The Naira at Fair Value?

By Chinedu Okoye 

The Rollercoaster Ride:

The Naira has been on a rollercoaster ride in the past 8 weeks. In April it was the world's best performing currency given it's meteoric rise against the Greenback. 

But this strenght was short-lived as the Nigerian local currency reversed all its gains I May becoming the worst performing currency im the first two weeks.

Zero Equilibrium economists believe the Naira maybe at fair long-term value (assuming the independent variables affecting the currency remains unchanged). 

This opinion was forged from comparing and  contrasting views of Goldman Sachs and the Economic Intelligence Unit.

Back Story:

On March 20th, Zero Equilibrium made an assertion in response to conflicting takes on the Naira by Goldman Sachs and Economic Intelligence Unit (EIU), the former predicted am appreciation of the Naira to N1200/$1, and the latter suggested a fall from it's then value of N1560/$ to N2130/$. 

The N1200/$ prediction of the investment bank was technical in that we saw over 2 trillion Naira come into government securities, and as stated in our previous article, these FPIs drove the appreciation, as other Independent variables saw modest increases.

The EIU forecast was based on longer-term fundamentals. Inflation, high short term rates leading to costly FPIs, tepid oil output growth. And more recently a struggle to capture Diasporan remittances as it fell 6.8% recently. 

Our Analysts Forecast:

Givem the disparity in both institutional forecasts, and our understanding on their merits, we wrote that the Naira was to experience a N400/$ appreciation to N1200/$ level, and then depreciate N560/$ putting the long-term value at N1760/$1. 

On the back of this, and given that the monetary policy effects of the February MPC and the subsequent committee that saw MPR rise 400, and then 200 basis points, with the CRR adjusted on February meeting to 45%, we adjusted our initial  long-term fair value to N1500/$1.

Our Theory Behind the move:

On the way down, after the devaluation, the Naira slumped to record levels not seen before at a quick pace. This we attribute to the bottlenecks and inefficiencies in the FX markets as the Central Bank transitioned from a fixed and fragmented exchange rate system to a managed float.

Given that the Naira had previously been overvalued at both the official and parallel markets, the float and subsequent liberalization (lifting of the 43 item ban) of the markets, saw the Naira plunge as uncertainty gripped the market. 

The unpaid FX Forwards and other obligations significantly reduced the available reserves. This added downward pressures to the Nigerian local currency.

Central Bank Policy:

The system was in dire need of foreign exchange and credit arrangements were made with multilateral lenders (Afrexim Bank). The Central Bank also mopped up the excessive liquidity with increased rates and issuances of short-term government securities at attractive yields. This attracted foreign capital as over 70% of the subscription were from foreign Investors.

The backlogs were cleared and the financial system also saw modifications to policy framework especially in the forex segment, BDCs were fully incorporated and regulated, and the Naira traded on a willing buyer - willing seller model at the NAFEM Window. Official and P2P market rates also converged to below a 5% spread.

Naira then appreciated some 60% in the month of April making it the best performing currency against the Greenback. But this meteoric rise was short-lived as the dollar moved in the opposite direction against the currencies of African and US peer countries. 

The reserves fell with the appreciation due to FX obligations owed at the time and rose at the time of the more recent slump. This strongly indicates the Apex Bank's commitment to it's market determined rate stance, contrary to the opinion that the Bank was propping up the Naira with sales to BDCs. 

Naira' Fair Value, and Mean Reversion Characteristic:

The Naira had an accelerated rise from March to mid April as FX burdens from debts and inefficiencies were cleared out, this allowed for the FPI inflows to be reflected in the Naira exchange rate. 

The fall witnessed subsequently  could well be a normalization given that the USD fundamentals never supported a N1000/$ level. (Recall our above fair value call). Whether or not the Naira is at fair value (as we opined) within the N1200-N1000/$1 range remains to be seen. But the model of trading at the Official window gives Naira a mean reversion characteristics an as such as are closely studying daily rare moves. 

Subject to changes in fundamental factors, it remains our opinion that the Naira is within fair value range, and that despite fluctuations, the currency will revert back to its short-term mean. We are incorporating the 20 Day Moving Average into our Naira valuation models.