in inflationary pressures, thanks to naira’s weakening. Similar adverse pressures have strained reserves and fiscal vulnerabilities.

The oil-naira symbiosis

The simple reality is that, after the global financial crisis, many emerging economies have deployed direct government intervention and capital controls for competitive devaluation, whereas advanced economies have achieved the same indirectly through low policy rates and quantitative easing (QE).

The plunging oil prices have harmed all oil exporters, but not equally. Those economies that have been most resilient to crude price decline encompass oil exporters that enjoy adequate fiscal and monetary space, flexible economies and diversified revenue sources.

Unfortunately, Nigeria is not one of these nations. It belongs to a group of economies that have high fiscal needs but limited monetary space; rely excessively on oil revenues fiscally and import financing, and lack diversified revenues; and that are haunted by structural risks.

A year ago, I warned about Nigeria’s increasing domestic threats and the far more challenging international environment. Despite its BRIC potential, the nation was facing political, fiscal, monetary, security, and energy price risks, which, taken together, would challenge the growth promise of Africa’s largest economy.

Not only have these risks materialized during the past year; they are converging. In turn, the deep nexus between plunging oil prices and weakening currency is fueling the adverse risks.

Where is naira’s floor?

In 2014, the currencies that weakened more than 15% against the rising U.S. dollar included the Russian ruble, several Latin American currencies, as well as the non-Eurozone Nordics (Norwegian and Swedish krone) – all of which weakened from 10% (Mexican peso) to 55% against the U.S. dollar (ruble).

In the case of Nigeria, the naira fell more than 15% against the dollar, which is comparable to the performance of the Colombian peso. But unlike Nigeria, Colombia has a current account deficit (-3.0%) but its oil accounts for over a half of exports and a sixth of government revenues – in Nigeria the two latter figures are far higher.

Recently, Nigeria’s senate voted to cut its benchmark expectation for oil prices in 2015 to $52 a barrel, from $65 in December. At the same time, the value of the naira was pegged to the U.S. dollar at 190, well below the previous target of 165.

While these changes may have been necessary, they will not be enough. Amidst the senators’ vote, Brent crude traded at about $59 per barrel, while a dollar amounted to 200 naira; about the same as today. So the actual price of the barrel was 5% and the real naira 10% less than the target price, respectively.

The ultimate question, of course, is how low the naira will go. That was the nightmare of the former CBN chief Lamido Sanusi who warned for years that there was only so much that he could do with monetary policy.

Like Japan, Western Europe and the United States, Nigeria has not moved fast enough toward structural reforms and pro-growth policies.

Even as the shale gas revolution took off in the U.S., Nigeria’s prime oil buyer, the red lights failed to blink; even though in the past half a decade, U.S. oil imports from Nigeria have plunged by more than 90%.

Currency wars déjà vu

As the U.S. is recovering but Europe and Japan are not, monetary divergence will broaden between the Fed’s impending hikes versus low rates and quantitative easing (QE) in Europe and Japan.

After half a decade of “hot money” inflows, emerging economies must tackle disruptive capital outflows, while commodity producers face additional headwinds, thanks to U.S. shale gas and the plunge of energy prices.

In this view, currency wars have barely begun, as exemplified by the interest rates in the advanced world. Before the crisis year of 2008, U.S. rate still exceeded 4%. That level is not likely to be restored until 2018-2020.

In the absence of structural reforms, stagnation in America, Europe and Japan are being contained by unsustainable leverage, historically low policy rates, and excessive quantitative easing. In the coming years, the emerging world, particularly energy-reliant exporters, will suffer the consequent “collateral damage.”

In Nigeria, it is not a cause for resignation but for structural reforms to finally end the dependency on oil revenues and to reform the industrial structure.

The original version was released by BusinessDay Nigeria on March 2, 2015