Nigeria's Economy in Limbo: Navigating Naira Stability, Political Tensions, and USD Liquidity Challenges

Nigeria's Economy: Stability or Stagnation?

As the Naira experiences a rare period of stability, one might think this is a sign of positive momentum in Nigeria's economy. But the reality is far more complex. Behind the scenes, the Central Bank of Nigeria (CBN) is grappling with unprecedented USD demand, fluctuating political pressures, and a delicate balancing act to maintain liquidity without depleting foreign reserves.

In our latest Nigeria Macro Update with Charlie Bird we dive deep into the recent tactics employed by the CBN, from the high-stakes Retail Dutch Auction System (RDAS) to the suspended Eurobond plans, and the simmering political landscape that could ignite further economic uncertainty.

The big question: Can Nigeria sustain this fragile stability, or are we on the brink of another economic upheaval?

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Over the past month, the Naira has experienced a rare period of stability. While the exchange rate remains elevated, one might assume that this stability would be welcomed by the Nigerian economy. The absence of volatility could suggest that no significant structural changes have occurred, and the political status quo persists. However, this assumption couldn’t be further from the truth. The past month has seen new tactics from the Central Bank of Nigeria (CBN), heightened political pressures, and high-profile interactions between the government and key stakeholders dominating the headlines.

Faced with systemic demand for U.S. dollars across Nigeria, the CBN acknowledged in early August the significant backlog of USD orders at local banks. NAFEM orders were accumulating daily, but the willing-buyer, willing-seller model predictably failed to meet this demand.

Throughout the year, the CBN has employed various tactics to inject USD into the economy, ranging from selling small amounts of USD to Bureau De Change (BDC) operators at rates 15% below market, to larger tranches directly to local banks. The former approach had minimal impact on market liquidity, and while it briefly supported the narrative of appreciation, its effectiveness waned over time. The latter approach saw local banks reselling the discounted USD in bulk to a select group of top clients, which again limited the broader impact as large enterprises absorbed the volume.

USD Injections via Dutch Auctions

The latest strategy was the Retail Dutch Auction System (RDAS) for local corporates with Form M/A documentation for NAFEM orders. The mechanics of this auction have been well-publicized: corporates submit blind bids to purchase USD at their desired rate, and the CBN decides how much USD to sell, clearing bids from the highest to lowest USD/NGN rate until the total amount offered is exhausted. Any remaining bids at lower rates are not fulfilled.

With both NAFEM and parallel market rates trading around 1600, corporates were faced with a risk-reward dilemma. Those with urgent USD needs could submit higher bids to increase the likelihood of securing USD in the auction, while those with less immediate needs might gamble on lower bids, hoping the CBN would disburse enough USD to clear those rates. Alternatively, corporates could deploy a "waterfall" strategy, placing bids across a range of rates to maximize their USD acquisition at the most favorable prices—a tactic often seen in bond auctions.

Speculation abounded regarding the amount of USD the CBN would offer and the lowest bid rate that would clear the auction, known as the cut-off rate. The RDAS represented a significant gamble for the CBN. If desperation for USD led to high bid volumes at rates well above 1600, the CBN would be faced with a difficult choice: clear the auction at rates significantly above the prevailing market rate, sending a potentially negative signal, or sell more USD than desired to drive clearing rates below 1600, encouraging appreciation.

Was the RDAS successful?

As it happened, the CBN surprised many by disbursing over $875 million in the auction, with disqualified bids largely coming from banks whose submissions were late, much to the frustration of their clients. Despite rumors that local banks were rejecting most client bids below 1500, the cut-off rate settled at 1495, with a weighted average clearing rate around 1530—well above market expectations.

However, with only about a week’s worth of NAFEM volume cleared in the RDAS, and both parallel and official rates holding steady post-auction, it quickly became evident that the NAFEM order backlog would soon rebuild. The CBN likely hoped for significant Naira appreciation following the auction, driven by those looking to sell their USD allocations for quick profits, but the systemic demand for USD far outstripped the supply offered in the auction.

