Goldman Sachs v EIU On the Value of the Naira



By Chinedu Okoye 



Summary:

- Conflicting views on Naira valuation prompt reevaluation.

- Investment Banks cite short-term stability; EIU predicts depreciation.

- Disparity suggests short-term appreciation, long-term depreciation.

- Zero Equilibrium economists foresee short-term boost, long-term decline.

- Fair value estimated at 1500/$1, subject to economic fundamental improvements; earlier stance adjusted to N1200/$1.






Background:

Earlier in the week, Bloomberg reported Goldman Sachs' valuation of the Naira, stating that it looks cheap and is set to appreciate. In the same vein, days later, reports from the Economic Intelligence Unit, a UK-based firm, made a strong argument for movement in the opposite direction.

The views are contrasting, to say the least, and prompted a revaluation from our October 2023 forecast for the Naira. The findings of the analysis are presented below, highlighting the rationale behind the contrasting views and a final summation of the intrinsic value of the Naira today. In our opinion, the Naira seems to be fairly valued at current levels.



Technical vs. Fundamental Viewpoints:

The Investment Banks consortium is using a technical view in their Naira forecasts. FPIs are incoming, and this has so far, in combination with other factors, provided short-term stability to the Naira. Short and medium-term FPIs are attractive to Foreign Investors, and an expected Federal Reserve rate cut would increase the sovereign spreads against the US sovereigns.

In taking advantage of these spreads, the currency might experience a boost, but this might be short-lived as uncertainties and liquidity issues persist. On the back of this, the Naira is not cheap, hence the EIU's contrasting forecast.

The EIU forecast of a depreciation to N2130/$1 levels is based on the fundamentals behind the Nigerian local currency.

High inflation; high short-term rates; deficits; low reserves (most of our reserves are tied to forward contracts); and forex backlogs (some paid, some yet to be paid), all point to a longer-term struggle for exchange rate stability.



Short and Longer-term Disparity:

With regards to currency trading and values, technicals are short-term looking, and fundamentals provide a longer-term view. This explains the contrasting views of investment banks such as Goldman's forecast for the Naira to appreciate to N1200/$1 and that of the EIU, which forecasts a further depreciation to N2130/$1.

A N930 discrepancy ensues, meaning the EIU expects a N560 fall against the Greenback, and the investment banks see a N400 appreciation. Both scenarios are possible, in that the Naira could appreciate within the N400/$1 range in the short-term and fall within the N560/$1 range in the long-term.



Blending Both Views:

The above is based on technicals and fundamentals around the Naira. Zero Equilibrium economists see a short-term bump and a longer-term slide of the Naira against the greenback. Assuming both scenarios are accurate, the Naira appreciates N400/$1 in the short-term and then depreciates N560 in the Long-term.

This puts the long-term view at N1760/$1. Taking into consideration the expected Fed Rate cuts and possible CBN rate hikes or holds (holding rates at 22.75% and CRR rate 45% produces a tightening effect of the Federal Reserve cuts rates). The Naira could still receive a boost based on rate differentials making Sovereigns and private financial assets attractive - based on rates alone.



Zero Equilibrium New Naira Valuation:

In light of the above contrasting views, we now put the fair value of the Naira at 1500/$1 (+/-N200), for the long-term, barring changes to the fundamentals like an increased reserve, lower inflation, and further elimination of backlogs.

These fundamentals guide the new long-term view and remain subject to review. We had earlier taken a stronger position at N1200, which tends to coincide with the forecasts of Goldman and Co. But the EIU report presents strong arguments based on fundamentals that are too glaring to ignore and continue to plague the local currency.

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