Attention has now turned to whether the CBN will repeat this tactic. Rumors have circulated about RDAS becoming a weekly event, but as of this writing, this has not materialized. The limiting factor likely remains the foreign reserve levels available to the CBN. While net reserve levels are as opaque as ever, estimates suggest they are well below the approximately $35 billion reported by the CBN.

Sourcing Offshore USD

The CBN has explored various methods to quickly boost its USD reserves. Efforts to encourage International Money Transfer Operators (IMTOs) to sell USD directly to the CBN have been well-received, though the infrastructure for submitting FX requests and receiving Naira has been cumbersome at best, with modest volumes reported.

To target larger USD volumes, the CBN has suspended plans for a Eurobond issue in favor of a Domestic USD Bond sale. With a $2 billion notional on a 5-year tenor, the CBN hopes to attract participation from onshore and offshore Nigerians, including those with domiciliary accounts, diaspora remittances, and foreign investments. However, given that the secondary market for 2029 Eurobonds is yielding around 10-11%, enthusiasm for the domestic bond issue may be limited compared to a full Eurobond offering, which the CBN deemed too costly.

While a Eurobond issue remains a possibility in the future, the CBN may wait for inflation data to stabilize following last year’s FX reform and petrol subsidy removal. Although CPI data showed a decrease to 33.4% year-on-year in July, down from 34.2%, driven largely by food inflation, foreign investors are likely to demand a sustained downward trend in inflation before re-engaging.

Tightening Local Liquidity

On the local auction front, activity has slowed significantly. Open Market Operations (OMO), once a key tool for the CBN to tighten Naira liquidity, have seen no auctions since June, and recent auctions have cleared near-zero volume, effectively removing this tool from the CBN’s arsenal. T-bill auctions have also slowed to a monthly cadence, with clearing rates climbing from around 16% to over 20%, reflecting reduced foreign investor interest as domestic banks bid up local paper.

Over the past month, political pressures have mounted against the CBN tightening market liquidity further. Nigeria has shown resilience in the face of economic challenges, but tensions are beginning to fray, with organized protests emerging in recent weeks. While protests have long been a tail risk for President Tinubu, the recent successful protests in Kenya, which forced a reversal of an austere IMF-driven Finance Bill, have fueled unrest. Although protests have been concentrated in northern Nigeria, with a relatively muted response in Abuja and Lagos, the potential for widespread public dissent remains a significant risk. The situation is precarious, and the public is likely to demand material economic improvements sooner rather than later.

Sourcing Onshore USD

If the CBN can source sufficient USD to drive down the Naira exchange rate, it would undoubtedly be well-received across the nation. The recently proposed windfall tax on local banks' FX profits could contribute to this effort, but effective enforcement will be crucial. There continues to be significant friction within the banking system, including delays in local transfers and account balances, which the CBN must address with urgency.

Regarding USD liquidity moving offshore via imports, the ongoing dispute between industrial giant Dangote and the Nigerian government is a focal point. Following unmet contractual obligations, Dangote’s new refinery sought to capitalize on cheaper offshore crude prices, threatening the Nigerian National Petroleum Corporation’s (NNPC) domestic crude sales. In response, the government explored options ranging from formally prohibiting Dangote from sourcing offshore crude to offering Naira payment instead of USD for domestic crude purchases. As of now, existing agreements requiring Dangote to purchase domestic crude have been enforced from October 1st, representing a temporary win for the government that may have limited long-term impact.

In summary, the Nigerian economy remains in a state of limbo. While there are hopes for Naira appreciation, the 1600 level is increasingly becoming the new normal, with corporates begrudgingly accepting the pause in persistent depreciation. USD sales through new Dutch auctions offer a glimmer of hope, but they also strain the CBN’s (possibly dwindling) foreign reserves. Substantial foreign portfolio investment still seems distant, making the uptake of domestic USD bond issues critical for any future Eurobond issuance. Some are holding out for an IMF intervention, buoyed by the positive reception to last year’s FX reforms and fuel subsidy removal. However, with the political situation on a knife-edge, any austerity measures imposed by the IMF could quickly erode public support.